Tuesday, August 13, 2013

Case Study of Double Tops Signals Huge Nifty Fall

It's been a long long time since I posted last and it does call for an apology on my part, specially to my regular readers. But all this while, even while I was away, the Nifty was still following what we had predicted. In my last post, I had suggested that an upswing was expected which had a target of between 6090-6140. I had also mentioned that we should book profits above 6080 and should take a short position from there for targets of 4300 and below. And the Nifty did turn around from 6093 and has been moving down ever since and it has even crossed the previous low of 5570 it had made in June this year, clearly indicating the beginning of a new bear market.

All these predictions can be done by using Technical Analysis. And technical analysis is all about understanding the charts. The charts have a language of their own and we just need to understand that language and once we have understood that, the market will tell us before taking a direction. Even an amateur can become a professional technical analyst and I've trained many such people who have changed their lives because of Technical Analysis. Contact me if you are interested in learning the language of charts.

Technical Analysis actually works on the assumption that history repeats itself. In simple words, it means that if a set of investors react in a certain manner to certain circumstances then they will react exactly in the same way if they are put in the same circumstances as before. This essentially means that if we identify similar circumstances the charts too will make similar patterns. And that is the reason why patterns like head and shoulders, double tops and bottoms, triangles, rectangles, flags, etc. work. But these were examples of patterns which are given a name. In fact there are countless other patterns which repeat themselves but they do not have a name. Today, I'm going to emphasize more on Double Tops because the pattern that we will be looking at resembles a Double Top.

But before I actually go into it, let me explain what a Double Top is. A double top is a pattern where the prices make a top at the same price or in the same region. Essentially, it's a reversal pattern which reverses the earlier trend that a price movement has. Please understand that both the tops should be very close to each other when seen on the charts. It is formed when prices are in a strong uptrend and they go on to make a top. Then the prices start retracing and there is a decent correction to the preceding uptrend. The prices then start rising again and make another top just above or just below the previous top and start retracing again. Things start getting ugly when prices go below the low that was made between these two tops. One can find the target too from such patterns. It is usually the same distance below the low as the distance between the first top and the low made after that. Lets study this pattern along with a few chart examples.

Attached above is a combination of two charts which shows the hourly chart of Dow Jones Industrial Average and a weekly chart of the Nifty. The chart patterns in both the charts seem to be similar. No two charts can exactly be the same but the patterns can be somewhat similar. And these charts do look similar. Now since Dow Jones was an hourly chart and the Nifty is a weekly chart, we already know where the Dow Jones went but the same has not been seen on the Nifty yet. To see what happened in the Dow Jones after that, look at the chart below.

Dow Jones had made a high of 15294 and the correction was quite deep to bring it down to 14875, a drop of about 420 points. The prices start to rally again and go on to touch a high of 15279, just 15 points short of the previous high. The next decline was fast and was quick and the moment the prices went below 14875 we had a target and that was about 420 points lower than 14875. That gave us a price target of about 14455. And as can be seen from the charts, the prices made a low of 14475, just 20 points short of the target given by the pattern.

Another similarity can be seen with the price of Crude. Now, the chart shown of Crude Oil is the futures chart and futures chart don't exactly follow the principles of Technical Analysis because of the time decay in futures but the chart is close enough to get a general idea. The chart below is the weekly chart of Nifty and below that is the 15 minute chart of Crude Oil. The resemblance in both the charts is unmistakable. A huge rise first and then some correction to the prices. The bulls take control of the situation again and try a test of the previous high. They manage to come quite close but then lose control and the bears sit in the driver's seat now. The fall below the previous low brings them close to the target that was given. Since this was the 15 minutes chart of the Crude Oil, we can see what had happened after this. See the chart below.

Attached below is the 15 minute chart of the Crude Oil after this double top pattern was completed and one can see the ensuing loss in the chart. The prices had started rallying from a low of 6175 in Crude and had gone on to touch a high of 6637 on 2nd August, a rise of 462 points. A correction to this rise comes along the prices make a low of 6473 just 3 days later, a drop of 164 points, a correction of almost 35% of the previous rise. The prices start rallying again and this time touch a high of 6623, just 14 points away from the previous top. And when the bears gathered momentum and prices came below 6473 we had a target equivalent to 164 points below 6473 which is 6309. This decline is much sharper and achieves 6208.

If both these charts show the same type of price movement, lets analyse what can happen in the Nifty. The Nifty had started rising from 2227 in October 2008 and touched a high of 6338 in 2010, a rise of 4111 points. This huge rise was then interrupted by a decline to 4534 in December 2011, a drop of 1804 points from the top. The ensuing rally took the prices back up to 6229 this time, just 109 points short of the previous top. This difference seems to be quite a lot because it is a weekly chart but a look at the chart shows that these tops are not very far apart. Now the decline has started. I already have a target of at least 4300. Which means if this double top pattern is confirmed below 4534 we shall get a target of at least 1804 points below 4534 which gives us a target of 2730. Of course, this target may be achieved, or the prices may choose to exceed or fall short of achieving this target, but there is a huge possibility of a heavy fall in the Nifty in the coming months. I would put the target between the 3000 and 3500 levels though 2500-2700 also cannot be ruled out. It definitely will pay to be extremely cautious in the markets.

But since this target is on the weekly charts, it may take about a year for this target to be achieved. In between short spurts or dead cat bounces or bear market rallies will keep happening. Another such rally may take place now which could take the Nifty back to 5800-5900 levels.

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