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Sunday, May 5, 2013

Why Sensex should touch 25000 – a long-term view

When you stand very close to a large tree and look straight at it – all you will see is wood (i.e. the trunk). Step back a few yards, and you will see branches, leaves and flowers. Step back some more, and you may see several trees of different shapes and sizes. Only when you get to the top of a cliff can you see an entire forest full of trees.

Look at Sensex from the beginning of 2013, and you see an index trying to reverse a down trend that shaved off 2000 points (10%). The view from the beginning of 2012 till date shows a bull phase that gained 5000 points (33%). From the beginning of 2011 till date, the Sensex had a bear phase followed by a bull phase, and made zero gains.

Now let us go all the way back to the beginning of 2008. What we get is the ‘cliff view’ of the chart. While the Sensex has made no gains since touching the bull market top, there are three distinct phases visible in the long-term chart of Sensex below:

Sensex_May0313_LT

Phase I: A sharp bear market of about 14 months (from Jan ‘08 to Mar ‘09). The index dropped from 21200 to 7700 within 10 months, followed by 4 months of sideways consolidation.

Phase II: A bull market that began in Mar ‘09 with a quick jump above the 200 day EMA, followed by a large ‘gap’ that opened up after election results in May ‘09. The ‘gap’ was partly filled in Jul ‘09. The next leg of the bull phase was more gradual, and culminated with a slightly lower top of 21100 in Nov ‘10. A ‘diamond’ reversal pattern marked the end of the 20 months long bull phase that retraced the entire fall from Jan ‘08 to Oct ‘08.

Phase III: From the beginning of 2011 till date, Sensex has formed a bullish consolidation pattern known as a ‘cup-and-handle’. The formation of the ‘cup’ took 2 years with the Sensex touching 20200 in Jan ‘13. Note the ‘rounding bottom’ shape of the 200 day EMA that has smoothened out the fluctuations of the ‘cup’. The subsequent correction formed the ‘handle’.

A rise above the ‘rim’ of the ‘cup’ (right edge at 20200) on strong volume support will confirm the successful completion of the ‘cup-and-handle’ pattern, which is usually a continuation pattern in a bull market. The pattern has target measuring implications: the rise above the right edge should equal the depth to the bottom of the ‘cup’.

In this case: 20200 – 15100 (bottom in Dec ‘11) = 5100 (depth of cup from right edge). So, upward target of Sensex: 20200 + 5100 = 25300. 

Caveat: Technical analysis is not a science and the stock market doesn’t understand arithmetic and formulae. However, the ‘gurus’ of technical analysis have suggested the above formula after observing thousands of price charts over many years.

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