In a post back in Sep ‘09, I had written about the four different types of gaps that form in stock and index chart patterns, and their implications. There is a common myth that gaps should get filled. While eventually most gaps do get filled, this is not a ‘rule’. Gaps can remain unfilled for months and years. Some times they get partially filled (as in Jul ‘09). On rare occasions, they do not get filled at all.
We can now see two distinct gaps – marked by light blue ovals and labelled GAP1 and GAP2 – on the one year BSE Sensex bar chart pattern below. What can be the implications of the two gaps?
BSE Sensex Index Chart
GAP1 is obviously a ‘breakaway’ gap. Why? Because it marked the break out below a prolonged descending triangle pattern. It was also accompanied by strong volumes. That means two things: 1) the break out wasn’t a ‘false’ one; 2) GAP1 may not get filled in a hurry, though it may get partially filled.
What about GAP2? Note that prior to forming the second gap on Fri. Aug 19 ‘11, the index spent about 9 trading sessions in a small rectangular consolidation zone. The gap was accompanied by strong volumes, which makes it another ‘breakaway’ gap. But we already have one ‘breakaway’ gap (GAP1).
Can GAP2 be a ‘runaway’ (or ‘measuring’) gap that marks the mid-point of a move? Unlikely, because ‘runaway’ gaps tend to form at the mid-point of almost straight line moves (up or down). This gap came after a brief consolidation.
Can it be an ‘exhaustion’ gap marking the end of the current down move? Anything is possible in the market – but ‘exhaustion’ gaps are rarely the next gap after a ‘breakaway’ gap.
The process of elimination leaves us with a ‘common’ or ‘area’ gap, which forms within a consolidation zone. That means, GAP2 will probably get filled soon. The Sensex may consolidate sideways between 16000 and 17300 for a while, and raise bullish hopes before resuming its southward journey. If GAP2 is not filled within the next two trading days, then the downward slide will continue.
Please remember that technical analysis deals with possibilities and probabilities – not certainties. There is no rule that says GAP2 can’t be a second ‘breakaway’ gap. It can also be a ‘runaway’ or ‘exhaustion’ gap. These are interesting times for chart pattern watchers, even though they may be painful for investors.
NSE Nifty 50 Index Chart
The Nifty 50 chart tested the May ‘10 intra-day low of 4786 when the index dropped to 4796 on Fri. Aug 19 ‘11. The strong volumes indicate bear dominance. There is stronger support at 4730, which corresponds to the Aug ‘09 top.
The technical indicators are looking very bearish, pointing to a deeper correction. The MACD is falling below its signal line, further into negative territory. The ROC is below its 10 day MA and also falling in negative territory. Both the RSI and the slow stochastic are inside their oversold zones.
There is a sliver of silver lining. The ROC, RSI and slow stochastic didn’t touch lower bottoms even though the Nifty dropped to a new 52 week low. The positive divergences could lead to an upward bounce to fill the gap between 4932 and 4894 formed last Friday. But any such upward bounce will be a selling opportunity.
July inflation figure came in a bit lower at 9.22. The June figure was 9.44. But the May figure was revised upwards from 9.06 to 9.56, so the market took the lower July figure with a pinch of salt. Another 25 bps rate hike in Sep ‘11 is a distinct possibility. Market experts made a song-and-dance that the current FII selling is only due to the continuing economic turmoil in USA and the Eurozone, and has no connection with India’s economic situation.
The fact is, our domestic situation is not very conducive for buying shares. Higher interest rates have trimmed corporate margins and slowed down growth. A series of scams have put much-needed economic reforms on the back-burner. The Anna Hazare anti-corruption agitation has struck a chord among the youth, and come as a ‘manna’ from heaven for the hitherto sidelined opposition parties. The government has pushed itself into a corner with its ham-handed treatment of the agitators, and is desperately trying to project a ‘zero tolerance to corruption’ approach.
To cut a long story short, the near-term outlook is uncertain; and investors hate uncertainty. No wonder FIIs are selling big time, and investors are flocking towards gold and gold ETFs as comparatively safer havens.
Bottomline? The BSE Sensex and NSE Nifty 50 index chart patterns are now in technically confirmed bear markets. You make money in a bear market by selling short and then buying back at lower prices. But this is a strategy suitable for experienced investors only. Newer entrants should sit out the correction.