BSE Sensex Index Chart Pattern – Aug 27, '10

In last week’s analysis of the BSE Sensex index chart pattern, the short-term daily chart showed a break out above a narrow trading range. But the longer-term weekly chart did not technically confirm a break out above the year-long upward sloping consolidation channel.

The negative divergences in the MACD and RSI were warning signs of a possible change of direction for the Sensex. So, did the lack of technical confirmation for a break out and the negative divergences cause the correction?

Or, was it the statement by Mohamed El-Erian of PIMCO that economic data coming out of the USA was signalling that the economic recovery was losing momentum, which caused the FIIs to start selling? May be it was the opinion by Mark Mobius of Templeton that the slew of IPOs diverted money away from the secondary market.

Could it be that the watering down of the direct taxes proposals didn’t go down too well with the market? Or, was it the the fear of untamed inflation leading to higher interest rates? May be it was some, or all, of the reasons mentioned above.

Whatever be the reason(s), the one year bar chart pattern of the BSE Sensex index shows the start of a corrective move:

The about-turn from the top of the year-long upward-sloping channel halted for two days at the rising 20 day EMA, but Friday (Aug 27, ‘10) saw the index seeking support from the 50 day EMA.

Couple of observations worth noting. In Jan ‘10, the initial correction halted at the 20 day EMA, and bounced up before falling all the way down to the lower end of the trading channel. In Apr ‘10, the initial correction halted briefly at the 20 day EMA, fell to the 50 day EMA, then bounced up before falling to the bottom of the channel.

Can a similar pattern be expected this time? The efficacy of technical analysis is dependent on repeating patterns. Unfortunately, patterns don’t always repeat, and almost never in an identical fashion. For those trading the channel, any bounce up can provide profit booking opportunities.

The weaknesses in the technical indicators may preclude such an upward bounce. The MACD is positive, but below the signal line. The ROC has dipped into negative territory. The RSI and slow stochastic are below their 50% levels and falling rapidly. The MACD, ROC, and RSI are showing negative divergences.

On the down side, expect support at the 200 day EMA (17100) and the lower end of the trading channel (16300). Any break below the 200 day EMA will be the first warning of a change of trend from bull market to bear market. A break below 16300, should it happen, will herald a bear phase.

Bottomline? The chart pattern of the BSE Sensex index is showing the signs of a deeper correction after a 3 months long bull rally. Corrections in a bull market are healthy and provide the necessary impetus for making new highs. No need to panic. At the same time, book profits if your trailing stop-losses are hit – and watch the FII trading data closely.