Nifty and gold will correct, but gold may rally in a bit

Nifty and gold hit technical resistance levels last week and are likely to correct or move sideways. The precious metal and Nifty bounced off strong support levels a couple of weeks back after steep selloffs.

Resistance levels are areas where the supply exceeds demand, leading to a drop in price. Support levels are price zones where demand exceeds supply, causing a rally in price. Let us look at the Nifty (click here for chart). After the Nifty had fallen substantially we had mentioned that it was not the time to sell or short the Nifty, even though the trend looked bearish. This was so as the index had reached a gap support level and was highly likely to bounce. And that's exactly what happened.

Gaps are levels of extreme support or resistance. When prices close at a certain level and then open much higher the next day it creates a gap support. The gap support is shown by the white arrows on the Nifty chart. In the week before, we had marked the resistance zone in red horizontal lines which we have left on this week's chart. Notice that price went into a resistance zone on Thursday and then fell on Friday. Will this be a reversal? One can never be sure. It is likely the prices could go higher into the zone and then fall.

Apart from the supply zone putting a downward pressure on price, Nifty is also being stopped by the Bollinger Bands. The bands are shown by the curving lines. The upper band shows overbought levels, the middle band shows the median levels and the lower band shows oversold levels. You'll notice that the latest bounce in the Nifty happened when index went outside the lower Bollinger Band and also hit gap support. This was a double whammy leading to parabolic move up.

 Nifty and gold will correct, but gold may rally in a bit

Representational Image. Reuters

Look at where the Nifty is now. On Thursday the index went above the upper Bollinger Band, indicating an overbought condition and also hit the resistance zone. This again is a double whammy of resistance. On Friday, the index already reacted and fell. It is still possible for the index to hover in the resistance zone before falling. Right now the highest probability is for the index to fall at least till the middle line of the Bollinger Band. If that line is broken and the line points down we could see the resumption of sell off.

The second probability is that the index could move sideways before choosing a direction. The longer the index hovers at the resistance level, the higher the chances are of its breaking out higher. However, now is not the time to buy into the Nifty, given that price is at resistance. We'd be short the Nifty with a stop above the resistance zone.

Gold: Gold like Nifty reacted to the drop into a strong support zone and also being outside the lower line of the Bollinger bands (click here for the Gold Chart). We are looking at GLD the gold exchange traded fund to analyze gold prices. Gold hit a support level formed in February 2011 and then began its rise two weeks ago.

Notice that gold came up and hit the middle line of the Bollinger Bands. Since the line is sloping down it has acted as resistance. The price also came up to the previous support level which was broken recently. That's the support level from July 2011 which held up gold prices for a long time till it was broken two weeks ago. Previous support levels turn to resistance when prices come back up to it.

Given the sharp fall two weeks back, it's possible for gold to rally further after a correction. It is possible for the GLD index to reach the $148 to $150 level. Prices closed at $140.91 on Friday. In a sharp fall the number of sellers far exceed buyers. Since current sellers are future buyers and current buyers are future sellers, as prices rise one would have far more buyers than sellers. This is one of the reasons sharps falls generally result in a strong rise in price.

Updated Date: Dec 21, 2014 05:01:29 IST