Why Nifty is below all-time highs and trailing global indices

The Nasdaq, the Dow, the German Dax and few other global indices have slowly and steadily gone above their pre-recession highs, but not the Nifty. The Indian index made an attempt to cross its all-time high in November 2010 but failed. It has since not been able to reach these highs again.

So despite the Indian economy growing faster than the US or Europe, why is the Nifty unable to break out to new highs? There are a lot of fundamental reasons like high inflation, huge deficits, weak currency, bad government policies, tight money, etc. But we would like to focus on the charts that give us a few reasons: strong and not gradual rallies, and a base or price consolidation that is too long.

Each time we write an article without commenting on the current situation of the Nifty there are emails asking for buy and sell points on the index. So here is the chart of the Nifty ( click here for the Nifty chart) with the red lines showing the sell/short zones and the green lines showing the buy/buy-to-cover zones.

Now let’s get back to main focus of the article. Why is the Nifty still languishing below its all-time highs? To better understand our rationale we will look at the combined chart of the Nifty and the Dow ( Click here for the combined chart of the Nifty and Dow .) The chart on the top is that of the Nifty and the one below is that of the Dow. We are looking at a monthly chart to get a long-term perspective. Each candle on the chart represents the price movement for one month. The blue horizontal line shows the all-time highs of both indices. You can see that the Dow has made a new high but the Nifty has not.

Fast rallies or selloffs generally tend to be reversed, sometimes with equal speed. The sustainable rallies and selloffs are the ones that move steadily, forming bases along the way. What are bases? Bases are areas of consolidation where prices move sideways before making the next strong up or down move. They are essentially areas of price equilibrium where the number of buyers equal the number of sellers, which gives no reason for the price to move away in either direction. It is only when there is a imbalance of sellers or buyers that prices move in search of equilibrium.

Now when there is a strong rally, it means that the number of buyers far exceeds sellers. Since current buyers are future sellers, when prices begin to drop there more potential sellers leading to strong selloff. It is only when there are bases or areas of equilibrium that selloffs or rallies move in a steady fashion.

Let us look at the charts. First, on the Dow chart you’ll notice an arrow pointing in two directions. On the left you will see that prices fell like a rock and on the right you’ll notice that it rallied back up without a correction. The lack of any base resulted in prices going back up again without a pause. The first pause was when the the Dow hit a base, as shown by the blue square marked 1 (one). The market pause is shown by the blue box marked 2. If you look to the left of box 1, you will notice that the Dow feels steady forming bases along the way. The rise too has been steady for the Dow with rallies being stopped and corrected by the bases formed left of box 1.

Now let us look at the rallies and selloffs of the Nifty. The bottom two-sided arrow shows the last fall of the Nifty and quick recovery. Notice that prices only stopped rallying at base area 3, which was resistance given by base area 2. Then look at the long arrow on the top. The left side points to the sharp drop in 2008 and the consequent sharp rally in 2010. And next to that you will see that the sharp rally was reversed by a sharp drop shown by the arrow under box 5.

We feel that the Nifty would have broken to new highs if the final rise in 2010 was slow and steady. However, a sharp rise led to a fall in the Nifty and brought it back down to the base 4 level to form a new base level 6.

Remember, rising markets rally and fall back to test newly formed bases and if they hold the rally continues. So if you take a look at the Dow chart, base 3 was tested by base 4, which was tested by base 5, which was tested by base 6. Finally Dow went ahead and made a new high.

However, in the case of Nifty, it came down to base 4 level and got stuck for a very long time to form base 6. This is so as base 4 was a long one lasting many months. A look at the Dow bases will show that these were short, lasting two or three months. If prices were at equilibrium for a long time at one level, they tend to do the same when prices fall back to it. Why would prices move if they have reached a comfortable area of equilibrium. Due the long time spent at base 6, Nifty lost its momentum and Dow raced ahead.

Finally, the Nifty broke out of base 6 and is now retesting it. Hopefully, it will not get sucked into the area of equilibrium again and rally higher. But remember it has to clear base 5 before making any new highs. So it was long consolidation of base 4 and strong rally before base 5 that did Nifty in.

George Albert is Editor, www.capturetrends.com