The Nifty lost its bullish power and is now back at support by not catching a significant bounce. On the contrary, the index is hammering away at support, which is weakening that level, making it more susceptible to a breakdown.
Support levels are areas where demand exceeds supply, leading to a rally in price. However, if sellers bring prices down to the support level several times, it says a few things. Sellers are strong and buyers are weak. If sellers can successfully bring prices down multiple times, eventually the number of willing buyers will be exhausted and the index will break support. Only after the support level is broken can we say that bears won both - the battles and the war.
Before we go to the chart, we must mention that the markets in the US closed substantially lower on Friday. The tech-heavy Nasdaq 100 dropped 2.4 percent and the broad-based S&P 500 Dow dropped 1.66 percent. This will have a ripple effect on the markets in India on Monday. But we are not sure if the Nifty will break support on Monday due to the fall in the US.
In the US, the Nasdaq 100, which has been leading the markets down, broke a key support level on Friday, which means a further selloff in future is possible.
Now let's get to the Nifty chart (click here for Nifty chart). If you look at the chart you'll notice that we have not changed the horizontal lines, the text and arrows since the last time we published the image two weeks ago. The index had broken out of the lower resistance zone and was heading higher to the next resistance zone. The index, however, turned before hitting the next level. There is a reason for this and we will get to it later in the article.
For now, notice that the index sold off and is stopped by the support at 5,630, as shown by the blue horizontal line which we had marked two week ago. That is a strong support area as it was resistance twice in the recent past and acted as support in early October and is now acting as support again. Given the bleeding in the US and European markets, it's very possible that the Nifty will test the support again and possibly break. But remember that the index has to close below the 5,630 level for the next round of selling to take hold.
A break of that level can take the Nifty down to the next support level between 5,555 and 5,575. Below that is a huge gap between 5,438 and 5,525. The gap is shown by the green arrow. A gap happens when the index closes at a certain level and opens the next day at a different level. Gaps show areas of extreme demand and supply imbalances.
In the case of the Nifty gap the demand was so high and supply so low that the price had to rally much higher in search of sellers. Given the extreme demand in that area, we could see a rally once prices drop to that level. Even the higher level of support between 5,555 and 5,575 is a gap of 20 points. But the lower level has a much wider 87-point gap, which shows greater demand than the 20-point gap.
So let's finally get to the reason why the Nifty sold off before hitting its resistance level. The markets and the indexes are correlated. So if one index hits resistance first and turns the other will turn too, even if it does not hit resistance. The Sensex and Nifty are closely correlated and a look at the Sensex chart (click here for Sensex Chart) will show that the index hit resistance and turned, taking the Nifty down with it. The resistance level was from July 2011. The Nifty has already cleared its July 2011 resistance and was heading to its April 2011 resistance level, but it could not head higher as the Sensex refused to follow.
When analysing the markets, it's important to look at correlations to gain better trading precision. In this case Nifty traders not looking at the Sensex would have been flummoxed as to why the index suddenly turned lower.
George Albert is, Editor www.capturetrends.com