Markets are driven primarily by fear and greed and we’ve seen both in equal measure over the past few years. Greed as people borrowed money and piled into stocks for instant riches, and fear now everything is lost, and more if investments were leveraged.

It has happened before. It was the same in the 1980s and the crash of 1987 and the NASDAQ bubble of the late 1990s. As a cub reporter in Fleet Street I covered the ‘87 crash and investors’ attitude then was exactly the same as it is now and I’m hearing and reading the same reactions.

Boom-bust has happened before and will undoubtedly happen again for similar, or different reasons, but history will repeat itself.

The major lesson a savage market correction has for retail investors, short and long-term alike, is to have sensible timescales and aspirations and take profits when they seem reasonable. If you let your bet ride in a game of roulette, you could get super rich but you could lose the lot.

A professional trader will tell you there is no such thing as a bad profit and banking them, even small ones, is no bad thing. A SENSEX investment in early 2006 at 10,000 had gained 100 pct within two years and by any standards that is a colossal gain for a stock market. Even without the credit crisis the market was anyway staging a much needed correction to a hugely overbought position.

The nice bounce the SENSEX had at the 12,500 level ran slap bang into an unknown in the form of the scale of the credit crunch fallout and the market has retraced back to where it is now, around 2/3 of its entire upmove. (See first chart)

The market has run into quite nice technical support around the 2006 post sell-off low as you can see. You can also see that the close-to-close volatility is still very high. Spikes in volatility usually happen around market turning points and you can see evidence of this on the chart.

On the second chart you can see short-term indicators like the Parabolic-SAR has touched the price action and will now switch to bullish and the MACD has crossed which is also bullish. The Alpha-Beta trend is still in downtrend.

We need better confirmation but the turning point signs are good at the moment.

The last chart, just as a matter of interest, is the U.S. Federal Funds rate versus the Dow Jones index over the past 10 years. You can see the how the Fed Funds rate was cut during the 2000/2001 recession clearly and the similar picture we are seeing now.

I’ve been away for the bulk of the excitement but here are some thoughts about the current India stock market charts and the state of things in general.
The SENSEX collapsed through some very strong support levels in the face of fundamentals which were dire in the extreme. It breezed through 12,500 and is now sitting close to the 61.8 pct Fibonacci retracement of its entire upmove since 2001/2002.
The short-term bearish technical indicators are still in place and the 2006 post sell-off low around 9,700 is acting as support as the chart shows. The 61.8 pct Fibonacci retracement level kicks in around the same area.
Short-term indicators like the Parabolic-SAR, MACD and Alpha-Beta trends are all still bearish. We need to watch both closely in the next few days in any case. It is from the MACD and Parabolic-SAR we will get our early signs of a bottoming out.
On the second chart you can see the correlation between the SENSEX and the other Asian markets, here measured by the MSCI Asia ex-Japan index. It is positive and high and the India market is being very much driven by what is happening overseas. The decoupling the India markets enjoyed at the beginning of September after the government won the confidence motion has gone as you can clearly see on this chart.
The current market declines are a symptom of the economic problems caused by the credit crunch rather than being purely market related. In as much, this is not like the 1987 stock market crash but more like the 1997 Asia crisis and the associated market declines. At the moment the markets may be overacting to the downside but they are struggling to discount economic developments a year or so down the line. Given the outlook is so hazy right now the markets are understandably volatile and incredibly jittery.
I covered the 1987 stock market crash when I was based in London and remember at the time that it seemed like the end of the world and things were never going to recover. The authorities reacted, as they have now, by throwing liquidity at the markets and frankly that is pretty much the only policy response that is effective in the near-term.
One thing that is very noticeable is that the volatility of the market has increased a lot. If you look at the third SENSEX chart I’ve put on a study of the 10-day close to close volatility. As you can see the volatility is currently getting historically very high. You can see the earlier peaks of this study coincide with the end of the 2006 sell-off, the big turn down in early 2008 and the false dawn turn we had in July. High volatility is associated with turning points…and volatility is currently very high.
I publish a daily technical analysis view for the SENSEX, gold and oil at www.reutersindia.net

