Short-term trend at critical stage

M.S. Narasimhan

THE short-term rally witnessed towards the close of last week got further support and added another 6 per cent gain for the week.

The optimism was underpinned by a gain of over 10 per cent at the Nasdaq market on Wednesday after the interest rate cut by Federal Reserve. This, coupled with large scale fresh inflow of FIIs' investments, also kept the market in a positive territory.

While interest rate cut is not likely to have any long-term impact in the domestic market, the fate of the uptrend depends on aggressiveness of FIIs in investing in Indian market. In the last five trading sessions, FIIs have invested nearly Rs 1,000 crore, which is in contrast to the heavy liquidation that was witnessed during the preceding two weeks.

FIIs have turned net buyers even before the interest rate cut announced by the Federal Reserve on Wednesday. Though there is no material change in the performance of the economy during the last one week, the buying interest stems from the fact of attractive price of the stocks following overreaction of the market to negative news.

The buying interest is likely to fade in the following weeks. A 6 per cent loss at the NASDAQ on Friday and the erosion of over 60 per cent of the gains recorded at NASDAQ in the last two trading sessions could trigger a negative impact on Monday in the domestic market.

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The market opened on a steady note at the beginning of the new year but closed with a minor loss. The sentiment turned bullish on Tuesday consequent to the reports that FIIs were major buyers on Friday last. Though the news on interest rate cut by Federal Reserve was available on Wednesday, it had a marginal impact on the local market.

The market logged into a bullish phase on Thursday after witnessing a 14 per cent gain at Nasdaq on Wednesday. The Sensex opened with a gap of 120 points on Thursday but lost heavily towards the close of the market. On Friday, the market witnessed some activity towards end expecting a bullish trend to prevail in the US market on Friday. The uptrend looks weak on several counts except FIIs investments. It is likely to witness a free fall if institutional investments decline during the next week.

Though the uptrend is widespread, the attention of the market moved from old-economy stocks to software and other new-economy stocks during the last two days. The old-economy stocks, which were in limelight for the first three days has suddenly witnessed a large scale selling pressure.

On Thursday and Friday, when the market showed significant gain, the number of declines outperformed the number of advances. The divergence of A-D ratio from the prevailing trend gives advanced warning about the end of bullish phase. The long-short position of the BSE also points out an increase in speculative volume and it will aggravate the problem during the bearish trend.

The technical set up of the market has improved but failed to cross all hurdles to give a definite buying signal. The market is also close to major resistance levels. The market is likely to remain subdued, particularly on account of the weak trend in the US and other markets. Indices have crossed 50 and 100-day moving averages on Thursday when the market opened with a big gap.

It is now close to the 200 DEMA and also a near a major downward trending resistance trendline. This trendline has effectively arrested the previous uptrends and the indices require strong momentum and support to clear this trendline. While Sensex faces resistance at 4200 and 4287, the technology heavy-weighted BSE-100 is presently perched right at its resistance level.

The support levels available from short-term moving averages have also turned weak in view of flat movement in the moving averages. The market will revert back to the previous week's level if the indices fail to get the required support to clear 200 DEMA resistance level.

The intermediate trend indicator, MACD, has also changed its direction without undergoing the full cycle. It has not only moved upward but also crossed the zero level and entered into oversold region. MACD for the two indices are 10.42 and 0.56 respectively. MACD has also crossed its trigger level and thus gives intermediate bullish signal. However, in the past, whenever the MACD turns upward without completing the cycle, the life of the uptrend has proved to be short lived. It is thus desirable to wait for a clear trend before taking long position.

The short-term indicators have turned extremely bearish and they project a major correction in the near future. The 5-day ROC has crossed its normal resistance level of 5% and is placed at 5.33% and 6.51% respectively for the two indices. The Sensex could witness a loss of 200 to 300 points when the short-term correction sets in.

The 5-day RSI has also moved above its resistance level of 70 points in both indices and suggests an immediate reversal in the market. The stochastic oscillator has moved above its resistance level of 80 points and ready to trigger a short-term bearish market.

In a bearish phase, the market appears to have passed through a upward technical correction last week. This corrective phase was extended following a bullish trend in the overseas market and FII buying. However, the uptrend shows several weaknesses, particularly, considering the overall weakness in the other global markets.

The domestic market will also turn cautious ahead of the third quarters results that is due to be announced by major companies in the next two to three weeks. However, unlike the previous year, there is no major optimism over quarterly results. Though moving averages have triggered a buy signal, it is desirable to defer the buying decision in view of strong bearish indications. At the same time, short positions can be liquidated if the indices failed to move downward on Monday. Short positions can be considered if the Sensex falls below 4120 and can be enhanced if the Sensex declines below 4035.

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