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Slope is disturbing

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Devangshu Datta New Delhi
Last Updated : Feb 06 2013 | 8:07 AM IST
The market has reacted strongly enough to trigger fears that this is a serious downtrend.
 
The market has reacted after hitting new highs. This in itself is not surprising. But it has broken several key supports and reacted strongly enough to trigger fears that this is a serious downtrend.
 
Is this the end of the party? In the following, we try to establish some technical parameters that could give traders a perspective on how long the downtrend may last; the depth to which the market could react; and the likely behaviour when it does start moving up again. We've used the Nifty as the benchmark; as the broader index, it's more representative of sentiment than the more popularly-followed Sensex.
 
History: The market hit an all-time high on March 9 at Nifty 2183 and reached the same levels again on March 11 creating a bearish double-top. Since then, the reaction to an intra-day low of 2007 on last Thursday means that there's been a loss of 8 per cent in 8 sessions.
 
The steep slope is disturbing and there is also the fact that supports at 2150, 2125, 2100, 2050 and 2025 have been successively and effortlessly breached. Volume has also expanded along with the downside breakout, which is another bad signal. Supply actually increasing in a downtrend suggests that people are starting to panic.
 
Diagnosis: This is a strong intermediate downtrend - it's been in force for two weeks and intermediate trends can stay alive for anything from three-four weeks to 12 weeks. So be geared for some more net losses. We don't know right now if this is a long-term trend reversal and if the bull market that started in June 2004 is still alive.
 
For our purposes, we are considering the phase between late May 2004 (bottom at 1292) and March 11 (top 2184) as the major bull-market. Other technical analysts may choose to treat this entire nine-month phase as just part of a long-term bull market, which began in May 2003 (at a bottom of 930). That would yield different results but it's a valid approach and 'theoretically' more correct.
 
I have chosen the shorter period simply because I suspect the average Smart Investor reader trades in short time-frames (an even more short-term approach would be to consider only the phase since January 2005). Furthermore, I would prefer to ignore the panic bottom of 1292 for the purpose of retracement calculations.
 
That bottom was a wild over-reaction, it was followed by a very sharp pullback and it distorts all calculations. I've chosen to treat the consolidation through June 2004 at a base of roughly 1435 as the bottom for the purpose of the following Fibonacci calculations.
 
Targets: In terms of chart formations, the market is likely to continue down to at least the 1965 level or the 1925 levels it reached in mid/late January 2005. In terms of time, we should see net losses for another couple of weeks at least, maybe more.
 
However, there could be a temporary easing upwards next week because we have already hit an important Fibonacci support level. In terms of Fibonacci retracements, a dip to 1950 would be a 31.8 per cent retracement of the upmove between 1435 (June 2004) and 2183 (March 2005). On Thursday, we hit the first (23 per cent) Fibonacci retracement mark almost exactly at around 2110. The 50 per cent retracement level is at about 1800 and a 61.8 per cent retracement is at 1720.
 
Key cut off @ 1900: We would set the 1900 lows of January as a practical cut-off point - that's where the current exponential 200 DMA value stands. If the market closes twice below 1900, this downtrend is very likely the first move in a long-term bear market.
 
Reactions inside Indian bull-markets rarely force prices down more than 32 per cent. Bear-markets always lose more than 32 per cent. If the market holds above 1900, the chances are that this is just a strong powerful reaction and the bull market is actually alive. The rest of the analysis depends on whether the cut-off point is penetrated or not.
 
Reversals
    Case A - Bull market stays alive: If the market holds above the 1900-mark, assume that the bull-market is still alive. In that case, the highs of 2184 should be exceeded within the next 6 months at most. The market will consolidate around 1950 in mid-April and then start to move upwards again, hitting 2100 by mid-late May. In this case, there will probably be new record highs by September 2005.


 
Case B - New bear market: If the 1900 mark is broken, we're probably in a long-term bear market, which means that the 2184 mark won't be hit again in a hurry. In that case, the best we can do is hope to trade up and sell on the occasional rally while watching prices drift downwards in general. In this case, we expect the intermediate downtrend to end in late April. It will be followed by a bear-market rally that maxes out around 2125 in early June 2005. That will be followed by more decline and successively lower bottoms until support at 1700 level is reached. The 1700 point is where we would expect a serious bear-market to bottom out although it's possible that it may dip even further.

 
Sectors: In terms of sectors, the FMCGs appear the best bets in terms of being counter-cyclical defensive performers. The BSE FMCG Index is already heading upwards and it's almost caught up with the Nifty in the last week. The worst hit sector seems to be auto-stocks (perhaps because of perceptions that fuel price increases will badly impact sales). The other badly-hit sector is banking and finance, which has performed very badly in the past week relative to the bearish market. There are also signs that IT stocks could underperform through the next two-three weeks but this isn't a pukka trend yet.

 
In terms of market cap, any bearish phase leads to a thinning out of interest in smaller stocks; the penny stocks and mid-sizers, which have produced such marvellous returns over the last year could now see drastic erosion in value and liquidity. Stick with large stocks and build FMCG hedges for protection until the bearishness is clearly over if you prefer being long. If you're interested in short positions, concentrate on auto, banking and IT shares.
 
In terms of derivative positions, it seems very likely that most bear-spreads and short futures positions will pay off until mid-April at least. In May, we should see a rally of some kind, regardless of whether it's followed by another downtrend or a sustainable rise. It's impossible to be more specific until this downtrend finally ends and a clear support level is established. Only then will it be possible to make long-term projections with a certain amount of confidence.

 
 

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First Published: Mar 28 2005 | 12:00 AM IST

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