The BSE Sensex is on the cusp of another round of bearishness which could lead to fall of anywhere between 1000 to 1500 points depending on the strength of the bear.
The chart of the Sensex is forming a bearish chart pattern called the descending triangle. The Nifty too is forming the same pattern but it is much clearer in the Sensex. A descending triangle is nothing but a simple display of buyers failing to take control and push prices higher. To put it differently, it shows the strength of sellers in keeping prices down.
For the bearish pattern to be confirmed the Sensex has to close below 16,800 and the Nifty below 5075. A bearish resurgence can take the Sensex all the way down to 15,500 and the Nifty to 4650.
A look at the charts (Click here for Sensex and Nifty) below will show that the Sensex and Nifty are forming a descending triangle, which is a bearish chart pattern. Both markets clearly show lower highs and the Sensex shows flat lows, while the Nifty does not. A lower high is when latest high in price is lower than the previous high in price. This shows that the buyers are not able to push down prices. A flat low is when price keep hitting a same point and bouncing up, which shows there are buyers at the level willing to take prices higher. The fact that NIFTY does have a clear flat low indicates its relative strength to the Sensex and must not be used to pick bear targets and breakdowns.
The fact that the low of the Sensex has been hit many times makes it likely that there might not be many buyers at that level near 17,000. The theory is that most buyers have bought and taken prices higher, but failed to create a strong rally. Hence when prices go below that level not only will aggressive sellers emerge, but existing buyers will sell too putting tremendous downward pressure on prices.
However, this time around prices must clear the gap shown on the chart to move down. Gaps are areas of strong demand and prices often bounce from those levels. A gap happens in the market when prices close at one level and open at a different level higher or lower as a result of demand-supply imbalance. For the Sensex the prices opened higher making the 16,800 to 17,000 level an area of high demand. Price opened nearly 200 points higher on Jan 31, 2012 at 16,965 after closing at 16,863 the previous day. Now with prices coming down that level, there could still be a bounce. Hence it's important to wait for prices to close below 16,800 before going bearish.
Usually, after prices break below the lows that form the base of the triangle they make a measured move down to a target. A measured move is calculated by taking the widest part of the triangle and applied to the base of the triangle to identify a target below. The measured move is shown by the vertical lines on the charts.
For the Sensex to make the full measured move to 15,500, it has to clear the 16,000 area. Sometimes the measured move will not reach its target. There are times when the descending triangle formation may fail and the markets can go to the apex of the triangle and fail to pick a trend and continue side ways. Its also possible for prices to rally out of the triangle, in which case the formation has failed. A close above the descending line of the triangle indicates the possibility that the formation may fail.
Also keep in mind that the bearish picture is not very clear on the Nifty chart as the lower level has not been hit many times like on the Sensex.