Nifty faces strong resistance for medium term

It has been well established by Ralph N. Elliott in his Elliott Wave Theory that price movements of a security can be predicted by observing and identifying a repetitive pattern of waves. The price movement consists of 5 waves in the direction of the main trend followed by 3 waves in the corrective trend. The duration of these waves can last for centuries (Grand Supercycle), decades (Supercycle), years (Cycle), months (Primary), weeks (Intermediate / Minor), days (Minute), hours (Minuette) and minutes (Sub-Minuette). The 5-3 pattern remains constant although the time span of each may vary.

Technical traders use this theory to identify breakouts for profitable investment opportunities. There are several web sites and books related to this theory; Wikipedia describes the principles in detail. Cyclpro has an exhaustive list of rules and guidelines which need to be observed during the Elliott Wave Analysis.

However, for those with limited resources of time and energy, there are few basic rules that need attention.

1. Wave 2 cannot retrace beyond low of Wave 1; i.e. not more than 100%
2. Wave 3 is never the shortest among impulse waves 1, 3 and 5. This means either Wave 1 could be the shortest or Wave 5 could be the shortest.
3. Wave 4 cannot fall below high of Wave 1.

Using Fibonacci retracements of 38.2% and 61.8%, following relationships between waves can be identified.

Wave 2 = 61.8% of Wave 1

Wave 3 = 161.8% of Wave 1

Wave 4 = 38.2% of Wave 3

Wave 5 = 100% of Wave 1

The above values are approximate and have been found to occur frequently in well trending markets. It is not uncommon for Wave 2 to fall below 61.8%, there are cases in which Wave 2 has retraced only 38.2% of Wave 1. Similarly, Wave 3 has sometimes retraced even 261.8%.

So, what may happen in case these guidelines are violated?

The answer is simple. The move becomes “suspicious.” This is usually considered as a warning sign; a trend reversal may follow soon.

Let us now discuss the long term chart of Nifty.

In the above chart, it can be seen that:

1. The long term bull market started in April 2003 when Nifty had a low of 920
2. Wave 1 ended at 2015 during January 2004
3. Wave 2 retraced 66% and ended during May 2004.
4. Wave 3 retraced 227% of Wave 1 and ended during May 2006.
5. Wave 4 retraced 47.4% of Wave 3 and ended during June 2006.
6. Wave 5 retraced 343% of Wave 1 and ended during January 2008.
7. Wave a retraced 75.5% of the entire movement from low of Wave 1 (920) to high of Wave 5 (6357) and ended during October 2008 with a low of 2253.
8. Wave b has retraced 60.7% of Wave a when it touched 4744 in August 2009.

Cyclepro guidelines suggest that Wave b is likely to retrace 38.2%; the next most likely retracements are 50% and 61.8%. It also says that the time taken by Wave b is usually between 61.8% and 161.8% of the time taken by Wave a. Wave a lasted for 9 months; wave b is currently in its 11 th month.

Taking all these facts into account, we may come to the conclusion that Wave b may end anytime and Wave c is likely to start afterwards.

Nifty has not shown any kind of reversal signs so far in daily charts. The support trendline remains unpenetrated yet. We may see some more sideways movement in the near future. Nifty will face strong resistance around 4797.

Bullish stocks for short term:

CMP = Current Market Price BB = Bullish Breakout TT = Technical Target

1. Binani Cement: CMP 63.55 BB on August 28 TT 83.85
2. Gitanjali Gems: CMP 117.65 BB on August 25 TT 162.30
3. ISMT Limited: CMP 37.55 BB on August 27 TT 56.40
4. Omaxe: CMP 116.45 BB on August 28 TT 170
5. Tata Sponge: CMP 222.40 BB on September 4 TT 265.80

Stock of the week: Dr.Reddy’s Laboratories Limited

Dr.Reddy’s Laboratories Limited is a vertically integrated pharmaceutical company with presence in more than 100 countries. It has recently become India’s top pharmaceutical company in terms of turnover and profitability.

Brief company history:

The company was established in 1984 with a modest capital of Rs.25 lacs by Dr. Anji Reddy. Within a couple of years, the company went public and also entered international markets. In 1993 it started drug discovery program by establishing Dr.Reddy’s Research Foundation. By 1994 a GDR (Global Depository Receipt) issue was successfully made (worth US$ 48 million). In 1999 Dr.Reddy’s acquired American Remedies Limited, an Indian pharmaceutical company. In 2001 it acquired BMS Laboratories Limited and Meridian Healthcare in United Kingdom. It got listed at New York Stock Exchange (NYSE) in April 2001, becoming the first pharmaceutical company in Asia Pacific region outside Japan to be traded. By December 2006 its revenues touched USD 1 billion.

