BSE Sensex and NSE Nifty 50 Index Chart Patterns – Jun 10, ‘11

The bears tightened their grip during a week of listless trading. Both the BSE Sensex and NSE Nifty 50 chart patterns closed lower on a weekly basis – almost by the same amount that they rose a week ago. Both indices are trading below their three EMAs and their (blue) down trend lines, and are technically in bear markets.

As long as the Feb ‘11 lows hold, the bulls will be in the game. A break of the Feb ‘11 lows can lead to deeper corrections. Will it happen? A lot will depend on the stance that RBI takes next week. If interest rates remain unchanged, it will be a bullish signal for the markets. But with food inflation rising again, a 25 bps (0.25%) rate increase is likely. That may trigger more selling.

BSE Sensex Index Chart

The support-resistance level of 17780 may be crucial for the near term. If the two breaches in Feb ‘11 are ignored (as they should be, because the Sensex ‘whipsaw’ed back within the 3% leeway), then the entire formation from the Nov ‘10 top is a consolidation within a large descending triangle. A close below 17250 (a 3% breach below 17780) could see a fall to 14500.

I’m not saying it will happen – just discussing possibilities. The fact is, the Sensex is in a down trend. Till the down trend line is broken on the up side, the downside risk remains greater. Investors may be better off selling the rises instead of trying to buy the dips.

The technical indicators are showing signs of weakness, but haven’t turned bearish yet. The MACD is above its signal line, but both are in negative territory. The ROC has dropped below its 10 day MA, and is resting on the ‘0’ line. The RSI is above the 50% level. The slow stochastic is falling after reaching its overbought zone, but is above the 50% level.

Nifty 50 Index Chart

Volumes are tapering off and retail investors are deserting the market. A convincing break below 5345 can drop the Nifty to 4350. That is the measuring implication for the descending triangle – even though such a possibility may seem unlikely. If you want to remain invested, keep a strict stop-loss at 5200.

The IIP numbers were a big disappointment. Economic growth is clearly slowing down, thanks to the pro-active interest rate hikes by the RBI. Further rate increases may stymie the growth even further. At the Canara Bank yesterday, I noticed that fixed deposit rates for longer periods have been reduced by 0.25-0.5%. The first sign that we are nearing the peak of the interest rate cycle?

In last week’s update, I had mentioned that India Inc. may go on a merger and acquisition spree because the top 100 companies were sitting on several tons of cash. RIL’s acquisition of Bharti’s loss-making insurance businesses may be the first of many such deals to follow. Bharti is an obvious beneficiary. RIL seems to be showing signs of di’worse’ification!

Bottomline? The BSE Sensex and NSE Nifty 50 index chart patterns are finding it tough to extricate themselves from strong bear grips. Things may get worse before they get better. Stay on the sidelines. Better still, take a vacation.

Why small investors should avoid ‘cheap’ stocks

There are several reasons why small investors should avoid ‘cheap’ stocks, and I will take them up one by one. Before that, one must understand what is meant by ‘cheap’ stock.

Investopedia.com has the following definition:

“The illegal practice of issuing stock options at artificially low prices shortly before an initial public offering. Often underwriters will require a company to have more qualified management before they can go public. They attract these qualified individuals by giving options with a low exercise price.”

This was a practice which was prevalent prior to and during the dot.com boom in the USA, and is not unheard of in India. While it can lead to significant profits, the average small investor won’t be able to participate - unless his uncle or friend’s father was the promoter of the company. If a company is trying to sell its stock through bulk SMS and email messages at a lower price than its forthcoming IPO price, chances are that it is a ‘dud’ company and best avoided.

Then there are those companies that were the apple of investor’s eyes during the previous bull market, and reached stratospheric levels just before the crash in Jan 2008. Real estate stocks were at the forefront, followed by the stocks with the word ‘infrastructure’ in their name. Most of these apples had rotten cores. They have not only become cheap stocks, but continue to get cheaper by the day. Don’t go anywhere near them.

