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Thursday, April 8, 2010

What caused the 250 points drop in the Sensex today?

Can you envisage tomorrow's headlines in the pink papers analysing the 250 points drop in the Sensex? 'Greek tragedy causes Sensex slip'; or, 'Inflation up - Sensex down'; or something equally eye-catching and ridiculous.

Before you start scoffing at the headline writers, please remember that they have to earn their bread and butter by selling papers and not necessarily by educating investors. Fortunately, I'm not under any such compulsion. So my short answer is: Who cares?!

The fact is, Greece continues to face a sovereign debt problem which they were trying to mitigate through an issue of government bonds. Apparently that issue has fallen flat raising the spectre of a bail-out by other members of the EU or the IMF.

European indices started tanking mid-day and probably had a rub-off effect on our indices. Food inflation figures continue to rise, and that may lead to more monetary tightening by the RBI in the near future. Markets may have anticipated a rise in interest rates - which is considered negative for bulls.

But the real reason may not have anything to do with fundamentals and be purely technical. If the Sensex moves up 4 straight days in a row, one should not get surprised or worried by one down day. Such down days are good for the overall health of the market as it corrects potential overbought situations.

A quick look at some of the Sensex indicators show that the MFI, RSI and slow stochastic had entered their respective overbought zones after the Sensex crossed the 17250 level, and have since been oscillating in and out of the overbought zones for the past 10-12 trading sessions while the Sensex gradually moved up towards the 18000 level. All three indicators are showing negative divergence as they failed to make new tops when the Sensex moved above the 18000 level on an intra-day basis yesterday.

The FIIs have been buying relentlessly since the budget and of late the DIIs joined the bull party. Obviously, some amount of 'index management' is happening, and today's announcement of SAIL's divestment could be a reason for the buoyancy in the index. It almost seems that the Sensex wants to fall but isn't being allowed to do so.

What should you be doing as an investor? Focus on the 20 day EMA at 17500 and the 50 day EMA at 17150. If the Sensex falls below the 20 day EMA, treat it as a second warning of a bigger correction. (The first warning happened today, when the index fell below 17790 - its previous top made on Jan '10.) The third, and final warning will be if and when the Sensex dips below the 50 day EMA.

Of course, these warnings are not for selling out but for booking part profits, and on the assumption that you are invested in index funds/ETFs (or in stocks with high weightage in the Sensex). At all times, you should concentrate on your individual portfolios and set appropriate stop-losses.  


Jasi said...

A very brave post indeed, more than anything else. If there is anything that I have found the pink papers and the so called experts weak in, it is the reasoning behind market's falls. And trust me, the post you have written takes a lot of courage. Its like holding the bull by horns.
And I congratulate you for doing a pretty good job at that.
Thanks as always!

Subhankar said...

Appreciate for your comments, Jasi.