Nifty & S&P: May selloff didn't happen, but June looks bearish

They say sell in May and go away. But it did not work this May. So maybe the new truism should be sell in May and wait for June. And it could well be true as the long-term monthly chart formed a bearish candlestick pattern.

Both the Nifty in India and the S&P 500 in the US have formed a topping tails formation on the monthly charts. In all probability it could be the tail that wags the market. Topping tails are essentially bearish signals and bottoming tails are bullish ones. Let us look at the combined chart of the Nifty and SPY, the exchange traded fund that tracks the mighty S&P 500 index. ( See chart below)

The Nifty chart is on top and the S&P 500 chart at the bottom. Notice that the white arrows at extreme right point to the topping tails. The topping tails are bearish as they show that buyers tried to push the prices up, but the sellers were successful in beating the price down. The bearish tail on the Nifty is much stronger than the SPY. This is so as the body of Nifty’s May candle is much smaller than that of the SPY. But that should not be a surprise as the SPY has been stronger than the Nifty with the former reaching new highs, but Nifty has not breached its former all time highs.

The longer the tail the greater the chance of a deeper selloff. Most traders would go short if the price closed below the May lows, which is a confirmation that the downtrend is established. However, for such a play the stop-loss will be very wide as it will be above the May highs. This exposes the bearish trader to a huge loss. Ideally, one should go to the short term charts and find a stop above a daily high and short when prices rally a bit. So in the case of the Nifty, we’d ideally wait for prices to rally up to the 6,070 level before shorting with a stop above 6,140. In the case of SPY, we’d short at $166 with a stop above $168.

Now let’s take a look at the other times the markets made long tails and the price action after that event. On the Nifty chart, the extreme left arrow shows the bottoming tail which is bullish. After the tail was formed the Nifty rallied to touch its previous all-time highs. The white arrow in the middle shows a topping tail that led to the fall in the Nifty. SPY too has a similar example, as shown by the arrow on the left. Notice that after the tail was formed the SPY did go down but never closed below the tail and then rallied to new all-time highs.

Topping and bottoming tails on a monthly chart are pretty rare and show a strong potential of a trend reversal when it happens at the bottom or top of the chart. Tails in the middle of a trend indicate the possibility of price acceleration.

Bears should, however, remember that central banks around the globe are standing by to pump up the markets will even more liquidity. This could reverse any nascent bearish trend. However, the perspective in markets is that the central banks can’t continue to print money forever without damaging the trust in fiat currencies. In fact, the Federal Reserve is thinking of ways to scale back the accommodation made to the markets. Then, of course, we have the Nikkei, which had a huge 14 percent fall this month despite all the easing by the Japanese Central Bank. Bears point to that fall and say even central banks have limits.