Sectors of Correction

Nifty's last swing closing high was made on November 5th 2010. Since then Nifty has fallen just under 9% as of 26th November 2010. But the damage done to Market breadth has been immense. I have been posting a lot on breadth, lets take a look at the broader market (stocks trading in F&O segment) with a sectoral point of view.

The above table and chart shows how the different sectors have faired. No award for guessing the weakest sector! The other bigger sectors like Power, Infrastructure and Materials have also not faired well. Most striking to see was Financials losing 16% since the peak on Nifty! Looks like the sector that rallied the most has also not been spared in selling.

Auto, Healthcare, FMCG and IT has resisted the selling. We need to keep an eye in case these start getting sold.

Nifty : Cloudburst ?

After consistent selling for 3 weeks, Nifty has lost 600 points. Though 600 points is not a big deal the major impact has been on sentiments. All the TV analysts who were predicting 6500-7000 in a matter of weeks are quickly doing a U turn and talking about this being another good opportunity to buy! Well definitely we can get a bounce, maybe a sharp one as I feel there has been a lot of pessimism very quickly and kind of fear as well. Also data suggests there has been a lot of short addition and market do not like crowd one side.

The above chart shows Nifty along with MACD and Oscillator. We have overlays of 50dma, 200dma and Ichimoku clouds. As we see Nifty has broken 50dma, week before last itself and the cloud support on friday last week. The MACD shows no sign of divergence, rather its gaining momentum and the oscillator shows very oversold levels.

Now what we can infer from all these is that after breaking 50dma a very natural attraction towards 200dma can happen. We would have expected Nifty to give a fight at the clouds but looks like the clouds are far too weak to stop the downside momentum. The oscillator though a very bad indicator in a trending market, points to some kind of technical rally.

What I feel is that with some days of no bad news day we can see that technical rally materialize. It should be contained around the 5950 area. The pessimism will certainly erode and so should the shorts. But as the overhang of scam, Euro crisis and all other "news" again make headlines, market will rapidly fall to test the 200dma around 5500.

The other scenario can be no respite from all these and a selling party for next 10 days as well, where we hit 200dma and then bounce hard (maybe) to current levels. Whatever be the case next week should be eventful and volatile. Making money would certainly be never easy as it had been.

Breadth Indicator : Week Ending 26 Nov 2010

As mentioned in the breadth indicator post last week the Nifty took a battering and so did the breadth. The current breadth chart has been made on December series data which starts from 1st of October when the nifty closing was at 6150. Last closing of Nifty has been on 5750, a 400 point cut.

The breadth has turned negative in an extreme way, not that it was good during the rally, but 142 stocks out of 193 showing a reading of -50% or less is certainly a sign of weakness.

We have seen sharp and swift correction and very obviously expectations are building up for a bounce.


The way to play a bounce can be to go long the most beaten down stock (HCC, RELINFRA and RCOM) or the strongest stocks (DRREDDY and HEROHONDA).

Though expectation of a bounce are building up market never does oblige us, more bad news and FII selling (which has only just started) can easily make look you stupid and impatient.

Max Pain : November Series

Max Pain on Nifty Options is suggesting an expiry closer to 6000. We need to track if 6000 PE and 5900 PE is losing Open Interest. If that happens, chances are of Nifty moving sharply lower from current level of 5890.

Breadth Indicator : Week Ending 19 Nov 2010

We can see breadth has swiftly deteriorated along with deep cut in Nifty. See Earlier Post for it as well as details to interpret the chart.

The current state of breadth has nothing convincing about it, all we can expect is some kind of oversold bounce.

Nifty : Long term View

Wanted to share long term technical picture of Nifty. Please see the chart below, which is a log scaled Nifty chart from middle of 1994, didn't had data so will try to base my findings on whatever I can get hold of.

What we see till 1999 is a very range bound market, and after that a significantly strong rally for a year. I have labelled the Elliot wave counts and would be glad to receive comments on it. And if I am correct, predicts a disastrous correction after the end of the ongoing 5th wave (some signs are there that it may already have ended but I will wait for some more confirmation signs).

