BSE Sensex and NSE Nifty 50 Index Chart Patterns – Mar 25, ‘11

For the bulls, the Indian markets had one of the better weeks of trading in a long time. Both the BSE Sensex and Nifty 50 indices managed to close above the 200 day EMA after 2 months. I’m reminded of an old Billie Holiday song, which goes (with due apologies for the paraphrasing):

‘What a little FII buying can do, Wait a while, Till a little bear comes peepin’ through.’

Why am I even thinking of bears when India has just beaten Australia in the World Cup, and every one knows that the stock market goes up when India wins a cricket match? It is to inject a note of caution among the general sense of relief bordering on euphoria.

The chart patterns of the indices have serious bearish implications, though it isn’t certain that the bears will dominate once again.

BSE Sensex Index Chart

The calamity in Japan, rising inflation in India and anaemic growth of the economies in Europe and USA all seem to have been ‘discounted’ by the BSE Sensex, as a bout of FII buying propelled the index above both the 50 day and 200 day EMAs. Is the bear market over? The short answer is: Not yet. Some serious hurdles are on the way.

Last two month’s consolidation has been redrawn as a ‘flag’ pattern. Why the question mark? The consolidation has lasted 8 weeks, and flag patterns typically get completed within 4-5 weeks. The Sensex has been consolidating after correcting 18% (about 3800 points) from its Nov ‘10 peak of 21100, and flag patterns tend to occur in the middle of a move. If and when the Sensex breaks down below the flag, it can fall 3800 points.

Stock markets don’t move according to logic or arithmetic. But technical analysis enables us to be prepared for eventualities. As my tax lawyer likes to repeat: ‘Let us hope for the best, but prepare for the worst!’

The technical indicators are suggesting that the rally may continue. The MACD has moved above its signal line and is touching the ‘0’ line. The ROC has risen above its 10 day MA into positive territory. Both the RSI and slow stochastic are above their 50% levels and heading towards their overbought zones.

Note that the Sensex has reached a higher top during Mar ‘11, but the RSI and slow stochastic have not. This shows underlying weakness. There are likely resistances to the up move from the upper edge of the flag pattern, the support-resistance zone between 18950 – 19150, and the 5 months long down trend line connecting the Nov ‘10 and Jan ‘11 tops.

Nifty 50 Index Chart

Rising volumes during the week suggest that the rally has buying support – which is corroborated by the FII data. The question is: how much of the buying is due to short covering? Note that during the past 2 months volumes have receded during the flag pattern formation – as it should. But down day volumes were higher than up day volumes, which signifies distribution. The Nifty has corrected 1160 points from its Nov ‘10 peak. Any break down below the flag pattern can see another drop of 1160 points.

But it is not all doom and gloom. The fact that the Nifty has closed above the 200 day EMA after 2 months is a bullish sign. If the 50 day EMA is able to cross above the 200 day EMA, the bulls will regain control. Till then, we have to wait for the Nifty to breach the support-resistance zone between 5685 – 5755 and a convincing break out above the flag pattern. (The 5755 level just happens to be the 50% Fibonacci retracement level of the fall from the Nov ‘10 peak of 6338 to the Feb ‘11 trough of 5178.)

The approach of the RBI to hike interest rates in small steps in an effort to balance growth and inflation doesn’t seem to be working. Inflation continues to rise, and a bolder approach is necessary, even if it hurts growth in the near term. Oil price above the $100 mark is not helping matters. All eyes will now be on the Q4 results to determine the market direction.

Bottomline? The chart patterns of the BSE Sensex and Nifty 50 indices are showing signs of coming out of a 5 months long correction. A few more hurdles need to be crossed before the bulls can regain control. Accumulate slowly, and maintain strict stop-losses.