Nifty has dropped below 5200 – what next?

In last Wednesday’s post - ‘Will the market crash if Nifty falls below 5200?’ – I had mentioned a worst case scenario of a drop to 4020, based on the theory of break outs from descending triangles. A more likely support level was mentioned as 4840 – the May ‘10 low.

I want to revise the support levels, based on the theory of supports and resistances – covered in my post of Sep 3 ‘09. Support levels usually coincide with previous tops on the way down, and resistance levels tend to occur at previous bottoms on the way up.

Resistances, when broken, become supports; supports, when broken, become resistances. Volume action during a break of support or resistance determines how strong that particular level is going to be in future. Since 4840 is a previous bottom, it is unlikely to act as a support and will probably be tested and broken.

So, where are the Nifty supports? Let us look at a longer-term bar chart (from May ‘09 till date):

Note that the 5200 level, which formed the bottom of the large descending triangle, was the resistance level for the tops in Oct ‘09 and Dec ‘09. After crossing above 5200 back in Jan ‘10, the index dropped to the support level of 4700 in Feb ‘10. 4700 was the resistance level for tops in Jun ‘09 and Aug ‘09. It once again acted as a support in May ‘10 – when the Nifty dropped to 4840.

Below 4700, the next support is at 4500 – which corresponds to the resistance level for tops in May ‘09 and Jul ‘09. It subsequently acted as a support in Oct ‘09. In other words, the zone between 4500 and 4700 should act as a good support for the Nifty, and can be used as a ‘buy’ zone with a strict stop-loss at 4350 (3% below 4500). However, the descending triangle target level of 4020 is not being ruled out as yet.

Now, a few words about what transpired in today’s trading.

Take a look at the volume bars for the last few day’s trading. The index pulled back to the pierced 5200 support level today, but closed a little lower on reduced volumes. Such pull backs are quite common after a break out, and is a good selling opportunity for those who missed out earlier.

Can the Nifty move back up inside the triangle? There are no rules in technical analysis that haven’t been broken – so it is a possibility. Even if it can climb back into the triangle, will the index be able to close the gap? Yes, but not any time soon.

The strong volumes on the downward break last Friday (Aug 5 ‘11), followed by two more down days on good volumes should make the 5200 level a strong resistance to any up moves in the near term. Note that the RSI and slow stochastic are yet to emerge from their oversold zones.

I’m not in the prediction business – but odds are favouring a test of the zone between 4500 and 4700.