BSE Sensex Index Chart Pattern - Aug 07, '09

Before analysing the BSE Sensex index chart pattern, let us flash back a little. Regular readers of this blog may recall that I've been mentioning several bearish possibilities on the horizon, as the index kept making new highs.

A couple of my observations two weeks back were:

1. There is no doubt that the head-and-shoulders pattern had formed. Though the bulls managed to negate it, the underlying weakness that led to the pattern may not have gone away entirely.

2. If the Sensex does cross 15600 and goes to 16000 or so, and then turns back down and makes a low that is lower than 13220, we will get a higher high and a lower low. This would lead to a bearish 'broadening formation'.

During last week's discussion, I had mentioned 'that should the Sensex index fail to cross the 16043-16068 level convincingly and move down sharply again, the bear market from Jan '08 will technically still remain in force!'

Now a look at the 1 year bar chart pattern of the BSE Sensex index will clarify the relevance of the earlier observations:-

The bulls tried valiantly to push the BSE Sensex above the 16000 level. Four days in a row, the 16000 level acted as a stiff resistance. The BSE Sensex failed the final test of a new bull market - crossing the 61.8% Fibonacci retracement level of the entire bear market fall from the Jan '08 top. The bears saw their chance, took back control, and the Sensex shed 3.25% for the week.

A bearish 'broadening top' pattern is in the process of being formed. Such a pattern usually has five small reversals before a larger fall. We have almost a text-book example of the pattern on the BSE Sensex chart. The five reversals have been marked, and they occured on:

1. May 19 - 14930; 2. May 26 - 13525; 3. Jun 12 - 15600; 4. Jul 13 - 13220; 5. Aug 4 - 16002.

Such a formation is a distribution pattern, where the 'smart money' gets out and the 'weaker hands' (typically MFs and retail investors) jump in, trying not to miss the bus.

Volumes (unfortunately, not updated on the chart) tend to be uncertain, and price swings can be quite unpredictable. All the ingredients for the 'broadening top' are in place.

As with any chart pattern (and technical analysis), relying totally on it may not be wise. Past experience says that the low of 13220 (point 4 in chart) should get broken before one can be absolutely sure.

The index halted at its 20 day EMA. The next support is at the 50 day EMA. The final support will be at 13220 and the 200 day EMA. If all three supports fail, the Sensex will finally move down to partially or fully close the 'gap' made on May 18, '09.

The RSI has dropped from the overbought zone and is at its 50% level. The MACD is still positive and above its signal line, but moving down. The ROC is just in the positive zone but also moving down. The slow stochastic dropped from the overbought zone and is still above the 50% level, but the %K line is below the %D line.

Bottomline? The BSE Sensex index chart pattern looks like it is poised for a dreaded (or hoped for) major correction. Do not panic, or act in haste. Keep taking profits wherever available. Or, stay on the sidelines.