The Sensex fell 120 points - is it time to hit the panic button?

Regular readers of this blog will not even think about hitting the panic button just because the Sensex fell 120 points. They would have heeded my recent advice about being prepared for a possible correction as the index approached the Jan '10 top.

Probably just routine profit booking after four straight up days. May be even an effort by bulls to trap the bears. Why? Because the FIIs were net buyers even today and market breadth was positive after several days. That means, index heavyweights were sold (e.g. Infosys, HDFC) which pushed the index down and stocks outside the index were bought.

However, the fact that the Sensex tested the Jan 6 '10 top of 17790 two days in a row and briefly crossed it to hit 17793 on Mar 29 '10 before retreating by 200 points could also be a sign that an intermediate top has been made. So the index could be heading down soon.

The advance-decline line is showing a huge divergence with the Nifty index (thanks to reader Sanjeev - who sent me the link to the chart at the icharts.in site):-

Note that during Sept and Oct '09 there was a wide divergence between the falling A-D line and the rising Nifty index which culminated in a sharp correction.

From Nov '09 to Feb '10, the Nifty index and the A-D line moved together in lock-step. Post the budget, the Nifty index has soared while the A-D line has plummeted. Such a situation is unlikely to continue much longer.

Investors can play this three ways:

1. Book profits and wait for the correction to re-enter. That will be the riskiest way.
2. Book partial profits to generate some cash that can be redeployed during the correction. Less risky.
3. Stay invested with strict stop-losses - say, around 5150 for the Nifty and 17200 for the Sensex. Of course, this assumes that you are invested in index funds or index ETFs.

For individual stocks, the stop-loss levels should be placed at the previous (lower) tops. If the Sensex resumes its rally, remember to maintain trailing stop-losses.

(If you don't understand how to set stop-loss levels or what is a trailing stop-loss, you should read my FREE investment eBook.)

Related Post

Why you should forget about the Sensex and Nifty and look at the Advance-Decline (A-D) line instead