'Focus on capital protection'

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“A man has to guard against many things, and most of all against himself – that is, against human nature”- Jesse Livermore

The above quote is one of the guiding principles of trading. Our emotions are the biggest hindrances towards objective analysis of the markets. The correction in 2011 and sharp swings in the current year would perplex most traders. Discipline in trading was never more essential than it is now!

Richard D Wyckoff, a great trader and a pioneer of technical analysis, had defined broad guidelines to study the market cycles. It is evident and highly probable that the price correction phase was over with December 2011 lows and we have now entered an ‘accumulation phase’, which has the tendency to remain in a trading range for a long time. In this phase, trend-following systems face a lot of trouble as the trading range develops and the reversion to the mean becomes a norm. Currently, the Nifty has formed a trading range of 4,800-5,500 and now the markets are reverting from the upper band of the range. The emphasis now should be clearly on capital protection and therefore, the positions should be nimble and stops should be followed diligently.

Medium-term trend
The medium-term trend in the market shows a silver lining in the dark clouds. The weekly chart of the Nifty has depicted that the downward series of lower peaks and lower troughs has been broken. The June 2012 low in the Nifty was marginally above the December 2011 low, which is encouraging. This confirms the Nifty has started a process of base formation, after being in corrective mode for the entire 2011. The market seems to have moved out of a bear phase and is now in a consolidation phase.

Short-term trend
The Nifty started an uptrend in the beginning of June, which is now facing tremendous resistance. The resilience, being witnessed near 5,300 levels, has now been followed by strong profit taking that has the potential to put the index down to the 200-DMA (daily moving average) level, which is at 5,091.

The formation of a ‘Falling Window’ on July 12 was the first indication that the uptrend which started in June is now getting exhausted. Formation of a doji on June 12 and a following ‘outside bar’ confirm the weakness in the trend. The immediate support is at the ‘rising window’ support placed at 5,159-5,189 levels, while the 5,300-level would offer stiff resistance.

The daily chart of the Nifty has formed a ‘rising wedge’ from which prices have broken down. The breakdown comes after witnessing a negative divergence on the daily RSI. The pattern has bearish implications and suggests a short-term trading strategy of selling on strength.

Momentum oscillator MACD (moving average convergence divergence) has rolled bearish on the daily chart. However, the weekly set-up is bullish and is turning positive indicating a corrective move within a larger uptrend.

Trading strategy for the week
For the current week, we expect the Nifty to open close to 5,280 and gradually move lower towards the 38.2 per cent retracement level of 5,125 and possibly test the 200-DMA at below 5,100. Immediate upside is capped at 5,333 and should be used as a stop-loss for trading shorts.

 

The author is Head-Technical Research, Edelweiss Securities