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Tuesday, May 18, 2010

More support zones for the BSE Sensex chart

In last Saturday's post, I had marked the 16700 and 17400 levels on the daily chart of the BSE Sensex. That is the band within which the index may spend some time before deciding the next direction, which is likely to be down.

The 16700 level has been breached twice already on intra-day basis, but the Sensex is yet to close below it. The bulls are defending the level well so far.

On the weekly Sensex chart, I had marked longer-term support levels at 15700, and the gap area between 13200 and 12300. Does that mean that if 15700 is breached that the Sensex will fall by 2500 points down to 13200?

The answer is a definite 'may be'. Some more longer-term support-resistance levels were marked on the Sensex chart in a post on May 6 '10. Investors would do well to make a note of those index levels as possible buy/sell areas.

But there are some other important levels also - particularly the 50 week EMA (roughly corresponding to the 200 day EMA on a daily chart) drawn on the BSE Sensex weekly chart below:

SENSEX_18m_weekly_May1810

Why is the 50 week EMA important? It is used in technical analysis as a trend decider - above it is a bull market and below it is a bear market. Note that the 50 week EMA is still rising with the index above it and is currently at the 16000 level. It should provide very good support and bears will need to work hard before the Sensex can fall below to the 15700 level.

Some readers have asked how likely is it that the Sensex will fall to some of the other levels mentioned. The answer lies in previous bull market corrections - and we haven't had a proper bull market correction since the rally began.

The rally started from the 8000 level in Mar '09 and hit its high at 18048 in Apr '10. A total rise of 10000 points. A typical bull market correction corrects about 20% of the entire rise. That gives a 2000 points drop from the peak - which coincides with the 50 week EMA at 16000! That means the 16000 level may get tested soon but may not be breached that easily.

What about lower levels - how likely are they? Now we need to look at Fibonacci retracement levels - of 38.2% and 50% - of the bull rally. A 38.2% retracement means a level of 14200 (= 18000-3820), which coincides with a longer-term support-resistance level mentioned in the post of May 6 '10.

A 50% Fibonacci retracement will drop the Sensex inside the gap area at 13000. Can the Sensex fall even lower? I'm afraid the answer is 'yes'. Upto a 61.8% Fibonacci retracement is allowed in technical analysis without violating the bull market - which means a level of 11800 that will completely fill the gap area in the Sensex.

Please remember that gap areas in chart patterns eventually get filled. The probability of a drop below 12000 may be low - but it is not an impossibility. I would much rather have the gap filled sooner, rather than later - after the Sensex goes higher to 30000!

Investors need to monitor the trading pattern of the FIIs - they have been net sellers this month, and may continue to pull out if the dollar stays strong. Also keep an eye on fundamentally good stocks that are showing resilience while the Sensex falters. Those will be the ones to pick when the tide turns.

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