With Nifty moving below the 4,700 mark on a closing basis, the market has broken a strong support level that had been supporting it for a very long time. Now with this support level gone and the short-term indicators still in sell mode, and not close to the oversold territory, there is a higher probability that the market will see some further correction. This time the trouble has emerged from the banking sector, with both public and private sector banks coming under severe selling pressure over the past couple of sessions. What has made matters worse is the fact that some of the major capital goods stocks too have remained under pressure for a long time.

The kind of selling seen over the past couple of sessions clearly indicates that the market is going to remain under pressure for sometime, as it takes a while for stocks to recover after a bout of selling by large institutional investors. Along with these large-cap stocks, many mid-cap stocks too are likely to remain under pressure.

If one looks at the broader mid-cap basket, it appears institutional investors bought into some of the so-called trading stocks at different points of time over the past three years through various QIBs, and they have now decided to dump these stocks in order to clean up their portfolios of companies that have high debt and have failed to deliver.

So even after correcting 80 per cent from their all-time highs, these stocks are losing 10 per cent more of their residual values. This is a process of cleansing and it has happened thrice over the past 10 years. First, it happened with the so-called technology companies, then immediately after the crash of 2008, and now again in 2011. This is the first indication that a phase of bottom formation has begun in the market. However, it is anyone’s guess as to how much time it is going to take. One of the worst things investors do in such situations is to buy these stocks simply because they have fallen so badly. Just because a stock that was quoting at Rs 100 has fallen to Rs 20 doesn’t make it worth looking at for either investing or trading purpose. In fact, in such market conditions it would be better for investors to avoid such stocks at any cost.

On the domestic front, the news flow was positive last week. However, the Street did not react to it as the macro picture worsened. The fact that the Reserve Bank of India has indicated in very certain terms that interest rates have peaked is the most positive thing to happen for the market in a long time. But instead of a positive reaction, the market turned negative, mainly because some selling by ETFs came up in Friday’s session.

The inflation numbers, especially food inflation, showed a decline, even though it was below expectation for the Street and was mainly due to the base affect. But these numbers should further soften over the next few months, and unless there is another round of trouble with the domestic currency, they should not give any fresh shock to policy makers.

As far as global markets are concerned, the news flow was not negative. Yet doubts are being raised over the European package, and these ifs and buts were the reasons behind the frequent corrections in equity markets in that part of the world over the past week. The continuing uncertainty also led some foreign institutional investors to cut their exposure to emerging markets. This sort of uncertainty would continue for some more time and we will continue to see periodic bouts of selling by European banks and funds, which will keep affecting our market too.

Coming to technical charts, most of them are in the sell mode as they have drifted southward in the negative territory. They are not showing any sign of an immediate trend reversal. The moving average convergence divergence (MACD) on daily charts is in sell mode, as it has moved southward after facing resistance from the equilibrium line. Even on weekly charts, the divergence between the trigger and average lines has increased further, indicating more strength in the ongoing bearish trend. The 14-day relative strength index (RSI) is now placed in sell mode in the oversold territory, but it is far from giving any buy signal or indicating a major trend reversal.

Other extreme short-term indicators continued to move in the oversold territory. While some of them have signalled that a minor short-covering bounce is overdue on the counter, none of them showed any macro-level formation normally seen before a major trend reversal.

Coming to support and resistance levels for Nifty, in its ongoing downtrend the index has first support at 4,560 after which another strong support exists at 4,440, which is the lower end of the trend channel in which Nifty has been moving since October 2010. The macro patterns do not indicate any sharp recovery in the market from its present level, and Nifty needs to go through a phase of consolidation before it begins any sustainable upward move. As far as resistance levels are concerned, the first resistance would come at the 4,840 level. In case the index is able to cross this average, then we are likely to see a minor short squeeze, which will take Nifty closer to the 5,000 mark, where the medium-term resistance would once again trouble the bulls. This phase of decline in the market is going to create many shockwaves, normally seen when a market forms its bottom.

rajivnagpal@mydigitalfc.com