Technically Speaking

The support for the SENSEX at 14,677 and the possible double bottom formation we were looking at has broken in the wake of the surprisingly big jump in inflation. It has been obvious for months that official inflation numbers were not giving a true reflection of what was actually happening but even the highest forecasts were around 50 basis points off the 11.05 percent reported for the 12-months to June 7. It wasn’t that long ago that many pundits were saying the repo rate would not have to be raised so we are facing a situation now that many investors both onshore and offshore did not expect only a short while ago.
So support has broken and thus the longer term picture has clouded. The 14,677 level was key and all the short-term technical indicators I’ve been looking at are bearish under the rules of the various studies.
These are marked on the first chart and at the end of the article I have described briefly the rules of the studies.
The Parabolic-SAR dots have moved back to above the price action indicating a switch to a short position.* The MACD lines are moving down and apart ** and the Alpha-Beta signal, or filter, line is above the upper line and declining.*** The 14-day RSI is in oversold territory so that should help limit the near-term downside but it has in the past moved lower than it is now.****
So much for the short-term indicators, what about the longer term ones? We are currently sitting right on the 38.2 pct Fibonacci retracement of the entire low to high move of the BSE as you can see from the second chart. From a technical point of view this Fibonacci level is not that strong, as the trend had some good corrections on the way up. Nevertheless, we need to watch it carefully for signs of further support. It will be interesting to see if this level holds in the coming days. We have a market which is short-term bearish but has some good supports, although one very strong one has broken.
The general expectation is that inflation will peak sometime in H2 but we have to be cautious of that view changing as it will have a significant impact on the market. Money market rates are starting to show a worrying uptrend and if the view shifts that the inflation peak is further out, the market will get more negative.
It’s interesting that on Wednesday the stock market moved higher the day following a significant monetary tightening by the Reserve Bank of India.
Was it a relief rally that the bad news was out of the way, or a market that was feeling more comfortable that a challenging problem was being dealt with? In my experience elsewhere in the world, financial markets react well to strong and decisive action by central banks and governments and punish any signs of weakness.

*Parabolic SAR (Stop and Reverse) study gives signals for going long or short. While the study, the dots, is below the price action it indicates a long position but as the trend slackens the study touches the price action and indicates a switch to a short. It is supposed to be a constant position trading system.
**Moving Average Convergence Divergence (MACD) is a type of oscillator that can measure market momentum as well as follow or indicate the trend. MACD consists of two lines, the MACD Line and the Signal Line. MACD oscillates above and below a zero line without upper and lower boundaries. Signals are generated when the MACD Line and the Signal Line cross. A buy signal is generated when the MACD Line crosses from below to above the Signal Line, the further below the zero line that this occurs the stronger the signal. A sell signal is generated when the MACD Line crosses from above to below the Signal Line, the further above the zero line that this occurs the stronger the signal.
***Alpha-Beta Trend analysis is an attempt to avoid some of the false signals associated with crossing moving averages. Three lines are plotted: Upper band, Lower band and Trading filter. Together, the upper and lower bands define the uncertainty channel for trade decisions; the width of the channel varies with volatility.
If the trading filter moves from within the bands to below the lower band, this is a signal to buy or enter a long position. If the trading filter moves from within the bands to above the upper band, this is a signal to sell or enter a short position. If the trading filter lies between the bands, no trend is indicated. An uptrend is when the trading filter is below the lower band. A downtrend is when the trading filter is above the upper band.
****The RSI is a price-following oscillator that ranges between 0 and 100. The name “Relative Strength Index” is slightly misleading, as the RSI does not compare the relative strength of two instruments, but rather the internal strength of a single instrument. Because you can vary the number of time periods in the RSI calculation, you may want to experiment to find the period that works best for you. (The fewer days used to calculate the RSI, the more volatile the indicator.)
An overbought or oversold market is one where prices have risen or fallen too far and are therefore likely to retrace. If the RSI is above 70 then the market is considered to be overbought, and an RSI value below 30 indicates that the market is oversold. 80 and 20 can also be used to indicate overbought and oversold levels.