Sensex reloading for a 3,700 point charge

India’s leading stock market index — Sensex — is refuelling for a 3,700 point move in the near future. The direction of the index depends on the direction of the break from a consolidation pattern.

The Nifty will also move with the Sensex as both the indexes have similar chart patterns. In November last year, when the markets hit their previous highs from 2008, we had recommended that longs take their profits and aggressive bears initiate short positions. The downside target on the Sensex was 18,000, when the index was at 21,000.

After hitting it’s peak in November last year, the Sensex hit the target we had mentioned and went down to 17,500 level. However, since touching the peak, the index has moved in a consolidation pattern called a symmetrical triangle. In a symmetrical triangle, price moves in a continuously narrowing range as buyers and sellers battle to give market direction, but fail. The narrowing range forms a symmetrical triangle when we connect the peaks and valleys in price.

Once prices break out of the triangle they usually have explosive moves. Right now the Sensex is stuck in the triangle as shown in the graph. If the index closes outside the triangle on the downside, prices will head lower. On the other hand, a close above the triangle’s borders will take prices higher. Long-term traders tend to avoid asset classes moving inside a symmetrical triangle. They take positions only after prices close outside the triangle.

When prices are moving inside the triangle, professional traders consider the asset class to be refuelling for the next strong move. Since in a symmetrical triangle the direction of the move is not predicted with a high degree of certainty, it’s best to wait for prices to close outside the triangle before taking a position. However, the text books state that symmetrical triangles are continuation patterns. This means the Sensex will continue its upward momentum.

But one thing the text books don’t talk about is the location of the symmetrical triangle. Just like the value of square foot of land is much higher in Nariman Point than in the suburbs of Mumbai, so is the location of the triangle. Since the Sensex is near its previous high, a strong resistance area, the likelihood of continued rally from the symmetrical triangle is low. However, had the symmetrical triangle been near 12,000 with prices rising from 8,000 the rally would have continued.

How far the Sensex can go after a break from the triangle is estimated by the measured move. The measured move is the distance between the second touch in the triangle and the trendline on the opposite side. In case of the Sensex, the measured move is a little above 3,700 points. Once the Sensex breaks out of the triangle, 3,700 points is applied at the point of break to estimate the target. For instance, if the Sensex breaks below at 18,000, then 3,700 is subtracted to arrive at a target of 14,300. On the other hand, a break above 19,000 can take the Sensex to a new high of 22,700.

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