How much could the Nifty correct in February?

The technical view on the market indices is interesting. By definition, a bull market has a succession of higher highs on every uptrend, and higher lows on every correction. In the past seven-eight sessions, the Nifty has reacted by over five per cent from the all time top at 8,996 and found support in the 8,470-8,500 zone.

Several possibilities exist. It could bounce from here, all the way back to test the tops at 9,000. We could expect that to happen if the Budget is well-received and the 9,000-level should be breached if the bull run continues and strengthens. If market participants are more non-committal, the Nifty may range-trade between 8,500 and 8,700 or so. The third possibility is a continuing correction.

It’s normal for February to be bullish. The Budget is declared on the last working day and there is usually some optimism about the Budget. That helps to sustain an uptrend. This year seems unusual in that the sentiment has turned more bearish due to poor global signals. Also, the stunning AAP victory in Delhi Assembly Elections has led to fears that the BJP may turn more populist in its own policies.

How much could the Nifty correct if it does correct at all? There is a case for suggesting that the Nifty could slide till 8,175-8,225, if the current supports break. The prior highs of September 2014 were in that region and that level could provide strong support if there is a correction.

Another way of looking for the possible correction mark is via golden Fibonacci ratios. It is unclear why stock market moves should hit Fibonacci levels. But it happens often enough for these ratios to be considered significant. The key retracement levels are 23.5 per cent, 38.2 per cent, 61.8 per cent with many analysts also considering 50 per cent a significant retracement level.

The last bullish move started in October, from the 7,750 level and the Nifty moved till 9,000. That is a run of some 1,250 points, or 16 per cent rise over a three month period. The Nifty has since corrected by about 530 points - that is by over 40 per cent. It has already exceeded the first two Fibonacci levels. It could correct till 8,370 (50 per cent) or till 8,225 (61.8 per cent).

The second 61.8 retracement level also coincides with the prior high at 8,227. A retracement to 8,227 is therefore, likely. A slide until the 8,225-mark would be a steep correction. But there would be cause for real worry only if the market slid below the "last line" of support much further down, at 7,700-7,800 where the October-January bull run started. That 7,700-7,800 zone is also where the 200 Day Moving Average (200-DMA) for the Nifty is located at present.

A dip below 7,700 would set up a pattern of lower lows, and break the 200-DMA, thus causing anxiety about a big bear market. It is very unlikely that such a down-move would occur in February - it would require a loss of over 10 per cent in less than three weeks.

Index options can be deployed to cover the possibility of a sharp rebound as well as a steep downtrend. A wide long strangle of say, a long 8,900c (34) and a long 8,200p (20) on Tuesday’s closing prices would cover both an up-move and a down-move. Alternatively, if the trader believes the market will settle down and range trade through February, he could sell both those options.

The author is a technical and equity analyst