How do I justify the count?
After the obvious first look 5 wave formation from 1999, we try to see if the other assumptions are satisfied.
- The strongest wave is the third wave.
- Wave 1 starts after a long consolidation (rally starts when you have no interest in stocks)
- Wave 2 is a triangle and wave 4 a sharp zigzag (alteration principle)
- Wave 5 is accompanied with lots of divergences

Though I am still open to being incorrect, I will definitely not ignore this build up. The impact of the current formation has a long and large one.

What Impact IT can have?
First and foremost principle of Elliot Wave theory is that after a 5 wave upside be prepared to see a 3 wave downside move.
The size of the wave that we are talking about here is enormous. Its age as of now is 12 years! I would expect the correction to span around a third of it.
The correction should be a zig-zag one as we can see the correction before the rally started was a flat one.(?)
Fibonacci retracements do not mean much for such large corrections, so we will need to base our target on observations. Which basically says we have a minimum target of going below the end of 4th wave and most probably into the region of 2nd wave.
Also, again the fact that we are talking about an extremely large correction, it just cannot be a trading correction. It has to be accompanied with lots of bad news and a possible crisis. I expect the extremely bullish sentiment about the growth of emerging economies could be the reason.

Where can I go wrong?
I am expecting 5th wave top to be made pretty soon if not already made. This 5th wave as not going higher than 3rd wave top is called a truncated 5th wave, which are rare and have more than normal bearish impact.
So there is all possibility of Nifty clearing the recent highs as well as 3rd wave top and make a new life time high, throwing all fears into the garbage yet again. But remember this 5 wave pattern will still be very much in contention and it will be only a matter of time when the large correction which I am pointing starts.

Though the sentiment is extremely bullish and people don't even think Nifty can fall to 5000, 4000 or 3000 ever depending on their bullishness levels, its important to remember that the more things look certain the lesser is its probability in stock markets.

Only time will tell as to what is going to happen, but I feel if I am correct we are going to get another fabulous investment opportunity and it may well be of our life time.

Follow up : When to Sell Gold ?

But the time to sell will come. Here are the signs I’ll be looking for:

Gold and gold-related financial products will be commonplace.

Even today, most financial institutions still hold the “barbarous relic” attitude toward gold. Yes, you can get GLD through any stockbroker, but with a few exceptions, the brokerage firm’s heart isn’t in it. They offer GLD for the same reason even the best seafood restaurants have a steak on the menu – they know someone will ask for one, even though that’s not what they are in business to serve.

Before the bull market is over, that attitude will change. Mainline brokerage firms won’t just have gold-related products available, they will advertise them. They will boast about them. They’ll claim to specialize in them. And it won’t be just the brokers. Your local bank will offer gold-related CDs. Your insurance company may be offering life insurance denominated in ounces.

Gold going mainstream won’t mean that the bull market is over, but it will be a sign that it’s getting long in the tooth. An early warning signal.

You’ll be hearing gold chatter wherever people talk about investing.

The inhabitants of Financial News TV Land will be talking about gold approvingly, and each of them will be trying to suggest he was early in recognizing the gold bull market. You won’t be able to get through a golf game or a cocktail party without someone talking about gold. Even your brother-in-law will want to explain it to you.

The gold standard will become respectable.

Today advocates of the gold standard are seen as standing to the good side of whacko, but not by a big margin. But as gold attracts more converts in the investment world, the politicians will want to associate themselves with it by proposing some brand or other of gold convertibility for the dollar. Respectability for the gold standard will be a sign that a majority of the people who are going to buy gold already have.

Other things will look cheap to you.

When gold nears its peak, even if you suspect that that’s what’s happening, you won’t feel certain about it. But when you start seeing investments – probably conventional stocks – that look like strong bargains, treat those sightings as a sign it’s time to start selling gold. You know the reasons that led you to buy gold. If you are tempted to sell part of your holdings to buy something whose low price seems to give it better prospects, then you probably will be selling at the right time. You could be selling to the last new buyer.

