BSE Sensex Index Chart Pattern - Apr 23, '10

The BSE Sensex index chart pattern spent a volatile week which seemed particularly confusing for small investors - more so for those who are not yet familiar with basic technical analysis concepts. (Those who have been following this blog regularly may opt to skip reading the next few paragraphs.)

One of the easiest concepts to understand is stock market trends. It has been observed that markets tend to move in upward or downward trends - often called a 'bull market' or a 'bear market'. Some times the market is undecided and moves sideways. But eventually it will either start moving up or down.

It is imperative that investors have some idea about what the current market trend is, before jumping in feet first. A simple way to do that is to learn how to draw a trend line.

In an up trend, an upward sloping line is drawn to join the prominent and higher bottoms. In a down trend, a downward sloping trend line is drawn by joining the prominent and lower tops. Easy enough?

Now comes the interesting part. A 'break' of a trend line - i.e. a price chart falls below an up trend line (or rises above a down trend line) - means the end of the trend. Those favouring (or benefitting from) the existing trend - viz. bulls in an up trend and bears in a down trend - don't want to give up easily.

That is why we often see a 'pull back' to the trend line. That means, shortly after a trend line is broken, prices tend to go back or 'pull back' towards the trend line. During an up trend, a pull back gives an opportunity to sell. In a down trend, a pull back is an opportunity to buy.

Thanks for bearing with me through this trend line lecture. Its purpose will be apparent once we look at the one year bar chart pattern of the BSE Sensex index:-

An up trend line (2) has been drawn from the most recent low of 15652 made on Feb 8 '10. Last Friday, Apr 16 '10 this up trend line was broken, but not quite convincingly. On Monday, Apr 19 '10 the FIIs sold heavily - thanks to the Goldman Sachs fraud news. The Sensex dropped more than 300 points to a low of 17277, stopping short of the 50 day EMA, before recovering to close at 17401 losing 190 points.

FIIs turned net buyers during the rest of the week and the Sensex pulled back towards the trend line (2). Note that the earlier up trend line (1) drawn through the lows of July and October '09 was broken in Jan '10. The entire rally from the Feb '10 low has remained below the earlier trend line (1), which is a sign of weakness.

A bear may look at the MACD and use the opportunity of the current pull back to sell. A bull may look at the slow stochastic - which has bounced off the oversold zone, and the RSI - which has moved up to the 50% level, and conclude that this is a buying opportunity. Such opposing views make the stock market such an interesting and challenging place to invest in!

I prefer to remain neutral and fully invested as per my asset allocation plan. Why? Observant readers will note that since the early Sept '09 low of around 15300 to the recent high of 18000, the Sensex has moved in a sideways band of 2700 points.

Friday's close of 17694 is just 237 points above the Oct 20 '09 high of 17457. A 1.35% gain in 6 months. Cash sitting idle in a savings bank account gives better returns! Till a clear trend emerges, there is no point in taking sides.

In a bull market, such a long consolidation should eventually lead to an upward breakout. But one can never be certain about the stock market. In case the Sensex decides to go down - less than expected results from Reliance could act as a trigger - watch for support from the 50 day EMA. If that doesn't hold, the zone between the previous lows of 15300-15650 should provide support.

Bottomline? The chart pattern of the BSE Sensex index is in a sideways consolidation phase, and may remain in this phase for a while longer. A clear trend will emerge only on a break above 18500 or a break below 15300. Till either happens, be patient and stock specific. Keep tight stop losses. Don't make huge bets in 'cheap' stocks - it can be very harmful to your wealth.