Despite the financial carnage on Wall Street, the SENSEX ended the week a touch higher after bouncing off the very solid 12,500 support level we have had drawn on the chart for some time.
On the face of it, that would seem like a spectacularly robust performance but the Dow Jones has done almost the same thing. While it is still trading as I write this, it looks like ending the week only marginally lower. All things considered, I find that pretty amazing.
The U.S. cavalry has certainly ridden to the rescue with the authorities taking on some huge liabilities in an attempt to calm the markets. But it is not clear whether this will work or that we won’t see more huge failures.
Early in my career I covered the 1987 stock market collapse and remember well the kind of panic we are seeing now spreading across the globe. The dynamic of the current crisis is very different to that of 1987 but two things never change in financial markets – fear and greed. At the moment fundamentals matter little, the key to the whole thing, and how it unwinds from here, is sentiment.
After the 1987 crash the authorities also threw liquidity at the markets but in the form of sharp cuts in interest rates to counteract the negative wealth effect on the economy. This actually led to economic overheating because stock markets recovered very rapidly after the 1987 collapse.
The sharp recovery was due to companies which had issued equity to either raise money or for M&A, taking the opportunity to buy back stock at rock bottom prices.
A fact well worth bearing in mind given the amount of equity has been issued in the past couple of years.
The chart is the same one I’ve been using for a while showing the SENSEX since the end of 2005. All the important support and resistance levels are shown and you can see just how important that 12,500 level is.
Another interesting development lately has been the correlation between the SENSEX and the other Asian markets, measured on this chart on the left by the MSCI Asia ex-Japan index.
You can see the correlation line is turning positive after being negative for well over a month. The decoupling the India markets enjoyed after the government won the vote of confidence lasted around six weeks, but that premium is now exhausted. The influence of other markets is getting much stronger again.

For more regular technical updates please see my website www.reutersindia.net
The SENSEX moved up off longer term support at 14,097 to bump up against resistance at 14,645 on Friday. You can see these levels marked on the two charts on the left the first is short-term, the second longer-term. The short-term trend indicators we have had are marked with arrows on the first chart and the latest ones on the Parabolic-SAR and MACD studies are now bearish as you can see. The Alpha Beta trend is now neutral from bullish. So, the near-term indicators are pointing down and we need to keep a close eye on these supports carefully as it might mean this small downtrend we are currently seeing may be short-lived. So far, they are holding well.
The second chart shows the longer term chart support being the 38.2 pct Fibonacci retracement of the entire SENSEX upmove. We are on very significant support and this is why the market is holding up despite the bearish indicators.

DECOUPLING
While the SENSEX decoupled quite nicely from the other Asian markets following the government victory at the vote of confidence and the associated politics. It was clear investors took this outcome positively and bullish for economic reforms. However, given the inflation and growth backdrop at least some of this enthusiasm has evaporated and the negativity elsewhere on the Asian stock markets has begun dragging on the SENSEX again.
That said, at 12.40 percent inflation number for mid-August was lower than expected by the market and indeed moderated slightly and the 7.9 percent GDP number was taken calmly by the market despite being slightly lower than anticipated.
The third chart is a correlation chart of the SENSEX versus the MSCI Asia stocks index ex-Japan which shows the India market decoupled form the Asia markets since the beginning of the month but you can see the line is turning less negative so the Asia market are starting to have more influence and the SENSEX moving less under its own steam. The correlation index is still negative as per the sub-chart but less so in the past few days. It seems the drag of the Asian markets is starting to exert more influence over the SENSEX.

WATCH THE RUPEE
The fourth chart has the 10-day correlation study of the SENSEX vs INR and this is turning down quite sharply so the link is clearly breaking down now. A very high correlation between the two has existed for around a month and the SENSEX moving in lockstep with the INR. If you watch one, you must watch the other.

GOLD – HITTING RESISTANCE
And finally a look at gold. Gold has seen an excellent bounce off the strong 785 support level, a level that has been evident on the chart for weeks now. It was very strong support in Q4 last year.
But, 835 is the big resistance level and as you can see from the chart is providing a solid barrier to further gains. All the recent closes have been below and US trading on Friday did not break the pattern. One to watch for sure, and a break above would set up a move to the next two resistance points as marked on the chart at 850 and 859. But 835 is the key overhead resistance level being around the peaks reached in 2007.
The Commodity Channel index has broken up through the negative 100 line which is a bullish signal. The Parabolic-SAR has also switched to bullish and the MACD lines have crossed.
But the signals are not that strong and we should continue to not yet be looking too much to the upside and there is need for caution. The start of the bearish move is marked with the latest set of black arrows the MACD and P-SAR flagged it very well.
. Gold’s negative correlation to the USD. As we all know the dollar movements affect the gold price but at the moment this negative correlation is strong and risingThe last chart is a very long-term chart of the gold price versus the oil price.

