BSE Sensex Index Chart Pattern - Mar 19, '10

In last week's analysis, I had observed the bullishness in the technical indicators of the BSE Sensex index chart pattern and concluded that the Sensex could gain some more.

Relentless FII inflows propelled the Sensex briefly above the 17600 level on Friday - less than 200 points away from the Jan '10 high of 17790. The index closed the week at 17578 - its sixth straight higher close on a week-on-week basis.

Looks like it's game over for the bears, doesn't it? A look at the 6 months bar chart pattern of the BSE Sensex index reveals some dark clouds that could pour cold water on the bull fervour:-

It has been a one-way up move since the low of 15652 made on Feb 8 '10. All the three EMAs are moving up nicely with the index well above them. If the FIIs keep up their buying spree, the bears will get completely routed.

What about the dark clouds? Look at the volume bars. Except for a couple of big spikes, volumes have almost petered out. A sustainable bull rally requires strong volume pressure. This entire rally has been a tale of steadily decreasing volumes, which is technically suspect.

Next, the RSI. It is looking hugely overbought. Typically it reacts immediately after touching or entering the overbought zone. This time it is trying to play catch up with the slow stochastic, which has been inside the overbought zone for almost 3 weeks.

Next, the MACD which is rising and is above the signal line. But it is lower than the highs made in Sept and Oct '09, while the Sensex moved higher than its Sept and Oct '09 highs. Likewise, the MFI is also showing negative divergence.

So we have two indicators that are looking very overbought, and two that are showing negative divergence. Even if the previous high of 17790 is cleared, caution should be the watchword. If the previous high is not cleared, then the bulls may have a real problem on their hands.

A bearish double-top formation, with the two tops separated by nearly 3 months, could lead to a strong correction that could take the Sensex down to the 13500 level. There is no certainty that such a double-top will form - but investors need to be prepared for the eventuality.

The economy seems to be chugging along nicely, and growth is much better than that of the developed western economies. The advance tax numbers have been quite encouraging. But the inflation numbers are in double digits and the RBI took quick action to raise the repo and reverse repo rates to try and cool down any overheating.

Bottomline? The chart pattern of the BSE Sensex index is looking overbought. This bull rally has defied a wall of worries. Don't need to get out in a hurry. Stay invested but stay nimble. And most important of all, be patient.