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Saturday, June 19, 2010

BSE Sensex Index Chart Pattern - Jun 18, '10

Last week, I had mentioned the possibility of the up move in the BSE Sensex index chart pattern facing resistance from the 50 day EMA and the 17400 level. I had also cautioned that if the FIIs continued their buying spree, the Sensex may go past the 17400 level to test the top of 18048.

During the month of May '10, the FIIs were net sellers while the DIIs were net buyers, as the Sensex corrected more than 2000 points from 18048 down to 15960. This month, the roles have reversed. The FIIs have turned net buyers and the DIIs have resorted to selling, and the index has so far retraced 84% of the fall.

In last Thursday's post, I had written that once the Sensex nears the Jan '10 top of 17790, bears may start selling and bulls may strengthen their hands by booking profits after the sharp rally. That could lead to the formation of a bearish 'head and shoulders' pattern on the chart.

The 'head and shoulders' pattern has not formed yet - and may not form at all - but at this stage, being aware of a possible change of trend may save investors from incurring losses. Let us look at the 6 months bar chart pattern of the BSE Sensex index:


Two long-term support-resistance lines have been drawn at 17400 and 17800. Note that the sharp rally from the recent low of 15960 has quite easily overcome likely resistance from the down trend line, the 50 day MA and the 17400 level.

On Friday, Jun 18 '10, the index made an intra-day high of 17723, but closed much lower at 17571 - forming a 'reversal day' pattern (higher high, lower close). The hesitation near the Jan '10 top of 17790 was along expected lines.

If the 'head and shoulders' pattern does form - with the left shoulder marked 'S' formed in Jan '10 and the head marked 'H' formed in Apr '10 - then the Sensex is now in the midst of forming the right shoulder. The up-sloping 'neck line' of the 'head and shoulders' pattern connects the two recent lows of 15652 and 15960. The down side target from such a pattern is around 13500.

Observant readers may have noticed that 'head and shoulders' like patterns visible in the MACD and RSI indicators as well. The RSI is also showing negative divergence. Technically, that makes a pretty strong bear case.

But the index is above the 50 day and 200 day MAs; the MACD is positive and above the signal line; the slow stochastic is well inside the overbought zone and volumes have picked up in the past few days - so the bulls have no reason to retreat.

If the Sensex moves above 17800, it is likely to face resistance from the previous top of 18048. That could create a bearish 'double top' pattern with the valley point at 15960 (in-between the two peaks). The down side target from such a 'double top' pattern - if it forms - is around 13900.

There is a fundamental reason to be cautious as well. It is the rate of inflation - which does not seem to be coming under control despite the best hopes and sound-bytes from the country's economics wizards. Inflation by itself is not a bearish indicator. But if interest rates are hiked to control inflation, that would be bearish.

Is the bull party coming to an end, finally? I wouldn't count the bulls out - specially when they are in the current garb of FIIs with deep pockets.

Volumes play an important secondary role in chart pattern formation. Volumes are supposed to be lower during the formation of the right shoulder of a 'head and shoulders' pattern or the second peak in a 'double top' pattern. The current trading volumes can't be called 'low'.

Can a surge of buying by the FIIs take the Sensex past 18048? Sure it can. There is long-term resistance between 18500 and 19000. Buying now means an upside of about 6% and a possible downside of 20%.

Bottomline? The chart pattern of the BSE Sensex index appears to be in the midst of forming one of two bearish trend reversal patterns. As in life, there are no certainties in technical analysis. Investors must take their own decisions. I am just sitting back, and waiting for the dividend cheques to roll in.

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