Saturday, April 20, 2013

Nifty Entering Resistance Zone - Buy Puts

In the last four days the Nifty has shown an amazing bounce-back from a low of 5500 to a high of 5794.35, a movement of almost 300 points. That is an excellent bounce-back, especially when we were expecting the Nifty to go lower to 5200 levels. Well, we are still looking at those targets, this is just a temporary pullback that we are seeing. The pullback was expected, especially on seeing the support the Nifty was finding near the 5500 levels. Negative news including the Infosys results failed to take the index below the 5500 levels. I had warned about the pullback on this site too when I said that it is time to be careful. This warning was given earlier but since it did not come about that time, it came now.

The fundamental situation has changed since the last time we posted. Gold prices have fallen down and so has the crude. Suddenly, the Indian economy wasn't looking as bad as it seemed just week back. How exactly do the Gold and Crude prices affect the Indian economy is a matter of discussion for another article. Due to this 'perceived improvement' in the economical picture, this bounce-back was very much likely. 

However, there are some important things that one needs to see about this bounce-back, specially the fact how it respected the Fibonacci levels. The Nifty has come down from a high of 6111.80 in January to 5477.20 recently, a drop of 634.60 points. 50% (a Fibonacci level) of this move happens to be 317.30 points. If added back to the low made at 5477.20, we get 5794.50 as the 50% Fibonacci resistance level. As, already mentioned, the high made by Nifty was 5794.35. I have seen the markets respecting Fibonacci levels but not with such precision. And while you are still in awe, here's another one. In the last pullback, the Nifty had made a high of 5971.20 in mid-March and now a low of 5477.20, a drop of 494 points. A very important Fibonacci level happens to be the 61.8% retracement level. 61.8% of 494 translates to 305.30 points. When this 305.30 is added back to the low of 5477.20 we get 5782.50. And guess, what was the closing price of Nifty on Thursday? It was 5783.10. Isn't it fascinating? If you want to know more about Fibonacci, click here for a webinar on Fibonacci levels.


Let's get down to specifics now. And by specifics, I mean the charts. Attached above is the daily chart of Nifty. While the Fibonacci levels are not shown on this chart, there are two other brown coloured trendlines shown above and there is the Relative Strength Index (RSI) shown at the bottom of the chart. Of the two trendlines shown, one is a horizontal line at a level of 5825 and the other is a downward sloping trendline connecting the January and the March highs extended till now. This trendline also on Monday (when the markets open) will be at a level of between 5835-5840. The other line has also proved to be a pretty strong trendline which connects many points including the October 2012 highs and the December 2012 lows. At the current position, the Nifty is just within touching distance of those two trendlines. Looking at the RSI, it is currently at a level of 57.81. If the Nifty really is bearish, the RSI should not be able to cross 60. So, my guess is that Nifty will go upto the 5825-5840 resistance zone, while it takes the RSI up to 60 and we should see a reversal from those levels. 

The Strategy:

One important thing that I missed telling you was that there was another high made on 2nd April at 5754, which was now taken out by the Nifty on its rise to 5794. This brings the Nifty into an intermediate term uptrend, though, if we strictly follow the Dow theory, it still has not been confirmed as yet. Even if the Nifty does go into the resistance zone of 5825-5840, it would be risky to sell a thing which is in an intermediate term uptrend. Short positions should only be created on signs of a reversal or when the trend is pointing downwards. In this particular case, we have neither. 

We should not take undue risk, as technical analysis is not about taking extra risk, it is only about maximizing your returns with the minimum amount of risk. Slightly deviating from the topic but here's a small commercial for you. If you want to learn more about technical analysis and want to learn it in a structured way and learn how to earn maximum profits from technical analysis with minimum risk, why don't you register yourself for my next batch of online course on technical analysis? This batch is due to start in the first week of June, though, dates have not been decided as yet. As always, the first three registrations get a full 10% early bird discount on the course fee. For registrations you can send a mail on vikas@sharma.es.

Coming back to our strategy, to take the minimum risk, I think it would be best to buy Nifty 5700 or 5800 puts expiring in the month of May (the April expiry being too close). The 5700 put was trading near 75 on Thursday while the 5800 put closed at 114.10. I suggest, you should buy two puts, one to be covered when we make a decent profit (on signs of another bounce-back) and the other to be covered only when we achieve our next target of 5200 on the Nifty. While we have a risk of only 114, if the Nifty does go down to 5200, we will be recovering a good 600 points on expiry thus giving us a clean profit of 486 points. This means a risk-reward-ratio of 1:4.26, which is extremely good for our trading profits.

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Happy trading!!!