There are cheap stocks which are also called ‘penny stocks’ because they trade below Rs 10. Most of them are unknown, fraud companies who have no business and no intention of doing any business. Occasionally they boost up their share price from Rs 3 to Rs 8 by planting fake stories in the media about the great opportunity for investors once they dismantle the fourth rate defunct plant that they have bought in Uzbekistan or Burkina Faso and reinstall the plant in Jhumri Tilaiya. Avoid such stocks like the plague.

Some cheap stocks may appear cheap, but are not. A Re 1 face-value stock trading at Rs 15 is equivalent to a Rs 10 stock trading at Rs 150. A Rs 10 face-value stock trading at Rs 15 may not be cheap either, if it belongs to a loss-making company, or one that is trading at a P/E of 80 or 100. Stay away from such stocks.

What about stocks that appear relatively cheap with P/E ratios below 15 that generate strong cash flows from operations, have low debt/equity ratio and double-digit profit margins? Ah-ha, now we are talking. I just love to dig and find such stocks. They are the ones that will give a nice boost to your stock portfolio’s performance.

Stock Chart Pattern - Castrol India (an update)

The previous write-up about the stock chart pattern of Castrol India was posted back in July ‘09. A lot of water has flown down the Ganges since then, and the chart has formed some classic technical patterns. It is a good time for an update.

This zero debt, profit-making, cash-generating lubricants company requires very little capital expenditure, pays regular dividends and has issued bonus shares several times – the most recent was a 1:1 issue in Apr ‘10. (All price levels in the previous post should be divided by two for comparing with current prices.)

The stock had a spectacular 52 months bull run from the intra-day low of Rs 77 (pre-bonus 154) in Jun ‘06 to the intra-day high of Rs 590.10 in Oct ‘10 – a 667% gain. That was just the capital appreciation. The total dividend payout was Rs 93. Including the dividend – a 787% gain (8-bagger returns!).

While savvy investors have been sitting back and raking in the ‘moolah’, small investors have been running after mythical multibaggers like Suzlon, Punj Lloyd and Bartronics. Let us have a look at the one year closing chart pattern of Castrol India:

Note the classic head-and-shoulders pattern that halted the long bull run. Why classic? Watch the volume action (marked by the thick blue down-arrows). A volume spike when the left shoulder (LS) was being formed; lower volumes during the head (H) formation (which itself ended with an advanced warning sign of a small head-and-shoulders pattern); even lower volumes during the right shoulder (RS) formation.

The volume spike on the day after the break down below the upward-sloping neckline was a sign that worse was to follow. The pullback attempt following the break down from the head-and-shoulders pattern stopped well short of the neckline and entered a bearish rising-wedge pattern.

Interestingly, the bear market rally in Dec ‘10 also ended with a head-and-shoulders pattern where the head itself formed a mini head-and-shoulders pattern. The down-trend finally ended on Feb 25 ‘11 - correcting about 27% from the Sep ‘10 top, shortly after the 50 day EMA crossed below the 200 day EMA (the ‘death cross’).

While the stock price dropped to its 52 week low, all four technical indicators reached higher bottoms (marked by blue arrows). The strong positive divergences gave a signal that the bull market was ready to resume.

The sharp recovery climbed past the 200 day EMA within a month, pulled back to the long-term moving average in end-Mar ‘11 – giving a good entry opportunity, and tested the Sep ‘10 top on a huge volume spike.

Negative divergences in all four technical indicators, which made lower tops, led to a drop down to the rising 20 day EMA. The stock price is completing a bullish rounding-bottom pattern. A likely test and breach of the Sep ‘10 top of 528 can take the stock to its 52 week intra-day high of 590 in the near term.

Will the bears go into hibernation? Very unlikely in the middle of summer. But the technical indicators are not holding out much hope for them. The MACD is positive, and has crossed above the signal line. The ROC is rising in positive territory above its 10 day MA. The RSI is about to enter the overbought zone. Only the slow stochastic is showing some weakness, as it is below its 50% level. All three EMAs are rising, and the stock is trading above them. The bulls are back in control.

Bottomline? The stock chart pattern of Castrol India endured a six months long bull market correction; in spite of the ‘death cross’ and the two months spent below the 200 day EMA, the bears could not take control. Like Colgate, this stock can be added at any price, and most definitely on dips and corrections.