Capitulation and Selling Climax Go Hand in Hand

The Nifty today opened flat with no global cues to follow but soon the strong downward momentum started pushing the Nifty down. It did attempt some sort of recovery in the late afternoon session, but failed miserably and closed after making a new low for the day. Today’s close was also the lowest close since 24th August 2007. It finally closed the day at 4191 while the low of the day today was 4156.10, which was again close to the 4157 support that we had mentioned in Sunday’s post.

The market is falling with so much of momentum that all supports are being wiped out. Such kinds of fall ultimately lead to panic like situations and then capitulation. But in such situations it is difficult to predict where the bottom would be. Seen above is the 60 minutes chart of the Nifty. This chart shows the 5 wave pattern that the corrective wave C of the Nifty has been following as has been mentioned in the posts dated June 18, 2008 and June 3, 2008. One of the concepts of Elliott Waves, which was not mentioned in any of the previous posts is that you can find out the wave 3, wave 4 and wave 5 approximate targets if wave 1 and wave 2 have been formed. Now to find out the wave 5 target here, we connect the end of wave 2 and end of wave 4 with a trendline. We then draw a trendline parallel to this line which passes through the end of wave 3. This line should give the approximate target of wave 5. As one can see, the target given by this line is near 4130 and a low of 4156 was already made today. It is possible that the target is achieved early in the morning tomorrow. It is also quite possible that with the strong downward momentum this target is overshot. Only time will tell where the market will stop.

But there is another short term positive visible and that is a bullish divergence between the price and the RSI as has been marked within the circles. The price has gone on to make newer lows while the RSI is still above its previous low. This suggests that even though the price is on the way down, the internal strength in the Nifty is actually increasing which suggests that an end to this downtrend may be near.

But then I just heard the news that the RBI has increased the CRR and repo rates by 50 basis points each. While the repo rate has been increased immediately, the CRR hike is to be implemented in two steps of 25 basis points each. Our newsletter, and many other market participants, were already expecting a rate hike, as was mentioned in yesterday’s post. A story on expressindia says that a meeting tomorrow between the Left and the Government will decide the fate of the nuclear deal and the government. The Left has made it pretty clear that if the Government decides to go ahead with the deal, it will withdraw support. The UPA allies are of the opinion that with inflation at a 13 year high, chances of a re-election in the event of snap polls are bleak and are pressurizing the government to delay the deal. However, there is strong speculation that the Prime Minister, Dr. Manmohan Singh, who has invested a lot of personal reputation in this deal, is unlikely to abandon the deal and may resign in case an agreement is not reached. If this happens, it may well mean that we are looking at a capitulation happening very soon, maybe as soon as tomorrow.

Uma, in her blog post regarding volumes, rightly says that One of the key signs of a market that's bottoming out, is low volumes. But, the huge volumes being traded on NSE show no signs of going down. What she says is perfectly right, except in cases of a selling climax, which usually accompanies capitulation. A selling climax happens when there is a big price fall along with a huge volume expansion. The result is that there are no sellers left post-climax. The aftermath is light volumes and flat prices. This article by Devangshu Datta, a technical analyst, very well explains all about a selling climax.

In my opinion, we are going to see a selling climax and a capitulation tomorrow or the day after. The consequent behaviour of the post-capitulation markets will be, as expected, light volumes and flat prices. But we would have to go through that pain if we want the markets to improve and recover and cross their earlier highs. It may be a very difficult task because a drop of 35% from there has brought us here but to reach the same level we need a rise of 55% and not 35%. But with strong fundamentals and God’s grace even that might be possible. Who knows?

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Capitulation? Not yet!!!

The Indian Government, two weeks ago increased the price of petrol by Rs.5/- per litre, diesel by Rs.3/- per litre and the price of domestic LPG by Rs.50/- per cylinder. This was bound to set inflation on fire, which it did as was shown by the inflation figures zooming past 11% for the week ended 7th June 2008. Not to say, that this price hike was not needed. In fact, it was very badly needed and much earlier than when it was finally announced.

Back in 1974, India was a very poor country and when the price of crude virtually doubled overnight, India could afford no subsidies to its citizens and they had to bear the brunt of the price increase. The same happened in the US in 1979 when they abolished all subsidies and the full price of crude was passed down to the consumers, which eventually led to the demand going down. Today, India is a much richer country but none the wiser. It can afford all these subsidies which is why the price passed down to consumers is only about $60 a barrel as against the $135 a barrel ruling in international markets. This heavy subsidy artificially keeps the demand high and hence the prices. The moment the full price is passed down to consumers, the demand will go down which should bring the prices down. So, in effect, by subsidizing crude prices we are artificially keeping the demand high and hence the prices are not coming down. So, while it is increasing the subsidy burden on our government, all that money is actually going to the OPEC countries. This is very well explained by Mr. Swaminathan S Anklesaria Aiyar in a column titled Swaminomics on the Times of India. This article also got me thinking on what am I doing in India? I should instead have been in Venezuela where petrol costs only Rs.2/- a litre. Paradise. Absolute paradise.

