Two veteran chartists thrash out the prospects for stocks. Milind Karandikar says it is time to prepare for slow rallies and swift falls, while Devangshu Datta feels markets will trade in a range over the next six months.

"Where will the market be in January 2007?" I've been asked variations of this simple question ever since the sell-off began a couple of weeks ago. The answer depends on a related question, which is also simple but impossible to answer with certainty at this moment:

Is the major bull market over?

We don't know. The market entered a strong intermediate downtrend on May 12 after hitting an all time high of 3774 Nifty. That downtrend found support at an intra-day low of 2896 on May 22. If the 2896 support holds, the bull trend is not over.

In that case, we may see Nifty levels in excess of 3775, possibly in excess of 4000 by the year-end. At the very least, if the 2896 support holds, the market will range-trade between 3000 and 3700 in the next four-six months.

Potential bad news

If the 2896 support breaks, we are probably in a long-term bear market and, in that case, we could see prices heading lower and, finally, settling somewhere into a bottom between 2250 and 2550 sometime in the first half of calendar 2007.

If things get really bad, the market could bottom lower, somewhere in the 1900 range, and it may trend down for the next year or so. If the support breaks, it is likely to happen quite soon. Probably within the June settlement and, definitely, by July. If the market stays above 2900 until July, the 2006 bull market is almost certainly alive.

Key support

That 2895 support is important for several reasons. By definition, trend changes are signalled by a sequence of lower bottoms. Therefore, if it is not breached, the trend has not changed.

Second, the 200 day-moving average is hovering somewhere in the 2900 region. The 200 DMA is a reliable lagging indicator of a long-term trend. If prices move below the 200 DMA, we are usually in a bear market.

Thus far, the 200 DMA support has held, as it did in April-May 2005 and, also in October 2005, on the last two intermediate corrections.

The third reason has to do with trendlines connecting successive dips. Trendlines are cruder indicators of support than MAs but in this case, they reinforce our feeling about the importance of the 2895 support.

If we examine weekly prices and draw a trendline connecting the lows of April 29, 2005 (1902 Nifty) and the lows of October 28, 2005 (2316), that 23 degree angle trendline indicates support runs just below 2900.

Once again, this suggests that if the 2895 support holds and this weekly trendline remains intact, the bull market remains alive.

The good news

Well, the 2890 support hasn't broken and prices don't appear to be under quite as much pressure as before the derivative settlement.

On short-term and intermediate indicators, the market appears quite oversold so a rise or a sideways movement is more likely than another plunge below 2900. I will tentatively assume that the long-term trend remains intact. One way or another, this is likely to be confirmed within the next six-eight weeks.

Sideways movement

The likeliest projection over the next three-four months seems a sideways movement and consolidation between 3000 and 3600. Once again, I am making this judgment partially on the basis of weekly price trends.

The Nifty is trading well above that weekly trendline now and it may need to find support and bounce off that support again before it can once more challenge the heights of 3775.

Volumes have eased off without totally vanishing and this is another sign of a likely sideways movement. We will need another phase of powerful delivery-based buying before the market is ready to move up.

My best guess is that somewhere around September 2006, the market will find support in the 3250 region and start to move up again with greater strength. It will probably not be capable of challenging the 3775 top until the last quarter of the calendar year.

Sideways movements are the most difficult and ambiguous to interpret. There will be phases when the market appears to be getting bearish and phases where it appears to be on the verge of getting bullish. This could be very dangerous and frustrating, but it is better than an outright bear market.

When everyone was waiting for a correction during the unprecedented rally of about 5,000 points from the bottom of 7,656, in the Sensex, in October 2005, it never really happened. Then everyone thought he understood the market thoroughly and the rally would never end.

By the time a majority of the market participants could realise their mistake, the market took the lead in 'correcting' itself and gave no chance to them to correct their mistake.

The severe jolt that they received forced the bulls to square off their F&O position and damage many portfolios. It looked like a giant leap of the economy backward and the authorities had to take a note.

As I have always mentioned in my earlier articles that perceptions of the economy can suddenly change leading to such violent market movements and, technically, they signal the beginning of a new psychological pattern.

The fall of October 2005, which also appeared to be the advent of a new pattern, was completely deceptive. The market turned up thereafter and continued to move up for the next six months. But the recent fall in all the market indices is much more violent and qualifies more for 'the beginning' of a new trend.

Technical outlook

The rally from May 2003 is probably taking the shape of a pattern called 'diametric formation'.

This pattern can take the shape of a bow tie (contraction followed by expansion) or the shape of a diamond (expansion followed by contraction). In the Indian market, this rally seems to form a huge bow tie-shaped diametric formation.

With the fall of the indices in October 2005, I had assumed wave (e) of this pattern to be over. But that assumption turned out to be wrong, with the market scaling new highs for the next six months. In other words, the fall of October 2005 now looks like a part of wave (e) that started in May 2005.

The fall of the Sensex from 12,671 to 9,826 has been the fastest and the biggest fall in the recent times and, hence, wave (e) can be assumed to be over.

Now the question arises: What shape will wave (f) take? Such a violent crash, which has retraced close to 38.2 per cent of wave (e) (one-year rally) in just seven days, would most probably be the beginning of a huge consolidation phase.

According to NEowave theory, such a crash suggests the beginning of a triangle, either contracting or expanding. Since the larger degree pattern is now expanding in size, an expanding triangle fits better in the scenario. It may also turn out to be horizontal diametric formation.

The market is supreme and will decide its due course. NEowave theory only suggests that a huge sideways corrective phase, extending over a year, is probably in the offing.

I personally don't think that the long-term trend has reversed. The corrective phase mentioned above, i.e. wave (f), would then be followed by wave (g), which value-wise would probably be the biggest ever rally in the history.

Investment perspective

If my interpretation is correct, there are clearly only short-term investment opportunities and, that too, in certain sectors. One would have to be very careful in selecting the stocks.

The sectors, which have been in consolidation for a long time, may give an upward breakout. Whereas the sectors that have appreciated substantially over the last one year may stagnate.

There is a chance that during this consolidation phase one would witness very slow accumulations (the rallies) and very swift distributions (the falls).

The best strategy for investments would be to accumulate the stocks near the bottom of the range and increase cash positions as the market slowly reaches the top of the range. Right now, it is very difficult to say whether a bottom is in place for the Sensex, at least temporarily.

If the pattern turns out to be an expanding one, then crossing the previous high would trigger a sell signal and crossing the previous low would trigger a buy signal, which is completely contrary to the conventional theories. But that is how this pattern behaves, trapping both the bulls and the bears at the extremes.

Those having a weak heart should stay away from the market for some time and wait for the intra-day volatility to settle. Remember, the market gives opportunities several times, which one should be prepared to grab. A majority of investors are holding cash near the top that they greedily invest and are holding stocks near the bottom, which they fearfully divest.

But that's what a stock market is all about, driven by only two emotions - Greed and Fear.

Milind Karandikar is a Neowave Analyst.

Sensex Rise and Fall: Complete Coverage

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