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Wednesday, March 28, 2012

Technical Analysis of Markets - Direction of Nifty

Technical Analysis is a key tool in the hands of market analysts. It’s a marked deviation from the Fundamental Analysis approach of Scrips which we were applying in past few posts. Technical Analysis simply looks at price and volume for a given Stock or an Index and deploys mathematical insights from price and volume derivatives such as moving averages, momentum, oscillators and so on and so forth.

Strangely enough, fundamental analysts and technical analysts are always loggerheads with each other. Fundamental experts think of Technical analysis as nothing more than Snake oil, and Technical Analysts snigger at Fundamental Analysis as high finance mumbo-jumbo. What we strongly believe that these tools are complementary and using them together can result in astonishing results for a investor and trader.

To continue our discussion, let’s look at Nifty Index and try to derive the directional insights using some simple technical analysis tools. Nifty is weighted average of market cap of top 50 stocks on NSE, and hence fairly represents the overall market direction on any given day or period of time. You often would hear from Analysts & Commentators on TV predicting the direction of market. Most of this analysis is done using Technical Analysis of Nifty charts.

Our first chart below, shows the movement of Nifty index over a period of past few months, and also plots simple moving average (SMA) on this chart using an average of 50 days and average of 200 days. SMA is a simple technical analysis tool, which averages the closing prices over a period of past given number of days, e.g. SMA(50) is average of 50 days and so on.

Whenever 50 day moving average crosses above or below 200 days moving average of a market index, it’s a significant event. 50 days SMA line crossing below 200 SMA line is known as the ‘Death Cross’ and signifies the official start of a Bear Market. Conversely, 50 days SMA line crossing above 200 SMA line is known as the ‘Golden Cross’ and signifies the official start of a Bull Market. Here if you observe, in first week of Mar, 2012, 50 SMA comfortably crossed over 200 SMA and marks the significant event of Golden Cross for Indian Markets.

It is important to note that although this is an important and key event, nothing in markets is guaranteed and infallible. There have been false crossovers, though this is extremely rare in past one decade of Indian markets and Nifty index behavior. Golden cross in Nifty technically signifies that worse is probably over for the market, and one should patiently wait for further strength to appear in markets in near term.

 We will see one more chart for Nifty, which zooms in and provides a simple view of one common stock pattern. Patterns are the handy tools of technical analysts and through these patterns, Technical Analysts gain their insights and also become infamous for their predictions, some of them will turn true and others will obviously fail. It’s important to remember that nothing is guaranteed in stock markets, whatever the stock pundits may say, and tools and techniques are our best bet to understand the behavior of markets on daily basis.

This chart specifically looks at Nifty behavior over the past few days and do observe the falling wedge pattern on the Nifty during this period. Nifty has been falling slowly and creating a Wedge like pattern. A Wedge can be either a falling or a rising wedge. Typically, the wedge behavior is always counter intuitive and a falling wedge pattern is assumed to be bullish and rising Wedge pattern, more often than not, breaks down and hence is considered a bearish pattern.

We will explain this pattern in detail in next set of posts, for now we take the pattern on its face value and observe that there is high probability that Nifty would turn bullish in next few days. Also observe MACD, another technical indicator, at the bottom of chart which is showing a upward movement as Nifty is travelling within this falling wedge, hence conforming the near term bullish behavior of the index. 

Combine this with the first chart we just saw with a Golden Cross, and we can observe with this simple technical analysis that days are indeed turning to be better for Nifty, notwithstanding the negativity in press or whatever else is happening in the economy. Price never lies and tremendous bullish markets always start at the rock bottom of negative news. Remember, night is always the darkest just before the dawn, when the sun is just about to rise.

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