Technical view of then Indian equity benchmark (Sensex 30)

The below post is for education purposes only, and not intended as trading advice

Normally I would use the Nifty 50 as the Indian stock market benchmark, but I am currently constrained to use the Sensex 30 because investing.com does not seem to be updating the volume data for Nifty 50 over the past few days. 

Note, the objective of technical analysis is not to predict, but to identify high probability zones of price movement and identify points where trades can be entered into to exploit those opportunities.

First observe the overall, long term price trend of the Sensex:

Trendlines:

First thing to do is to draw long term trend-lines on the monthly chart to identify the stable trend, if any. 

The way to draw an uptrend line is to locate the highest high in the time frame you are looking at. Then look for the lowest low before the date of the highest high. From the low draw a straight line to the highest high, and slowly rotate it clockwise till it is not crossing any candles till after the date the of the highest high. Ideally, a trend line should have at least 3 points that touch, the more the better.  

The long term uptrend that started in March 2009 appears to be intact as the price crash found support at it. Trend lines are one of the strongest SAR zones (Support and Resistance) in a chart.The price had broken down but managed to climb up the next month, we shall look at this in more detail in a bit. The trend is not too steep, which adds to its reliability. Generally the flatter the trend line, the more reliable it is.

There is another trend line starting from March 2016 that was was steeper than the longer term, this trend line appears to have broken, but I will reserve my judgement on that. This was the acceleration from 2016 onwards.

Horizontal Consolidation Region (HCR):

HCR is a region which has flat tops, or flat bottoms, or both. This is an area of price congestion which have a lot of power to act as SAR zones (Page 78 of Trading Classic Chart Patterns by Thomas Bulkowski). 

In fact, HCR is the most powerful of the SAR zones, then comes "old highs and lows", followed by trend lines, then chart patterns, then moving averages (20/40/200 DMA), and finally round-o-phobias.  

In the above chart I have roughly marked out two HCRs in red channels, the first of which is  at 25,676-29,669, and has managed to arrest the down fall. HCRs are an important area to observe when shorting stocks or indices.

There is another HCR at roughly 15769-18170 levels, which is about 42% below current levels, and would be the next target. It is worth noting that this price coincides with the lowest, and least steep uptrend line that begins on May 2003.

Price - Volume action:

Was it possible to tell that a crash was coming? While hindsight is 20-20, and analysis can always be retrofitted to suit the outcome, if we already know what the outcom is, I will try to keep this as intellectually honest as possible.

As one can see from the weekly chart above, from October 2019 to Jan 2020, there was an appreciable increase in the index price (about 17%), but a sharp drop off in the volumes. What does this tell you? It suggests that large players were not involved in this rise, and it was primarily "weak hands" that drove this rise. This divergence between price and volumes (shown by the long blue arrows)was the first warning.

It is worth noting that the farther the price strays from a trend, or other SAR, it can be inferred that weak hands are predominant in the market. And if weak hands dominate, the Rule of Trends will apply. RoT basically means that volume should increase at at least a similar pace as price. 

Another key price action that was worth noticing was the number and frequency of doji stars increasing as 2019 was drawing to an end, and 2020 beginning. The ones especially worth noticing are the dojis that formed with high volumes between September to December 2019, because they formed on high volumes. 

Volume is the effort, and the price spread (open minus close) is the result. Since higher efforts should result in higher results, the rise of volumes resulting into just a doji (or a spinning top, a very small real body candle) was a clear anomaly. Since the September to December dojis (marked by the small blue arrows) were formed on a short uptrend, it can be surmised that strong hands sold off of their holdings and they were absorbed by weak hands who did the buying. Worth noting that the Wuhan Virus cases had just begun to appear on global media around this time, but were being downplayed by the media, allowing stronger hands to distribute their holdings fairly rapidly.

The market was almost at equilibrium as evidenced by the very small candles with high and low being very close to each other. Usually prolonged periods of such equilibrium is said to burst out in one direction or the other. 

The divergence between the price, and volume and appearance of several dojis and spinning tops should ideally have served as a warning that all is not well with the market. 

What were indicators saying?

I use the RSI (25) and MACD (12,26,9), and using the weekly chart. Maybe I am not as trained an eye as others, but frankly the indicators were not as obvious as I thought they would be. Indeed I found it easier to look for the dojis, spinning tops on the price, its straying from the trend, and the striking volume-price divergence, than looking for clues in the indicators. 

