BSE Sensex and NSE Nifty 50 Index Chart Patterns – May 20, ‘11

In last week’s analysis of the chart patterns of BSE Sensex and NSE Nifty 50 indices, I had observed bearish ‘flag’ patterns from which downside breakouts were expected. Possible lower targets were also mentioned for both indices.

The downward breakouts occurred on Tue. May 17 ‘11, but by the end of the week, both indices pulled back to the lower edge of the ‘flag’ patterns. Both Sensex and Nifty closed lower by a bit more than 1% on a weekly basis.

Are the pullbacks good opportunities to sell, or is there a possibility that the downward breakouts were ‘false’ providing decent entry points? The doubt arises because we are dealing with indices comprising several stocks, and, except for ‘black swan’ events, all the stocks comprising a market index are unlikely to move in unison. Even stocks from a sectoral index don’t necessarily move in lock-step.

BSE Sensex Index Chart

To reinforce the point mentioned above, I had a quick look at the charts of 30 stocks that comprise the Sensex, and the findings were interesting. 11 of the 30 had formed bearish flag patterns, of which 5 haven’t broken downwards yet, and 2 are showing signs of turning the flag into an upward sloping channel.

8 stocks are consolidating within triangle patterns. 6 are trading within downward sloping channels. 5 are trading within upward sloping channels. 20 stocks are trading below their 200 day EMAs and 10 are trading above their long-term moving averages.

Since each stock has a different weightage in the index, the net result is the ‘flag’ pattern on the Sensex. The downward target of 16800 may not be met. More realistic targets may be the long-term support level of 17600, and the Feb ‘11 low of 17300.

The technical indicators are bearish, which means the down move should resume next week. The MACD is negative and below the signal line. The ROC is also negative, though above its 10 day MA. The RSI has emerged from its oversold zone, but is below the 50% level. The slow stochastic is still in its oversold zone.

Nifty 50 Index Chart

Bulls may feel encouraged by the uptick in volumes on the last day of the week, when the Nifty pulled back to the flag pattern. In fact, Friday’s volume was the highest during the week. Moderation in the inflation rate – thanks more to the base effect, and encouraging Q4 results from heavyweights like L&T and ITC may further boost bullish hopes. A well-known fund manager expects the market to start moving up after a month.

The bears are in no mood to relent yet. The down trend line from the Nov ‘10 top is holding firm. The technical indicators are all looking bearish. Impending price hikes in diesel and LPG will worsen inflation – and lead to another couple of rounds of interest rate hikes by the RBI. To cap it all, the FIIs have been net sellers through the past week. It was DII buying that caused last Friday’s price spurt.

With oil and commodity prices showing signs of easing, and the Indian economy on a growth path, equity valuations may start to look more attractive over the next couple of quarters. We are close to the peak of the interest rate cycle, and markets tend to rally before interest rates hit their peak.

There is another reason for bulls to feel encouraged. It has been observed that time-wise, bear phases continue for a period which is a third or a fourth of the previous bull phase. The previous bull phase – from Mar ‘09 to Nov ‘10 – consumed 20 months. A fourth means 5 months (which has elapsed already) and a third means 6 months and 20 days. If this ‘thumb rule’ holds, then we are pretty close to the end of this particular bear phase.

Bottomline? The BSE Sensex and Nifty 50 index chart patterns continue to struggle in strong bear grips. The ‘death cross’ of the 50 day EMAs below the 200 day EMAs is imminent. Further down moves are possible, and investors should closely watch the Sensex support zone between 17300 – 17600 and the Nifty 50 support zone between 5200 – 5300. This is a good time to stay on the sidelines and research individual stocks.