Two experts debate the technical prospects for year 2006. One is bullish while the other feels that the market will move sideways over the next six months.

Devagshu Datta

Three consecutive years of strong performance have led to frightening levels of investor-confidence. It is the first time that the Indian markets have witnessed a bull run sustained over such a long period and with a such a broad effect.

In the past three years, the Nifty has moved up by over 175 per cent and this movement has not been one-sided. Previous bull markets have tended to run out of steam inside 12-18 months and usually, as in the IT boom of 1999-2000, one sector has led the way and outperformed everything else by a distance.

However, between 2003-2005, scrips from every sector have delivered decent capital appreciation. The gains have also been well distributed in terms of market cap. Big stocks, small stocks and above all, mid-sized stocks have all done well.

Naturally everyone would like to know the answers to two questions.

• A) Will the Bull Run continue through 2006?
• B) And, assuming it does, is it likely to remain as broad and secular as in 2005?

Before we start delving for the answers, it's important to note there is broad consensus that the Bull Run will continue.

The foreign institutional investors think so -- they have remained net-positive through the first week of 2006 after pumping over $10 billion into Indian equity in 2005. Domestic institutions are positive. And, going by movements in the small caps and mid-caps, the operators and retail traders also appear to be positive.

Contrarians would be braced for an unpleasant surprise in a scenario of such broad consensus. In a nutshell, contrarian theory expects prices to fall when everybody is bullish (and, they expect prices to rise when everybody is bearish). The rationale is simple -- when everybody is bullish, most of the buying that drives stocks up has been committed. (When everybody is bearish, most of the selling is over.)

However, contrarian expectations of a fall in 2006 may not come true because the buying power is not exhausted. If the FIIs wish to, they can certainly pour another $10 billion-plus into the market.

This is a small sum by global investment standards and new FIIs are queuing up to enter Indian equity at this instant.

Domestic financial institutions will also have no problems with raising and deploying cash -- only a miniscule percentage of retail savings is currently invested in stocks. Even retail players can dip into their pockets and increase market exposure.

Recap: We've concentrated on three indices, which provide a decent overall picture. One is the Nifty, which offers coverage of the 50 biggest stocks. The second is the CNX Midcap 200, which tracks midcaps as the name suggests. The third is the NSE 500, which offers a picture of big, mid, and small stocks.

All three indices have powered to all-time highs. Since January 2005, the Nifty has risen 39.4 per cent, the NSE 500 has risen 38.8 per cent and the Midcap 200 has risen 59.6 per cent. Clearly, midcaps have attracted most interest -- perhaps because the FIIs have entered relatively smaller stocks seeking value.

The last correction was in October. During that month, the Nifty declined by 11.3 per cent (open values to monthly lows), the NSE 500 lost 11.7 per cent and the Midcap 200 lost 11 per cent. In the next 9 weeks, all three indices have soared again.

Projections: The long-term trend obviously remains positive. The first rule for any technical trader is to assume a trend remains in force until such time as it is clearly violated. The long-term trend in all segments of the market (sorted by capitalisation) is strongly positive.

Every index is trading way above the respective 200 day moving average and 40-week MA (moving average) as well. While momentum indicators such as the RSI (relative strength index) suggest that the market is overbought, these oscillators have a tendency to stay in the overbought zone for very long periods during a strongly trending bull-market.

There is a negative divergence visible. The 14-week RSIs of all three indices peaked in September and the RSI values are now lower than in September although the price lines are higher. But it would be foolish to call an end to the bull market on this basis alone or to suggest trades against the trend until there's a serious priceline correction.

Time-Price Targets: It would be sensible to assume that the trend remains up and expect more gains for sometime to come at least. We can make a few minimum projections as to price-time targets. All segments of the market are likely to produce between 4-5 per cent gains over the next couple of months.

The Nifty has a pattern that suggests a likely upside of 3050 (current value 2900), and this ought to be hit by mid-February. The NSE 500 has a pattern that suggests a target of 2630 (current value of 2525) and this is likely to be achieved by mid-February.

The Midcap 200 has a price pattern that suggests a minimum target of about 4350 ( current value 4176) and this should be achieved by around Budget (end-February).

These are minimum projections. If the long-term trend survives the uncertainties of the Budget, it could travel a lot further. By definition, a bull market logs a succession of higher highs.

Trading rules: However the price patterns aren't suitable for us to make further target projections beyond the levels and time periods stated above. What we can do fairly easily is establish a set of trading rules that enable us to stay long until such time as the current long-term trends are broken.

The usual practice in a bull market is to use a combination of moving averages and peak-comparisons as trading benchmarks. While the priceline stays above a 200 DMA (or 40WMA if we're looking at weekly prices), the bull-market is likely to stay alive. While the price line continues to register a series of higher highs and higher lows, the trend by definition, stays alive.

In this market, the bullishness has been sustained for too long for the WMA/ DMA to be that useful. The pricelines are all trading way above the long-term averages. Either we lower our MA time-frame to say, 20WMA (100 DMA) or we try and develop some indicator that produces earlier signals.