This is a long 100-day correlation and as you can see historically the linkage goes from positive to negative with slightly more bias to the positive. At the moment the correlation is very high. If you watch gold you currently have to keep a close eye on oil.

The recovery from the July low major support level is itself now staging healthy corrections at predictable levels but more of that later. The major thing to note since the recovery set in is that the SENSEX has decoupled from the Asian markets and is moving under its own steam.
While the performance on overseas markets will continue to influence the markets here the major decoupling which has taken place is dramatically demonstrated by the chart here on the left. For daily technical comments on the SENSEX see my webpage www.reutersindia.net
On the upper part of the chart the SENSEX is charted against the benchmark MSCI Asia Pacific Stocks Index excluding Japan. The decoupling since the turn of the month is striking and amply backed up by the correlation sub-chart.
Above the zero line shows a positive correlation, the higher above the zero line the higher the correlation, and below shows a negative correlation. Anything above +0.7 or -0.7 for the correlation index is considered significant and as you can see on this chart the 10-day correlation is currently around -0.45.
It has been many months since the correlation with the rest of the Asian markets has been negative. The second quarter of 2007 was the last time, in fact.
Why? Well looking at it purely from the chart the only incident that seems to coincide with the decoupling was the government victory of the vote of confidence and the associated politics. Scandals notwithstanding, it would seem investors here view the outcome positively and are bullish for economic reforms.
It would seem overseas investors are not so sure as the rupee has not been firming and has been stuck in a 41.70-42.80 per US dollar range since the vote. The FII (Foreign Institutional Investors) data backs this up with a net inflow since the July 22 vote of just $225 million by my calculation of the daily figures. If foreign money is going back into the market it has been money left on deposit here after earlier stock sales, not fresh money.
It follows therefore that before we can even start thinking about getting back close to the old highs, overseas money that left the country during the sell-off, or fresh money, must come back in.
The near-term SENSEX chart is getting a little stretched with our bullish indicators which have been in place since the 12,500 low starting to fade. We are currently looking at a bounce of the 61.8 percent Fibonacci retracement of the May-July down-move and that could skew some of our short-term technical indicators like the Parabolic-SAR.
As the next chart shows the Parabolic-SAR now looks like it might turn bearish although other indicators like the MACD and Alpha Beta trend are still bullish. (For an explanation of these studies see my earlier blog From looking at the Long Term Trend to looking at the Long Term Support)
The Alpha-Beta study is indicating an uptrend with the signal line, the green one, crossing down through the lower line, the blue one. But we need to watch these indicators very carefully during any hesitation in the uptrend.
The longer term chart is still worth learning some lessons from. There was major technical support at the long-term trendline in Q1-Q2 and when that broke around the 38.2 pct Fibonacci retracement level in Q2. You can see both these supports. Since the 38.2 pct support broke the next big level was 12,500 which was the high reached before the 2006 sell-off and the 2007 low.
There is very good long-term technical support for this market between 11,900 and 12,500 as marked but with the oil price continuing to do the right thing, revisiting those levels would at the moment seem a fairly remote possibility.

Since the somewhat manic reaction to the government’s confidence vote victory, the SENSEX has retraced fully under the weight of falling overseas markets and the Reserve Bank of India’s latest monetary tightening.
From a technical point of view on the daily chart we have settled around support at 14,206 on Wednesday.
Nevertheless the short-term indicators are still bullish with the Parabolic-SAR and MACD pointing to the upside.
The black right pointing arrows on the chart mark where we got good technical signals for medium term trend movements. The upward pointing arrow is the possible signal we are getting now about the current possible turning point.
The Alpha-Beta study has turned neutral but has yet to confirm an uptrend. This is the green line (signal line) on the chart which is current between the upper and lower lines. Confirmation of a new trend will come when the A-B turns bullish and that will be when the signal line cuts down through the lower line.
On this chart you can see the major technical support at the long-term trendline in Q1-Q2 and when that broke around the 38.2 pct Fibonacci retracement level in Q2. You can see both these supports clearly on the chart.
Since the 38.2 pct support broke the next big level on the downside is 11,900 which is a 50 pct retracement of the entire low to high BSE upmove. As you can see we have bounced off good support around 12,500 which was the high reached before the 2006 sell-off and the 2007 low.
There is very good long-term technical support for this market between 11,900 and 12,500.
The bounce we had from 12,500 was clearly too steep as you can see and the market is currently settling into a more sustainable trend. We need to be looking for more technical confirmation that this was indeed the bottom of this year’s decline. All things considered, as long as the oil price continues to moderate, inflation doesn’t roar away and the political backdrop remains more positive we could have seen the trough everyone has been looking for.

