Thursday, May 20, 2010

The Sensex has fallen 1500 points - is it time to buy?

The Sensex had hit its recent peak of 18048 on Apr 7 '10. It has since lost more than 1500 points in 6 weeks. That may sound like a big drop, but in percentage terms it is a 15% retracement of its 13 months long rise from 8000 to 18000.

What happened during the two previous corrections in Oct-Nov '09 and Jan-Feb '10? Let us look at them one by one.

The Sensex hit a high of 17493 on Oct 17 '09, followed by a sharp correction down to 15331 on Nov 3 '09. A drop of 2162 points in just over 2 weeks, that retraced 23% of the rise from 8000 to 17493.

It was a sharp fall, and the recovery was quick - which is typical chart pattern behaviour in bull markets. The next higher top of 17790 was made on Jan 6 '10 - within 3 months of the earlier top.

This time, the correction down to 15652 on Feb 8 '10 lasted more than a month. The drop of 2138 points retraced 22% of the rise from 8000 to 17790. The rise from the low of 15652 to the peak of 18048 took exactly 3 months.

A correction of around 20% is considered quite normal in a bull market. It helps to rectify overbought positions and brings in new money into the stock market at more attractive valuations.

If we try to seek a pattern - it is a human tendency to seek patterns where none may exist! - then we can conclude that this time around, the Sensex may also fall at least 2100 points and correct about 22%.

That means, we are looking at a probable downside target of 15800-15900. In last Tuesday's post, I had indicated that the index may receive good support from the 50 week EMA at 16000.

Since technical analysis is not a science, we work with approximate levels and not exact levels. We have a cluster of likely support levels here - 15652, (or let us say, 15700) which was the previous low; 15800-15900 as per our recent correction pattern; and 16000, where the 50 week EMA is.

The Sensex is still a good 500-800 points away, so while you may be ready to jump in, just a little patience may give you the chance to enter at lower levels. If you are one of those investors who missed the earlier rally from Mar '09 and was feeling left out, any level close to 16000 can be used to enter good stocks (preferably large cap).

The ongoing correction has lasted 6 weeks already and may continue for some more time. There is every possibility that we may see even lower levels, as mentioned in this post.

How will you know? Track the 50 day EMA and see if it is coming close to moving below the 200 day EMA. Breaking below the previous lows at 15652 and 15331 would be other indications.

At times like these, Mr Market plays a game of testing the investor's patience and will power. There is an old saying: the early bird catches the worm. The corollary to that proverb is: the early worm gets caught!


Jasi said...

ha ha ha ... i still cant control my laughter at ur last line. :)))
Subhankar sir, as always pretty interesting take at things.
Yea im also one of those who are wondering whether to attempt catching the falling knife ;)
Btw I was wondering, since you spoke of buying large caps, how do the dynamics pan out if someone intends to buy MFs and a good mix of largecap, midcap MFs?

Thanks as always!

Subhankar said...

Glad to note my message got across!

There are lots of levels mentioned in my recent Sensex posts - so that investors can watch whether the knife has stopped falling.

If you mean buying a DSPBR Top 100 or an HDFC Top 200 - by all means do so.