The 20 WMA does seem to produce useful signals; the previous two corrections in October and April both ended on the support of the 20 WMA. So we could look for a violation of the 20 WMA going forward. If the 20WMA is broken, the bull market is perhaps in trouble.

Another possibility that seems to work fairly well is a trend line joining the lows of April and October. This trend line would need to be violated for the bull-market to decelerate, or reverse direction. If we draw such a trendline on weekly charts, the indicator would be smooth enough not to kick the trader out on a small whipsaw while still being sensitive enough to call a genuine trend reversal.

There are several other indicators one could watch for signs of potential weakness or reversal. One is week-on-week volumes. If volumes show a declining trend over a period of 3-4 weeks, the market will run out of steam. Then, the contrarian logic of 'all the buying is over because everyone is bullish' may come into play.

Another interesting indicator is FII attitude versus domestic mutual fund attitude. The two major institutional segments have often been net buyers at the same time. Once in a while, these parties have been on opposite sides -- the foreigners have bought while the Indians sold, or vice-versa. They have very rarely been net sellers at the same time. If this happens for a month at a stretch, the trend is likely to be forced into complete reversal.

A third indicator to watch would be the direction of indices. So long as the indices are in phase and moving upwards direction together, the overall trend is healthy.  Divergences, such as the Nifty moving up while the Midcap 200 moves down, for example, could be dangerous.

Correction timing: The next major test of the trend will be the Budget. That's when every investor and trader goes into introspection. A good Budget backed by good macro projections might accelerate the uptrend.

A disappointing Budget or GDP data that is poorer than expectations could lead to a severe correction. A bad Budget could kill the bull-run. Be prepared for confusion in March and April anyhow -- every budget leads to a period of chaotic volatility.

If the market pulls through the post-Budget period comfortably, it will continue to run up for the rest of 2006. The five-year CARG for this market (this is a full cycle incorporating the bear market of 2000-2002) is running at about 18-19 per cent. If that is extended by another year, we will witness the Nifty at 3450 levels by January 2007.

Conclusion: The market is in a strong uptrend. This bullishness is distributed across sectors and small as well as large stocks. This is healthy.

In the near-term of the next 2 months, we can expect a minimum return of around 4-5 per cent. Beyond the Budget, price lines are not amenable to direct target projection. However since the market trend is strong, we should continue to see positive returns. The Budget itself holds the largest threat of provoking a trend reversal.

We can establish trading rules using the 20 Week MA (100 Day MA) as a support trendline. Or we can draw trendlines that join the lows of April 2005 and October 2005 and use these as supports.

Any correction that finds support on the 20WMA or the April-October trendline will not cause a major trend reversal.  A support that break these two lines, will probably trigger a new bear-market.<hr>

Milind Karandikar

When everyone thought that the BSE Sensex is headed down at 7656 on 28th October 2005, it reversed violently and still continues in an uptrend. When the FIIs turned net sellers, the mutual funds came to the rescue buying heavily and pushing the index up.

After all, it is always a tug of war between the bulls and the bears and their resultant force that decides the direction of the market.  By using Neowave theory an analyst can try to predict such turning points.

But remember that such predictions are seldom. Usually when a violent price action contrary to an established trend occurs one can ascertain the beginning of a new pattern.

In my view, such a pattern has begun at the Sensex top of 8821 (5th October 2005).

Technical view: If my interpretation of the pattern developing from the top of October 2005 is correct then the market is likely to remain in a huge trading zone for major part of 2006. I had mentioned in my last article that wave 'E' of a large diametric formation beginning in May 2003 has ended.

Thereafter wave 'F' is developing within which internal wave 'a' was over at the bottom of 7656 on 28th October 2005 and wave 'b' is in progress (See chart).  It will probably be followed by waves c, d, e (or c, d, e, f, g). This means the pattern in wave 'F' position is suspected to be an expanding triangle (having five legs) or a Neowave diametric formation (having seven legs). 

This kind of price action would force the indices to move in a large trading zone for the next 6 -- 8 months. Thereafter a very large directional upward movement (wave G) can be expected.

This Bull Run would probably resemble the one from May 2003 to January 2004, which would take many stocks to new lifetime highs. The large size of wave 'b' compared to wave 'a' in the current pattern is trying to suggest the strong post pattern implications.

Investment Perspective: Right now the market is at a very crucial juncture. As mentioned earlier, the market is likely to move in a trading range in the next 6 to 8 months i e till wave F is completed.

I personally feel that the upward potential is limited whereas the downward risk is unlimited. Wave 'b' mentioned earlier would get over any moment and wave 'c' would begin its downward journey.

Since timing entry and exits can be very risky with the markets moving into a large trading range, holding cash may turn out to be a better strategy than holding stocks.

A tip to the small investors: The reason behind many small investors remaining small is that they have BIG greed. To become a successful investor one has to overcome greed, invest only in fundamentally good stocks, book profits from time to time, retain those profits and wait for another opportunity to re-enter at lower levels.