Buy selectively, sell the weak sectors

Consolidation continues in the domestic markets as Nifty settled flat during the holiday-truncated week. Market breadth remained under pressure as advance-decline ratio was seen negative on down as well as up days.

Midcap and Small cap indices underperformed the benchmark indices by registering losses of 1% each. Sector-wise, capital goods was the best performer gaining over 2% while banking and auto posted nominal gains.

However, consumer durables was seen as the biggest loser, dropping over 4%, followed by FMCG, realty, metals and power, which also sustained moderate losses.

Nifty formed another ‘Doji’ candle pattern on weekly charts, which signifies indecision and is regarded as a reversal pattern.

Notably, this ‘Doji’ pattern has formed in continuation to last week’s ‘Harami Cross’ combination because of which we now have two consecutive ‘Doji’ patterns, which have produced the trading range of 5630-5720.

Traditionally, it is believed that a breakout from either side of a double ‘Doji’ combination leads to strong moves in the direction of the breakout.

While the smoothed momentum oscillator on weekly charts remains overbought and has produced a sell reading last week, the daily oscillator which was in the oversold zone failed to produce any meaningful rallies during the week.

This suggests that the character of momentum is probably changing and the overhead bearish cues from the weekly chart are likely to dominate from hereon.

Volatility, as measured by India VIX, also called the fear index, fell to historical lows of 12.87 during the week but bounced back by the end of the week to settle near 14 levels while US CBOE VIX has been steadily rising for the past couple of weeks.

Extremely depressed levels of volatility indicate extreme optimism as well as complacent attitude among investors.

While the benchmark indices remained lacklustre throughout the week, pressure was amply seen in sectoral indices. The FMCG index reversed from its all-time highs forming a ‘Two Bar Reversal’ on weekly charts and is likely to move towards its make-or-break levels (MOB) of 5515-5527 in the short term. Commodity driven metals and oil & gas indices, which have been lagging for quite some time, have also moved below their short-term MOB levels, indicating a weak technical structure.

BSE Power and Realty were seen producing a lower low on the short-term charts at the same time, registering a sell reading on smoothed momentum indicators on weekly charts.

Most PSU banks also reversed sharply from their medium degree MOB levels, vindicating our bearish view.

However, Bank Nifty is not yet exhibiting any bearish signs as it is supported by the superior strength in the private banking. Technical developments in global markets are also showing interesting characteristics.

Hang Seng has reversed from the February 2012 high forming a ‘Shooting Star’ pattern on weekly charts, suggesting overhead resistance and can correct if short-term support at 21410 is violated. Korea Kospi and Taiwan Weighted, too, have violated their individual MOB levels at 1920 and 7265, respectively.

Dow Jones Industrial, Nasdaq and S&P 500 have also violated their individual MOB levels and are now in a bearish mode.

Technical analysts are also watching a highly bearish ‘Rising Contracting Wedge’ pattern in S&P 500, which may break if 1380-1390 levels are violated calling for much larger downsides.

Technical weakness is now quite notable especially in sectors such as infra, realty, oil & gas, metals and PSU banks while global equity indices, both Asian as well as western, are showing notable technical breakdowns.

Low volatility can easily translate into high volatility if global markets weaken further and especially if 5630 levels are violated with a closing below the double Doji pattern on weekly charts.

High beta space has already topped out a couple of weeks back but private banking and auto stocks are still showing upside momentum which can have the effect of delaying the downside break.

The time has come for traders to be extremely selective and can approach the markets with a neutral view, selling weak sectors such as oil & gas, PSU banking, metals and infra and subsequently remaining long on private banking, auto or even pharma stocks.

Traders can also benefit from the depressed volatility levels by going long on Nifty at the money put options once 5630 is decisively violated.

The writer is senior vice-president, derivatives and technicals, at Violet Arch Securities. Views expressed here are his own