I got the feeling there was a change of mood in the India market this week. The nasty gap down early in the week gave way to some good volumes and closes near the high.
The near-term technical indictors are still mixed and in the coming sessions we need to keep a close eye both them and the volume to underpin the longer-term view.
The kind of sentiment swings we have seen over the past few weeks are typical of a market close to a turning point after a sharp sell-off , and the kind of price action we have been seeing is indicative of some fairly wild changes of market mood. The media has likewise been quite schizophrenic – doom and gloom one day, bullish and positive the next.

Longer term this market is searching for its low with a lot of bad news discounted. It is likely not too far away in technical terms and may indeed already be here.
Click it to see a large version of the chart above.
The first thing to note is the very good support and resistance the 200-day moving average is. This will be a key level during a SENSEX recovery although it is a long way off yet.
Next note the 12,500 line. This is around the high the market reached just before the 2006 sharp sell-off and the low the market bounced off during another quite steep correction in 2007. I’ve marked both these areas.
As you can see this level has again lent the market support and the SENSEX bounced off it very nicely this week.
The Fibonacci levels you can see are the 38.2 pct 50 pct and 61.8 pct and are retracement levels of the entire SENSEX upmove from 2001-2008.
As you can see we are close to the 50 pct retracement of this move which stands at 11,900. There is very good long-term technical support for this market at and between 11,900 and 12,500 as marked. This could well be the trough investors have been looking for.

A very nice key day reversal pattern on Wednesday completed on Friday. So far it is a textbook classic with Wednesday’s higher high and lower low but close near the high and Thursday’s lower high and higher low with a close near the low.
With this key day reversal you can see the MACD fast line, the green one, has the makings of an upturn. Short-term indicators are still bearish with the Parabolic-SAR, MACD and Alpha-Beta trend all pointing to the downside but we must watch for these to change and to call the turn. Despite this possible key day reversal, it’s too early to call a short-term trend change but keep an eye on these indicators for clues in the coming days.
The index is now well below the 38.2 pct Fibonacci retracement of the entire low to high move of the BSE. From a technical point of view this close below is not good news and the next big support level is 11,900. This is the level you keep reading about in the newspapers ‘at around 12,000.’ Lots of people are quoting it without really knowing why it’s important.
I think the thing that worries me most is that people are trying to call the end to this correction to the day or a particular level and that is a dangerous game. Technicals give good signals for turning points within 10-15 pct of the trend change. Sometimes you are lucky and the signals are strong, as with the January downturn. But with fundamentals so bearish at the moment - oil price, inflation, politics, weak world markets, US economic downturn - it would be well to get good technical confirmation of a bottoming out.

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.

The 200-day Moving Average lent some support on Tuesday with the close near the line.

The drift lower saw the RSI come back at bit to just below the key 70 level. This could be the start of a reaction low I was talking about on Monday - see below.

Otherwise technical signals like the MACD and Parabolic-SAR are still near-term bullish. (See the middle chart for their initial signal where I have marked where the MACD cross coincides with the Parabolic-SAR switching to indicate a long position)

We need to watch both these studies carefully as the bullish signal could change.

The recovery has so far been very similar to what we saw after the sell-off in 2006 with a slight overshoot to the downside below the longer trend. We are now back above our long term trendline and current end-year forecasts of around 19,000 look reasonable as you can see from the lower chart. One thing to watch for is a minor downward correction to the recent upturn to form a ‘reaction low.’

Have a close look at the 2006 downturn and you will see what I mean. From a technical point of view don’t be surprised to see the BSE correct back towards the long term trendline for a short time.

All that has really happened is that the BSE has corrected from the extremely overbought levels seen late last year. Since last November the chart had been pointing to a correction such as the one we have seen, as regular readers of this item will know.

Please note the 200-day on this weekly chart is calculated week-to-day so the absolute level of the line does not exactly coincide with the value on the daily chart - for our purposes it is close enough)

(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.)

Below is a picture of the BSE valuation vis-à-vis the main Asian markets since the start of the year and since the longer-term upmove started in May 2005. As you can see the BSE is underperforming its Asian countrparts so far this year but measured since May 2005 it is still outperforming.