By George Albert
The time has come for equity bulls to take a breather as the Nifty is at a resistance level and the dollar index has reached a crucial support area. A further rally is possible but only if the Nifty can break out of resistance and the greenback close below support.
Resistance levels are price zones where the supply of an asset exceeds demand, leading to a fall in price; support zones are levels where demand exceeds supply, leading to a rally in price. Two weeks ago we had mentioned that the Indian market was entering a bullish zone. It rallied from that zone and has now reached a resistance level.
Putting additional downward pressure on the Nifty will be the Dollar index at support. Generally, the equity markets move inversely with the dollar. Let us take a look at the charts of Nifty (Click here for Nifty chart) and the dollar index (Click here for dollar chart). Notice that the Nifty rallied into a resistance level between 5,562 and 5,636. The index had fallen from that level in February this year. If that level is breached, the Nifty can go to the next level – labeled resistance zone 2 on the chart.
The dollar index, on the other hand, has reached a level of support between 78.06 and 79. The index had rallied from that level in late April, showing that there are interested buyers in that zone. The dollar is considered a safe haven and equities are a risk play. When the market gets risk-averse, they rush to the dollar for safety, leading to a rally in the greenback and a drop in equities. If that happens now it will be at the support zone of the dollar and the resistance zones of the Nifty.
Aggressive traders should go short on the Nifty in the resistance zone and go long on the dollar at support without waiting for additional confirmation. Cautious traders would wait for an indicator, such as the commodity channel index (CCI) or the MACD (moving averages convergence divergence), to give a buy signal before taking a position.
At the time of writing this article, the CCI on the dollar index was at negative 158. One could take a dollar position if the CCI closes above negative 100. In the case of the NIfty, the CCI was at positive 212. If it closes below positive 100, one could short. Remember that to take a position, prices have to be in the resistance zone for the Nifty and the support zone for the dollar when the CCI gives the entry signal.
Some of the readers must be thinking that now is not the time to go short on equities with the European Central Bank and the Federal Reserve Bank committed to pumping cash to bolster their economies. It is possible that the markets will continue to rally with the additional liquidity, but remember that there is already a lot of liquidity in the system and still the markets keep falling.
There are always arguments to make both the bull and bear case. So let’s focus on what the charts are telling us. They clearly show the Nifty at resistance so, at the very least, one should not buy now. It’s possible that the markets are set to go much higher and if that were the case we’d wait for a correction before buying. For right now the two options are go short or do nothing. Buying after prices have rallied is not a good trading strategy. If you wanted to buy, the time was when we recommended it two weeks ago.
Before we conclude, let’s take a look at the price action of the Nifty. Notice that the index gapped up into a resistance zone. A gap happens when prices close at a certain level and open the next day at a higher level. This happens when there is extreme demand. However, when there is a such a huge gap taking prices to resistance, there is generally a correction. A correction could take prices down to 5,500 or even 5,450.
George Albert is Editor, www.capturetrends.com