The Nifty continued its southward journey today, but did find support between the 4230 and 4240 levels on two occasions during the day. This was very much in line with our expectations in yesterday’s post where we had expected 4234 as one of the levels where the Nifty could find support. One of the supports was also placed at 4157. So, could the Nifty go down to that level or is 4234 the final low? The answer is, we don’t know. The markets would have to capitulate first to indicate that a reversal is possible. Capitulation happens when most of the investors lose their confidence in the markets and close their positions. Capitulation results in a panic like situation where the prices shave off quite a lot and quite fast. What happened in late January 2008 was a capitulation like situation when the markets lost about 30% from its highs in just 10 trading days. A similar situation is happening now when the markets have lost almost 10% in the last 4 trading sessions. But I don’t think a capitulation has happened yet.

With the inflation going past 11% and the repo rate being only 8%, all our investments in fixed deposits are now earning negative returns. This imbalance in the bank rates and the inflation cannot be maintained for long. The RBI shall have to intervene and increase the rates by at least a 100 basis points (could be in 2-3 steps rather than in one go) and such measures would have to be taken much before the scheduled credit policy meeting due on July 29, 2008. The market has already started discounting rate hikes into the prices but a strong reaction, albeit short, will be expected when the rates are actually hiked. Probably that will be the day of capitulation.

The 17 MPs (Members of Parliament) of BSP (Bahujan Samaj Party) have already withdrawn support from the UPA (United Progressive Alliance) Government on fears of the Government’s increasing proximity to the JD (Janata Dal) and the SP (Samajwadi Party). The Government is taking all steps possible to go through with the nuclear deal without forcing the Left Front to take drastic action. I wonder if they would be able to pull it off. The Prime Minister, Mr. Manmohan Singh, is already looking for reasons to resign. While the present government falling can only benefit the country, I doubt the market will take it that positively. Probably that will be the day of capitulation.

Nobody knows when that day of capitulation will come or how far down will the markets go or how much pain is still left. But one thing is for sure, the day the capitulation comes, we shall know. Such days are usually accompanied with huge and steep declines and extreme panic. The panic will build a lot of fear in everybody’s minds. But believe me, only the courageous few who decide to buy on such a day will end up as winners. Others shall see the opportunity come and then see it go. It is important to set aside your emotions of panic and fear on such a day and be as greedy as you can. As Warren Buffett says, "Be greedy when others are fearful and be fearful when others are greedy".

I leave you today with two charts, the top being the daily chart of the Nifty while the one at the bottom being the weekly chart. Both are giving contradictory views and my views are pasted on the charts itself. The market may follow one of the views. It is also possible that it follows one view for a short period of time (2-3 days to a week) and then follow the other view. What it finally decides to do, only time will tell.

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Markets Below Strong Support

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Today was a terrible day for the Nifty. It opened deep in the red today and with each passing hour it turned a deeper red, so that by the time it closed it was 250 points below yesterday's close while the Sensex closed 770 points in the red. Seen below is the daily chart of the Nifty.

There are quite a few lines here which may become a little confusing for some. The best option is to right click the chart above, click on 'Open in a New Window' and a larger image will open in a new window. Then you can toggle between the two screens (by using either your mouse or by pressing Alt and the Tab key together) and it will become easier for you to read the chart.

First of all let us talk about the blue lines. These were the two parallel lines forming a range within which the Nifty moved for a number of weeks. This range was between 4800-5500, a range of 700 points. The Nifty broke out of this range on Friday last week when we mentioned that the target for this breakdown gives a target of 4100. Coming to the thick brown line, as we had mentioned in one of the earlier newsletters, that this is the line drawn from the lows of June 2006 and Aug 2007 and is a 21 month old line and was providing support to the Nifty at 4700. That low has also been broken today. This may be the first sign that we are entering into a long term bear market now (which will be confirmed if we were to go below 4000). But there are supports in between, which have been marked by the dashed brown lines (highlighted by the blue arrows). The first support is at 4500, which is nothing but a cluster of about 10 days of prices, thus forming a very minor support. The second support and a stronger support is at 4100, which happens to be the pivot low formed in June 2007 and Aug 2007. This support matches with our target of 4100.

Long term traders and investors are now advised to refrain from entering long positions. Traders may like to go short at these levels. By looking at the charts, it does seem to be all gloom and doom. But the fundamentals speak a different story, though not as loudly as a month ago.

I finish today's edition on a gloomy note, but at the same time a word of optimism too. 'When you think that everything is finished, that is just the beginning.' One day the market will go terribly down and everybody will be thinking that there could be no possible way that the markets could recover now (which looks like the situation today) and that will lead to a panic and everybody would want to sell their holdings and would vow never to invest in the markets again. That is the end for those who sell out and when the majority does it, it is known as capitulation. And THAT, my friends, is the beginning. The markets would recover that very day.

Happy investing!!!

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