A good time for equity bulls to book profits

The Sensex and Nifty are both hovering at resistance levels making it a great level to short the market. The Sensex is deeper into the resistance zone than the Nifty and the bond markets are not in step with equities.

Resistance levels are areas where the supply of stock exceeds demand leading to a drop in price. Support levels, on the other hand, are price points where demand exceeds supply leading to a drop in price.

A look at the chart will show that the Sensex is deeper into the resistance level than the Nifty.

The chart on the top is that of the Nifty and the one on the bottom is the Sensex. Notice that the Sensex is at the top red horizontal line while the Nifty has yet to touch its bottom line. The space between the red lines shows the resistance zone.

The fact that the Nifty is a little shy of resistance shows that it is weaker than the Sensex. A weaker index is a better candidate for shorting than the stronger candidate as they tend to fall much more in percentage terms. It is possible for the markets to fall from here or go higher to the white lines marked on the chart and then correct.

That both the indexes are at resistance means this is not good place to buy, though. It is, however, a high profit potential level of short the indexes.

Bonds and equities out of sync

Another reason we are apprehensive about going long now is that the bond market has not joined the equity market’s celebration. Let us look at the combined chart of the 10 year US Treasury (UST) and the Nifty.

Notice that from the most recent bottom the Nifty rose almost 8 percent but the 10-year UST only rallied 2.06 percent. It is true that the equities are more parabolic than bond but the differential is huge.

Also notice that equities fell by 10 percent while the UST fell by 6.2 percent. So the differential between the fall of equities and UST is less than double the rise in equity.

That euphoria is a cause for concern. Bonds are often an early indicator of what the equity markets could do. Look at the blue horizontal lines on the charts that market turning points in both markets. The bond markets fell much before the equity markets did.

Then the bonds stabilised and equity markets rallied. UST then had a brief fall but equities went sideways. After the UST began to rise up slowly the equity markets celebrated.

UST prices are holding support, which is giving equity bulls a reason to rejoice. However, if the bond markets break support and fall one could see equities catching up rather quickly.

Hence it is a good time for equity bulls to take a profit. Prices are at resistance anyway. And why not take a chance on short equity position given the lack luster rally in bonds.