BSE Sensex Index Chart Pattern – Sep 09, '10

In last week’s analysis of the BSE Sensex index chart pattern, subtle differences in the RSI and slow stochastic were observed when comparing the Apr ‘10 and Sep ‘10 patterns. I concluded that the likelihood of a correction down to the lower end of the upward sloping trading channel was diminishing.

In a week shortened by the Eid holiday, the Sensex tested the upper end of the trading channel on Mon. Sep 6 ‘10 and then gradually moved above it during the next three days on the back of FII buying. The index closed the week at 18800 – 1.75% higher than the Aug ‘10 top of 18475.

Why is that relevant? Well, technically a breach of the previous top should exceed the 3% ‘whipsaw’ lee-way. Till the level of 19030 is crossed, the Sensex will remain vulnerable to a pullback towards the year long trading channel.

Is the Sensex on its way to test the all time high of 21200, or is it now poised for the correction that every one has been hoping for? Let us look for clues in the 6 months bar chart pattern of the BSE Sensex index: 

All the three EMAs are moving up, and the Sensex is moving higher above the EMAs – a clear sign of a strong bull market. In May ‘10, the Sensex had dipped below the 200 day EMA for a day, only to jump back above the long-term moving average the very next day. That was at the end of the Apr-May ‘10 correction.

The Jun ‘10 top fell just short of the 18000 mark, but was accompanied by good volumes. Note that the previous peaks of all the four technical indicators were touched in Jun ‘10 – within a few days of the Sensex top.

The Sensex has steadily moved up, making higher tops in Jul, Aug and Sep ‘10. Now check the technical indicators. They are looking bullish, but instead of reaching higher tops, they have made lower ones. Also check the volumes – which have drifted down, and on some of the down days have been quite strong.

The negative divergences in the technical indicators and the receding volumes may lead to the much expected correction. However, the way any drop in the index – even on an intra day basis - is attracting buying means that a correction may not drag the index down very far.

Seems that only the FIIs are convinced about India’s growth story. The DIIs have been selling mainly because investors have been redeeming their fund units. Anecdotal evidence, and a recent discussion with a broker friend indicate that many investors have booked profits and are sitting on the cash, waiting for a correction to re-enter.

The FII buying may continue to propel the Sensex upwards, but at some point they will realise that valuations are beginning to get stretched. Higher inflation and higher industrial production is likely to force the RBI’s hands into raising interest rates. A slew of planned IPOs can suck out a lot of the money flowing into the secondary market.

Bottomline? The chart pattern of the BSE Sensex index is making new highs on FII inflows. Stay invested with trailing stop-losses and enjoy the ride. Part profit booking is always a good idea near a market top. But there is no need to be pessimistic. There is no euphoria of the end-2007 kind. If you are one of those who missed this rally, miss it some more. Enter only after a 10-15% correction – if and when it happens. Look for value in individual stocks.