The bears are still in play as resistance on the Nifty is still intact and the index has been unable to break out of the level for a few days now. The resistance level for the Nifty is between 5,861 and 5,955.
Resistance levels are price zones where the number of sellers far exceeds buyers, leading to a fall in price or the stopping of a strong rally. For prices to rally higher, buyers have to absorb all the oversupply. However, given that prices have not fallen drastically, it shows that there are enough buyers to absorb the sellers, but not enough to rally prices higher. The same is true on the sell side, with not enough sellers to take prices lower. So we have good old-fashioned consolidation, or a battle between buyers and sellers.
Given the fact that the Nifty is at an oversupply zone it means this is not the time to buy. It is the time for buyers to take some profits and for short-sellers to initiate some short positions, with a stop above the 5,955 zone. We have spoken about the broadening formation of the Nifty in our previous articles and that formation is still intact. If the Nifty continues to stay in that formation the index can fall below 5,600.
The bulls will point to the Nifty’s confirmed uptrend line, as shown by the sloping blue line on the chart, to argue that the index is headed higher. And they could be right, but not unless the resistance level is broken. It is possible for the index to fall to the uptrend line and then rally again. However, a break of the uptrend line can be bad for bulls.
To get some clarity on where the equity markets could be headed, we thought we’d look at some correlated markets. So let’s take a look at copper and the US dollar. While copper is not giving any clear signal, the US dollar shows that equities could fall. Let us look at copper first.Copper often is the leading indicator for the stock markets. Equities tend to follow copper with a lag. This is so as copper is used in most manufacturing processes and an increase in copper prices indicates that manufacturing and economic activity will soon pick up.
As a result, when demand for copper increases from the manufacturing sector, the price of the metal rises. Equity market investors, seeing a possible pick up in the economy due to increased copper demand, bid up share prices.
Unfortunately, copper right now is moving in a consolidation pattern called the symmetrical triangle. The pattern is shown on the chart by the two white sloping lines. In a symmetrical triangle the price moves in a continuously narrowing range and tops in price are connected with a down-sloping line, and the bottoms with an up-sloping line, giving the shape of a triangle. This is generally a continuation pattern – which means that prices trend up or down and consolidate as a symmetrical triangle and then head in the same direction as before the consolidation. However, it is best to wait for the break of the triangle to confirm future direction. If prices break lower, it will continue lower, and vice versa, if it breaks higher.
Since copper prices are still inside the triangle, it is difficult to glean any directional signals for the equity markets.
So let’s look at the US dollar….. Last Friday, the dollar index hit its uptrend line and also a support zone, shown by the blue horizontal lines. We call it a support zone as prices rallied from that level earlier. Since the dollar index has a confluence of levels (up-trend line and support zone), the chances of a bounce increase.
The dollar and equity markets are generally inversely related, hence if the dollar rallies next week, equities could fall. The dollar is considered a safe haven and equities a risk play. So when people seek safety they rush to buy the dollar and sell equities. Dollar bulls, please note that if the support zone and up-trend line is broken a dollar rally is off the cards.
So now we have two factors favouring the equity bears with the dollar at support and the Nifty at resistance. Copper, on the other hand, is neutral. So it’s safe to say that a short position in the Nifty with a stop above the resistance zone between 5,861 and 5,955 is still a good bet…..
-Umesh Shanmugam(Research View)