Nifty's bounce has slowed at a resistance level and is weaker than the global indices, which had strong rallies this week. However, the Nifty can continue its march up if the resistance level is cleared and it follows the global indices on Monday.
In last week's article we had said that the Nifty hit support and was likely to rally. That's exactly what happened. We have also maintained that the index has been moving in a broadening range formation for the past few weeks and the formation is still intact. However, the rally which started earlier in the week was stopped when the index hit resistance. Resistance levels are areas where the supply of stock exceeds demand, leading to a fall in price.
The resistance level is shown on the charts by a blue ellipse ( See above). Notice that the Nifty reached the level of the gap and has since not been able to rally higher. Gaps are areas of extreme supply or demand imbalance, which lead to a fall or rally in price. A gap happens when prices close at a certain level and then open higher or lower the next trading day.
In the case of the Nifty, the price opened lower as supply exceeded demand. Now, with the Nifty reaching the level of supply, its upward march has slowed. The gap area has to be cleared for the Nifty to move higher. Additionally, so far the Nifty rally has been weaker than some of the global indices. For instance, the US index S&P 500 rallied more than 3.5 percent till Thursday. The US markets close on Thursday is the last day of the week when the Indian markets can take cues from them. On Friday, when the markets closed in India, the Nifty had only rallied about 1.7 percent during for the week.
This clearly shows that the Nifty is weaker than the S&P 500, which could make a further rally in the Indian index more difficult. However, there is good news for Nifty bulls from the S&P 500 price action on Friday. The US index rallied strongly on Friday, which resulted in a total rally of almost 5 percent for the week. The rally in the S&P 500 can lead to a further rally in the Nifty.
It is important to note that the broadening range formation of the Nifty is still intact. Please check our earlier articles for more details on the broadening formation, which is essentially a very difficult pattern to trade, as it keeps making lower lows and higher highs. A lower low is when the latest low price is lower than the previous low and a higher high is when a latest high in price is higher than the previous high.
The Nifty recently made a lower low and then began rallying higher. However, if the index fails to rally above the gap resistance that's holding it back now and falls to make a lower low, the broadening formation is no longer valid. For the formation to be valid the Nifty has to make a higher high, which seems possible given the rally in the S&P 500.
The case for the Nifty bulls is not clear-cut. That is so as the index made a lower low on Friday before rallying in the final hours of trading. That was the first lower low of the week. In a bull market, prices make a series of higher highs and higher lows. A higher low happens when the latest low in price is higher than the previous low. A higher high happens when the latest high in price is higher than the previous high. The first threat to a bull market is when the price, after making a series of higher highs and higher lows, makes the first lower low, which is what happened to the Nifty on Friday.
So the Nifty trader right now is getting mixed signals from the markets. The global markets are giving the green signal, but the Nifty itself is flashing amber. Given the weak rally in the index compared to the global markets, the lower low and the inability to clear resistance is advising caution for the Indian trader. However, the rally in the S&P 500 and recent broadening formation signals that the Nifty can rally higher.
Traders who bought based on our identification of support in last week's article should stay put with a stop below the latest low. People who did not enter last week are late to the rally. But they could still buy with a stop below Friday's low and hope for a rally or be stopped out with a small loss. Hopefully for bulls the broadening trend of the Nifty and S&P price action could bring some gains over the next few weeks.
George Albert is Editor, www.capturetrends.com