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Markets clueless on direction, this isn't the time for bravado

The markets broke the support level mentioned in last week's article and have paused at a lower level. From a medium term perspective the markets seem to be consolidating before making their next move.

Consolidation periods tend to be difficult to trade in due to lack of up or down trends. The market has held on surprisingly well in the light of the disappointing Reserve Bank's credit policy. The market wanted a rate cut but the Reserve Bank held steady, given the inflation and rupee scenarios. Ideally one would have expected a deeper fall with the indexes slicing through a few support levels, given the market's disappointment, but only one support level was broken.

Reuters

Reuters

In last week's article we had shown the gap support levels of the Nifty and Sensex, stating that the latter is stronger. Support levels are areas where the demand for a stock far exceeds supply, leading to a rally in price. To read more about gap support level please check last week's article.

Unfortunately, the support level mentioned in last week's article did not hold and the price fell to a lower support level and stayed steady there. There are several reasons why the support level might not have held, but we feel the key reason is the fact that the support level was close to a resistance level, which pushed prices down. In essence the resistance level was much stronger than the support level. Resistance levels are areas where the supply of stock exceeds demand, leading to a fall in price.

Let us take a look at the charts to analyse the market. The chart on the top is that of the Nifty and the one below is the Sensex. We have left the lines on the chart from last week. The broken blue line was the first level of gap support that was broken. Notice that prices went lower to the next support level and have held steady for the last three days. Nifty being weaker has gone deeper in the lower gap support level than the Sensex, which just touched it.

Combined Chart

Combined Chart

The support levels on both the indexes right now are shown by the solid blue lines. If that support level is broken prices can go down to the next level marked by the white lines. The single green line at the bottom of the chart is a strong support level, which has held since April of this year.

So where does the market go from here? We think the indexes are in a consolidation pattern, unless the green support line is broken or the Sensex breaks its May high. On the higher side, the Sensex has to break the May high to invalidate the consolidation pattern. A look at the chart shows the consolidation pattern. Notice that the indexes have been making higher lows and lower highs. A higher low happens when the latest low in price is higher than the most recent low and a lower high happens when the latest high in price is lower than the most recent high. This shows a narrowing price action, indicating that the market is not clear about future direction. The higher lows are shown by green arrows and the lower highs by the red arrows on the chart.

There is also an unconfirmed uptrend line forming on both charts, as shown by the red up-sloping line. The line has been touched twice and needs to be touched one more time and result in a bounce for the uptrend line to be confirmed. That line could also act as support and the Nifty is quite close to it. Generally, the weaker index tests support levels. In the case of the Nifty the uptrend line also converges with the white horizontal lines of support, which could be touched early next week. A convergence makes a support stronger.

Trading consolidating markets can be difficult so it's wise to book at least partial profits early so that a stop-loss trigger on the rest of the position does not lead to a loss.