My few observations on RSI are in the picture below. I did not get anything independently from MACD that I would have considered actionable at that time. 

Patterns foretold a crash?

Again with the caveat of hindsight, I examine whether the it was possible to trade this market. As mentioned earlier, the appearance of several dojis, the sharp contraction of volatility, and bearish divergence of price with volume should have alerted investors to lighten exposure on the long side between January and February 2020.

However, at what point was the market short-able if at all. The first pattern that I spot is the head and shoulders pattern. Since the peaks are almost similar in size, one can even say that it is a triple top (three eves), or triple buddha pattern. Setting the target as the distance between the the middle top to the neckline, and extending it below the neckline breaking point we get a target of 36,596 (marked with a star). Note the short would have been entered only on a confirmed break of the neckline at 38,516 or thereabouts. Interestingly, a Fibonacci based target would also put the 2.618 level at close to this H&S price target area (at 36,176).

Worth noting that at this target, the price would have broken through a trend that it had held since Jan 2017, indicating that the weakness would continue. 

Where would I have closed my shorts?

On March 13, 2020, there appeared a bullish piercing pattern where after a downtrend, a green candle opened below the low of the prior red candle, showing that the bears are in control of this session as well. However during the session the bulls fight back and the new green candle now 'pierces' into the prior red candle's territory (at least 50%). The psychology of this candle is that after few days of sustained selling this bull revival that reversed the intra-day trend would put bears on the back-foot, and less sure of themselves. 

As we have seen with the market fall, seldom does one reversal signal cause an actual reversal of the market. But, they do serve as a warning signs that a change in market psychology is imminent. The shorts would have stayed on.

The confirmation of this bullish piercing would have been the the closing price of the candle after the piercing candle to close above the high of the original red candle (the one that was pierced). This however did not happen.

Instead the next session threw up a harami, which is also a reversal signal. But I didnt view this particular harami as particularly powerful as the candle forming the harami did not have a very small real body or a doji. Additionally, the harami was formed near the lower half of the preceeding candle and not in the middle of it. Such haramis are called "low price" haramis, and usually signify a lull in the markets rather than a reversal.

Finally, there was a three candle formation called the morning star that appeared on the dates 18,19, 20 March. A long red candle, followed by a small real body candle (colour doesnt matter). On the third day there is a long real body that pierces into first day's red candle's body meaningfully (ours did about 50%). Ideally none of the three candle's real bodies should overlap with each other. 

In the context of the piercing pattern and harami earlier, and the first two day formation of the morning star, I would have probably covered the shorts on the third day. Possibly late in the trading session when the formation of the morning star seemed very likely, but honestly would have covered nonetheless. 

What next?

The index rallied from its low of 25,638.9 on March 24, 2020 and retraced to its 50% Fibonacci level. Near its low, there were two volume spurts (25, 27 March), which I think might be Institutional buying. However since then the volumes have been anemic and there has been a period of indecision with daily ranges decreasing quite noticeably. 

Between 29/Apr  to 4/May there appeared a bearish evening star reversal which is the opposite of the bullish morning star we saw earlier. This was a stronger variety of the evening star patterns called abandoned baby where not only is there a gap between the real bodies of the candles involved but there is a gap in the wicks as well. The gap may suggest that this was a final surge of buying for now, and buyers are exhausted. There is a natural resistance level formed near the high of the middle candle which in this case also coincides with the 50% retracement level.

Generally if volumes are high at the start of a trend, it can be presumed that there is institutional buying. That has not been the case here. This, coupled with the indecision and a strong reversal signal (abandoned baby evening star), I would bet that the market turns down here to make another low for perhaps an eventual double bottom reversal. I would like to see that bottom happen on high volumes to give me some reassurance of Institutional participation. 

So there are only two scenarios where I could go long the market.

1) The market crosses and closes above the 50% Fib retracement level, i.e. 34,019, or

2) Market makes a definitive double bottom at near 25,678

In the meanwhile if I had to trade, I would be short the market at current levels, 31910 with a stop loss of 34,019, and a price target 1 of 29,782 (50% Fib retracement of current bounce), and target 2 28,804, 61.8% retracement)