Nifty enters a bullish zone, and a bounce is expected

By George Albert

The sharp selloff in the Nifty in the week to 31 August has taken it to a bullish zone from where it could bounce back when the markets open on Monday. A sharp rally in the US and European markets will provide additional confidence to bulls in India.

The rally in the US was driven by renewed hopes that the Federal Reserve would pump more money into the system after Fed chief Ben Bernanke spoke at meeting of central bankers at Jackson Hole, Wyoming in the US. While he has said nothing new, it eased fears in the markets that the recent positive economic numbers in the US would not stop the Fed from easing some more.

Leading the surge. Reuters

The US and European markets do have an effect on Indian equities, but Nifty last week entered a bullish zone which will be the most important reason for the bounce. A bullish zone is essentially an area of support where the demand for an asset exceeds supply. This leads to a rally in price. A look at the chart gives us a clearer picture of the bullish zone. (click here for the Nifty Chart ). The support zone (5,220 to 5,258) is marked by the two green horizontal lines on the chart.

The reason this zone is bullish is because prices created a gap and then continued to rally. A gap happens in the market when the price closes at a certain level and then opens at a different level the next trading day. If prices open higher, then the gap is considered bullish. The gap on the Nifty is an up-gap and is shown by the blue arrow. Prices gap higher when demand exceeds supply exponentially. A lack of sellers forces prices up as buyers seek them out. The rally from a gap shows that market players consider it a good price to buy. Thus, when prices come back to it there is often a bounce.

You will notice on the chart that when Nifty reached the support zone it rallied once and then sold off the next day to come back down to that level. Given the fact that gaps are strong bullish zones, we could see a rally again. The continuation of the rally could see prices touching resistance levels - as shown by the red lines. Resistance levels are areas where the supply of an asset exceeds demand, leading to a drop in price. Ideally, traders buying at the support zone should get out of their positions gradually at each of the resistance levels to lock in profits and let the balance of the position run for higher profits.

Simultaneously, traders should move their stop-loss levels to prevent losing profits or making huge losses. A stop-loss is an automated order that gets a trader out of a position once a specified price level is hit.

The larger the gap, the stronger the support. The gap where the Nifty is right now looks like a strong level due its wide zone of nearly 40 points. That also creates a disadvantage for bulls as it does not give a good point of entry. One can enter into a buy position anywhere in the range and it's possible that the Nifty can go all the way down to the bottom of the gap. Now if someone bought at the top end of the gap, they'd be sweating as the markets went lower. They'd also not have a good entry price, and hence a lower profit potential.

On the other hand, traders waiting for prices to go lower before entering a buy position may be left behind as the price could rally before touching their level. The other disadvantage of this gap level is that unless prices close below 5,164, as shown by the blue horizontal line, prices could still rally. This creates a huge range before the price could rally.

But if prices don't rally, people buying at the top green line at 5,258 would have a stop at 5,164, leading to a huge loss. We'd use 5,164 as a stop as price can rally as long as it does not close below that level.

So how does one resolve this problem? We'd wait for the commodity channel index (CCI) to move up and close above negative 100.The CCI shown at the bottom of the chart is now at negative 163. If prices are still in the bullish zone and the CCI moves above positive 100, one could go long.

George Albert is Editor,

Updated Date: Dec 20, 2014 19:42 PM

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