Heading for a sharp reversal?

M.S. Narasimhan

THE bearish trend gained further momentum and the indices hit new lows in the current phase.

In sharp contrast to the earlier trend, domestic operators have now decided to look ahead instead of the earlier trend of following the overnight price action at the US markets.

The underlying fear is that if the Nasdaq crashes, the Indian stocks will hit the lower circuit on opening without giving any opportunity for local players to even book losses.

This is one of the major constraints in the market today forcing quite a few market players to play safe in the market. The volume declined significantly in this process. Since there is some sign of stability in the US market, the Indian market could follow suit after a couple of days.

In the next phase, the market will focus on corporate results since many of the old economy stocks are expected to announce their results in the next two weeks. Initial results that flowed to the market are extremely good and old economy scrips such as BHEL and Reliance have reported strong earnings growth.

Software and other new economy stocks have also performed well. Given the recent decline in prices, they could attract buying interest from institutional investors.

There is general agreement among the analysts that Indian software companies are entirely different from that of many Internet companies in the US. Once repurchase pressure is over, buying interest will be strong in many of the frontline software stocks.

While mutual funds have remained net sellers during the week, FIIs have turned aggressive buyers in the market. If the current investment trend of FIIs continues, they will surpass the net investment figure of February 2000, the month in which the BSE Sensex crossed the 6000-mark.

The market opened with a negative gap of 372 points but recovered 80 points of loss during the day. Though the market opened with a positive gap of 100 points on the next two days, the indices closed below their previous values.

There was panic on Thursday on both sides and the indices bounced back to the previous level after creating a new low in the current phase.

Among the Sensex stocks, Reliance, Tata Steel, Grasim and Reliance Petroleum posted gains while other index heavyweights posted heavy losses. Many of these stocks are in an extremely oversold position. Massive short-covering will occur if Thursday's recovery is sustained on Monday.

The broad indicators also give the impression the market is oversold in the short period. While long positions in the BSE have declined by Rs. 450 crores, the short position in the market has increased to Rs. 500 crores.

The quantity of short positions is expected to be much higher in view of the sharp decline in the prices during the week. The recovery, however, depends on wider participation of stocks. The advance-decline ratio at the end of the week shows that only a very few stocks have turned upwards.The technical conditions of the market have deteriorated further during the week but the short-term indicators are bullish. Since the market moved with frequent gaps on the downside during the last two weeks, it warrants a strong short-term uptrend to close the gaps.

The uptrend has to add 600 points to close the gaps in the Sensex. All the moving averages are in the downtrend and are positioned above the price line.

The indices have moved below 200 DEMA for the second time giving an extreme bearish view. As the gap between the averages and current prices has widened sharply, it would require a sharp reversal to narrow down the gaps.

While the moving averages point to an imminent reversal in the near future, they will also provide critical resistance levels at 4900 and 5100. The confidence of the market can be restored only when the Sensex moves past these levels.

The intermediate trend, after showing some signs of revival, has turned bearish. The MACD indicator, without moving to the positive zone, has turned downward and moved below its trigger line. In other words, the oversold position of the market has increased without any major correction.

The momentum of the intermediate trend will pick up once short-covering is initiated in the market. The intermediate trend again has the potential to add nearly 600 points.

The short-term indicators have also touched the extreme values in the oversold territory. The 5-day ROC, which touched 18 per cent last week, is now placed at -14.17 per cent against the normal range of 5 per cent to -5 per cent. In the short run, it has to add another 200 points to restore stability in the market.

The RSI has also turned weak and moved below the 30-point mark in both the indices. The indices are expected to post positive returns during the week.

The Stochastic Oscillator is below its support level of 20 points and placed around 10 points in both indices. This indicator also gives a positive signal for the market. In other words, short-term indicators support Friday's intra-day recovery and give an indication for sustaining the trend.

The market has reached an oversold stage and a strong correction is already due. However, it is delayed due to external pressure and in this process, short levels in the market have gone up further. If the institutional investments pick up, there will be panic in the market for short-covering.

Many technical indicators support a sharp reversal and thus the volatility of the market will continue. This time there is a fair chance for the volatility to be on the upside. For long-term investors, the current phase gives an opportunity to expand their holdings and look forward to a fair return.

(The author is Associate Professor at the Indian Institute of Management, Bangalore.)