Sensex at an equilibrium level

The Sensex and Nifty have paused their downfall as prices touched an area of equilibrium. Prices move only when supply and demand is out of balance, but stagnate at areas of equilibrium.

As the Sensex and Nifty have similar price action, we will focus on the Sensex. In November 2010, we had mentioned that the Sensex was reaching an area of resistance and it was time to establish short positions. Resistance in stock market speaks for price points where supply exceeds demand. We had also mentioned that the Sensex could fall all the way down to 18,000 more than a 2,000 points drop.

Since the Sensex hit its target and has been hovering around the 18,000 market for several days, we feel it’s time to take a fresh look at the market. The Sensex has a wide area of equilibrium between 15,900, and 17,500 which makes the next drop down difficult. Bears will have to do a lot of fighting to push the index down. The reason is simple. In an area of equilibrium, buyers and sellers are in balance, which means prices need not move.

Why do prices move? They move up due to lack of sellers and when prices move high enough it prompts sellers to sell. The reverse is true when prices move down. When there are enough buyers or sellers at a certain level, there is no reason for prices to move.

So why do we call the 15,900 to 17,500 an area of equilibrium? Since the middle of 2009 to the middle of 2010, for 11 months, the Sensex moved in that range. This is a clear indication that the level is an area of equilibrium. Only after it broke out of that area did the Sensex rally to flirt with it’s all-time high and collapse.

So how does one trade the market? We’d pick support and resistance levels on the smaller time frame charts to take positions. The best demand levels on the daily charts are at 16,500 and 15,950. The supply levels on the other hand are at 18,700 and 19,200.

Now, let us look at a traditional tool that several traders and investors use to look at the market — moving averages. The Sensex is below its 50-day and 200-day simple moving averages. This is considered a sign of bearishness. Additionally, for the first time since the bull market began in March 2009, we have the death cross. The last time the Sensex had the death cross was in March 2008 and we all know what happened after that. Strangely, this time around too, the death cross happened in March. The death cross is when the 50-day moving average crosses and falls below the 200-day moving average. This is considered an extremely bearish signal.

Even though the path is pointed down, the Sensex has to clear the area of equilibrium to fall further. And as we always say look at the demand and supply areas to buy and sell.

The author is based in Chicago and is the editor of www.capturetrends.com