NSE Nifty Index Chart Pattern – Sep 24, ‘10

Regular readers may be surprised by the title of this post. I have never written about the NSE Nifty 50 chart pattern for two main reasons:

1. For reasons best known to NSE authorities, the day’s opening level is taken to be the same as the previous day’s closing level; in other words, any upward or downward gaps at opening are not considered at all. Without ‘gap’ analysis – which forms an integral part of technical analysis - it is difficult to set upward or downward targets and figure out support and resistance levels.
2. My friend Nishit writes about the Nifty chart pattern on his blog regularly, and I didn’t see any point in duplication of efforts.

Of late, I have received several requests from readers to analyse the Nifty chart pattern in a similar way that I analyse the BSE Sensex index. With heightened interest and activity in the stock market as the indices approach their all time highs, it would be unfair on my part to ignore reader demands. After all, the blog is meant for readers’ benefit.

So, here is my maiden attempt at analysing the one year bar chart pattern of the NSE Nifty index:

The index had been consolidating in a slightly upward sloping channel with a width of about 600 points for the past one year, till it broke out on Sep 6, ‘10. Such a long consolidation period is invariably followed by a strong break-out in the direction of the index prior to entering the consolidation zone. In this case – upwards.

The minimum upward target for the breakout is the width of the trading channel added to the break out point. In this case, it is about 6150 (= 5550+600). This week, the Nifty has consolidated in a narrow rectangular band of 105 points (between 5932 and 6037).

Such narrow bands don’t give clear indications of the next move. It can go in either direction. Even an upward break out from this narrow band can be followed by a pullback. The Nifty is about 5% below the all-time high of 6357. It is better to be cautious near an all-time high – in spite of the fact that the FIIs don’t seem to be cautious at all.

They weren’t cautious in late 2007 either, and we all know how that played out! I’m not saying there will be a repeat performance of 2008. I believe in India’s growth story as much as the FIIs do – notwithstanding the sorry mess created by a few utterly incompetent and corrupt people ruining the Commonwealth Games preparations at Delhi.

But there are very good reasons for being cautious. Check the volume bars. In Jan ‘10, when the Nifty was at 5300 level, volumes were much stronger. The upward break-out earlier this month from the consolidation channel should have been on significantly higher volumes.

The Nifty is looking quite overbought. All three EMAs are rising and moving away from each other. The MACD is rising in positive territory and has created a big gap with its signal line. That could be the prelude to a dip. The OBV is tracking the index – no divergences. The RSI and slow stochastic are both in their overbought zones. The concern is the RSI, which rarely spends much time in overbought territory.

The bigger concern is the food inflation – which just refuses to go down. First, the excuse was last year’s poor monsoons. Then we heard that the base effect would kick in and inflation rate will drop. It didn’t. Now, the excuse is the floods in north India!

With the relentless flow of liquidity from the FIIs showing no signs of abating, inflation control may require further hikes in interest rates. The bunching together of IPOs has also started draining money away from the secondary market.

Bull markets are supposed to overcome a wall of worry – and that is what is happening right now, with retail participation at low levels. But bull markets are sustained by the occasional sharp corrections to restore the health and balance of the market. Without a nice dose of correction, attaining much higher levels above the all-time high will be difficult.

Bottomline? The chart pattern of the NSE Nifty index took a rest this week after reaching the 6000 level. A break below the week’s low of 5932 can take the Nifty down to the 20 day EMA at 5800 or the 50 day EMA and the top of the consolidation range at 5600. On the up side, the target remains the previous all-time high of 6357. Hold on to your existing portfolio with trailing stop-losses. Book partial profits to reallocate assets. Further buying should be done only on a correction of 10-15%.