Cash The Chaos

Nifty(5257.95): Nifty has so far partially filled the gap that was above 5169 and from the early morning SGX Nifty quote does look like there is going to be a further push down. Next significant supports for the short-term supports are at 5190-95 and 5150-40. IF there is a gap down beyond 1% on the Nifty it would be prudent not to short. The best place to buy or sell is always at the first reaction to a move. We have seen Nifty drop from 5400 to low 5200's, now we will wait for the reaction come and through and see to it that the dip buyers have spent their energy.

The most important take away from yesterday's move was from Reliance.

Reliance - Daily Charts

It was indicated in yesterday's note that Reliance was showing early signs of weakness and here is the confirmation from Mr Market. If the rise from August low was the start of a fresh uptrend Reliance should not have overlapped into 858 but it did and hence the rise is corrective. If your know a bit of Elliot wave you know why but what is important is the implication. Also, notice the October low for Reliance was way above the August low and this strength was the reason why we did not see a breach of 4720 on Nifty. I expect Reliance to trade around 842-848 at open and provide a relief rally. It is this rally we would interested in selling into. Like Reliance's overlap we should also see Nifty overlap into 5215 to eliminate the bullish case (though 5170 would more ideal). Be patient and let the opportunity fall on our lap.

Nifty(5201.80): A break of the 8 week range of 4720-5160 came through on Tuesday - a breakout above the triangle that was highlighted on Tuesday. There is good news and bad news. The bad news for us is that this a breakout but the good news is that triangles more often occur at the penultimate leg of a move. While the validity of the Elliott wave count I have been maintaining since January is yet to get invalidated but looking at the market action in Europe and US, it does look like we will see a breach of 5329 on the Nifty and invalidate my preferred count.

Nifty Daily Charts with EW count

The chart above outlines three possibilities, arranged in the order, least probable to the most probable:

1) Nifty does not violate 5329 and we maintain our preferred path

2) The bulls are back and markets are headed for a new all time high

3) Short-term rally continues to somewhere in the region 5400-5600 and a reversal comes through post that

The first scenario is straight forward - market is going to tell us right at the open. The other two scenario's we will reason out the why's and the why not's. On the charts this scenario is labelled using the Red and Orange numbers.

Scenario 2:  The bulls are back and this is shown on the charts above by W, X, Y marked in green. There are numerous problems here:

(a) This scenario essentially means that the bear market has completely spared index heavy weights like Hero Honda, M&M, ITC and Cement majors. I have never seen a bear market end with index components at or near 52 week highs.

(b) The 2008-2009 bear market ended with a double zig-zag pattern and the above labelling also calls for a double zig-zag. Markets rarely ever repeat in the exact manner and that too in the immediate cycle.

(c) At the bottom of a bear-market, markets do not trade at 18 times trailing earnings, it trades somewhere in the region of 10-12 times trailing earnings or even lower. When markets open tomorrow it will trading closer to 19 times trailing earnings - these levels are closer to a top rather than a bottom.

Scenario 3: This scenario is labelled with Alt 1, Alt2 in purple colour. This scenario is just a variation of  my existing wave count. Only the internals are different. Exactly for the above reasons outlined in Scenario 2, this is the most likely outcome. The INR is an important part of the equation here - the structure for the currency is such that we have only seen a partial portion of the currency weakness. Sharp rallies like we saw in Europe and US overnight serve 2 purposes - it cleans out the weak hands and helps in pushing the sentiment to extremes.  However, patience is the key. We do not want to be too early on the short side.

We will also try to capitalise on the short term energy and pull some swing trades. The aim would be to not linger too much on the long side.

Dollar Index: The rally since the October low has been on weak dollar. There are quite a few possibilities for the dollar out here but the bottom line if the Dollar Index starts to reverse, RIP for the stock market rally. However, if the powers that be manage to push the dollar index below the red line shown, which I think is a low possibility, be prepared for a currency crisis or an inflationary holocaust.

Dollar Index - Daily chart

US stock markets: One sentiment measure I follow is now higher than it was when stocks where 6.5% higher in May 2011. This set up is normally associated with a market peak - it could be secondary or primary. Watch out as the market unravels.

Nifty(5049): Indian markets were locked into the range of 4720-5160 on the Nifty for the eighth consecutive week.

Nifty - weekly charts

The important take away has been that heavyweights TCS, Reliance and Larsen have formed negative candles within this range and Larsen is at the threshold of clocking a new low for the year. We also have the Indian Rupee at verge of striking the all time low it made in 2008. While a strong Rupee is not a pre-requisite for the Indian markets to rally, see the INR vs Nifty charts below the orange rectangle, blackline being rupee. Given this backdrop, the chances for Nifty to push much beyond the recent swing high is a tall order and just a small negative trigger is what is needed to tip the scales.

INRvsNifty

If you are wondering what that trigger could be: It is the Euro and the Euro zone. A quick look at the charts of the European bond markets seems to indicate that their plans are dead before arrival. While the equity markets have been rallying over the last few weeks, the 10 year bond yields of Spain, Italy have been rising. And no, this is not a risk on trade. Their yield spreads to German debt is widening. And the most telling fact is that the french spreads to the german bunds is at a 2 decade high!! Essentially, the while the European leaders are trying to sort the problem of Greece and Italy, the bond market is signalling that the crisis has arrived in France. (Sorry no charts) Watch out, the Euro has opened 0.25% lower this morning.

Nifty short term: The range of 5030-5140 might hold for the day. Any dip below 5030, is likely to take this market to 4970.

Nifty(5132): The short-term divergences in the charts are getting more pronounced. This is analogous to an auto mobile continuing on its path without fuel but on residual motion.

Nifty -intraday chart

I can also count a small degree wave 5 that is nearing completion. Volume footprint tells us that the area of 5090 and 5070 is very crucial and might act as the bull-bear divide in the short-term. Since the previous day's low is just slightly below this level at 5056 that must the stop for those who are long on the market.

Remember, the larger trend is still down as long as the market is still below 5330. With Nifty already near 5200, and significant overhead resistances ahead, the probability that this market will head much higher looks very low. At the same time, a significant decline also seems like a low probability before October 25th . Hence, we will pull a nuetral strategy on the market with the outer-perimeter in mind.

Nuetral Strategy- Bear Strangle:

Write n contract(s) Nov 24th 2011 5200 call at or near 45 and Simultaneously write n contract(s) Nov 24th 2011 4700 put at or near 136.

Margin Required: Aprrox Rs 32000/strangle

Credit Recieved: Aprrox Rs 177

As long as Nifty remains between 4523 and 5377 the strategy will make money.

At October expiry the strategy is likely to yield a profit of Rs 30/strangle - roughly 10% on the margin paid.