Richard Russell : Gold Bull Market

“I’m going on the thesis that the highly speculative phase of the gold bull market lies ahead. Now I’m depending on my experience with other bull markets:

1. Most great bull markets go higher and further than almost anybody thinks possible.
2. Most bull markets progress in three psychological phases.
3. I believe the first phase of the gold bull market has passed. It’s over. This is the phase where students of great values take their initial positions.
4. I believe we are deep into the second phase of the gold bull market. This is the phase where the institutions and funds join in the bull market show.
5. Often, more money is made in the third or speculative phase of a bull market than is made in the first and second phases combined. This can mean that the late-comers to bull markets often make a fortune, more than those who had the courage to buy early in the game, but they have to have fortitude to sit in the highly volatile second/third phases.
6. Obviously, I could be wrong, but I believe that gold and silver are both still a buy.
7. I’ve said this before, but I’ll repeat it. You do not trade in-and-out in a confirmed primary bull market. You take an early position and add to your position as the bull market progresses.
8. Great bull markets don’t usually provide marvelous entry points. Those who are waiting for the ideal or “safe” place to enter the bull market in precious metals may have a long and frustrating wait.
9. In a great primary bull market, you just “shut your eyes and buy.”
10. Are you buying right or are you buying wrong? Great bull markets tend to bail you out of your mistakes. Perfect timing is nearly impossible in a great bull market. You’re either in or you’re out.
11. Great or fabulous primary bull markets may come along once or maybe twice in a generation. I believe the bull market in precious metals is just such a one — a once-in-a-generation bull market. We may never see another one to match this one in our lifetimes.
12. I started writing Dow Theory Letters 52 years ago in 1958. Three times I’ve staked my reputation and my business on a bullish market call. The first instance was in 1958, when I told my subscribers that the third phase of the bull market lay ahead, and it was time to load up on stocks. I said so in my first Barron’s article. That call and that article put me in business. I thank Barron’s late, great editor Bob Bleiberg (who had faith in me and went out on a limb for me).
    In late-1974 at the end of that horrendous bear market, I told my subscribers that I thought the bear market was over, and it was time to buy stocks.
    In the year 2000 I told subscribers that I thought the bear market in gold was over, and that it was time to buy what was left of the gold stocks and “put ‘em away.” I told my subscribers that we should treat the gold shares (many under five dollars) as perpetual warrants. “Buy ‘em and forget them.”
13. Lucky thirteen. I’m confirming what I said in 2000. Buy gold and silver, put ‘em away and sit tight. The great speculative phase of the precious metals bull market lies ahead. My advice is concentrated in four words — Buy, and be patient.”

Breadth Indicator

I have tried to group all the stocks in F&O segment of NSE into deciles above and below their average price. Had to exclude few stocks that were split. The chart below is on the data for November series.

As per the definition the bar at 0% means the stock's latest closing is very close to its average closing price for the whole of November series. The bar at 100% means that the stock's closing is very close to the highest closing (it could be the highest closing). Also the bar at -90% means that the stock's closing is only 10% away from the lowest close, and similarly 90% means that the stock's closing is only 10% away from the highest close.

So what we get from the chart is not only how many stocks are closing at lows or highs, we can also see how many stocks are closing at what percentage distance away from high, low and average! So I would expect during a flat market a very "Normal" distribution, and at extreme market conditions a very skewed distribution.

So out of 192 samples here, we see 37 stocks are having a reading of 50% or higher and 64 stocks having a reading of -50% or lower. Certainly not a show of strength, as the reading we get for Nifty is 40%! And if we do a weighted average of the entire list we get a reading of -20%!

This shows that the 50 stocks in the Nifty are performing much better than the rest 142 in the F&O segment taken into consideration here. Talk about positive sentiment !!