Business Overview:

Dr.Reddy’s has six main areas of businesses:

• Active pharmaceutical ingredients (bulk actives and key intermediates)
• Generic pharmaceuticals (therapeutic equivalents of reference branded drugs)
• Speciality pharmaceuticals (dermatology)
• Branded formulations
• Biogeneric formulations
• Custom pharmaceutical services, including project management, R & D, formulations etc.

Some of the popular products include Ciprofloxacin, Ibuprofen, Ranitidine, Aquaderm etc. to name a few.

Dr.Reddy’s net revenues were worth USD 1.5 billion during the financial year 2006 – 07, 41% of which came from branded formulations and 34% from active pharmaceutical ingredients. North American and European markets accounted for 44% and 23% respectively. So the company is a global player in pharmaceuticals industry. Its main brands, Omez (Omeprazole), Nise (Nimesulfide), Ciprolet (Ciprofloxacin), Enam (Enalapril), and Ketorol ((Keterolac Tromethamine) together contribute more than USD 100 million to the total revenue.

In India, the stock is a constituent of both BSE Sensex (Free-float market capitalization: Rs.7830 crores; weightage: 0.84%) and Nifty (FFMC: Rs.10,655 crores; weightage: 0.45%). As mentioned earlier, the stock is also listed at New York Stock Exchange (Symbol: RDY) since April 2001.

The weekly chart of RDY at NYSE is displayed below. (Data Source: Yahoo! Finance)

A “symmetrical triangle” chart pattern has been formed in the medium term chart as shown above. Note that the stock attempted to break its previous high at 19.06 but failed. It can also be seen that, during the downtrend, higher lows and lower highs are formed. Symmetrical triangles are regarded as areas of indecision. As higher price levels are reached, selling starts to push them lower whereas some bargain buying takes place when stock hits support trendline. It can also be noted that bearish breakout has not occurred yet. Only a close below the support trendline will confirm such a breakout. Similarly, in case of uptrend, a close above resistance trendline with volumes will confirm upper side breakout.

Let us now discuss the short term trend using daily chart with NSE data.

I have written in my earlier articles about Fibonacci retracement levels. 38.2% and 61.8% retracement levels are very important and these levels should act as strong support or resistance during downtrend or pull back. 50% is strictly not a Fibonacci support but it is the average of 38.2% and 61.8% and many people consider this level also an important one. In the above chart, volumes are hidden to maintain clarity. During the first uptrend from 601 to 752 we don’t see a clear wave formation i.e. consistent higher highs and higher lows (it may not always be the case with every stock, but good trending stocks always show these most of the time). It can also be seen that during the corrective decline, at first 38.2% acted as a support; once low went below this level, stock tended to recover. But after some consolidation it once again fell further. We can see that the stock closed below 61.8% retracement. The pullback rally was again shortlived, taking the stock to nearly its support level at 601. Similar type of formation can be seen in the next wave pattern too; it has closed below 61.8%. The level of 601 is very critical. A close below this will favour further downtrend.

What are the technical indicators suggesting? Let us see some of them.

• The stock is trading well below its 50 DMA (50 day exponential moving average), 100 DMA and 200 DMA
• 10 day, 15 day and 21 day momentum (rate of change of price) indicators are all negative
• The Wilder’s DMI (directional movement indicator) favours further downtrend; -DI is above +DI and ADX is rising from a trough.

It is safe to classify the stock as “bearish” for the short term as none of the main technical indicators suggests clear uptrend, though, ideally, one would like to see the support getting broken in order to confirm.

The long term outlook in monthly charts suggests that the stock is likely to correct further.

In my earlier article “India stock market traps” I had mentioned about Elliott wave thoery. In the above chart, one can watch waves 1 through 5 during the uptrend. The correction from top of wave 5 (wave a) was extremely sharp; it nearly tested the support at 299.53, low of wave 4. As we saw with daily chart, it broke 61.8% retracement. The pullback wave ‘b’ has managed to take the stock above its previous high. However, watch the long upper shadows at the top of the trend indicating selling pressure. Now wave ‘c’ is in progress, meaning further downtrend is likely. The stock has also closed below 665.70 (38.2% retracement) and next support is at 527 (61.8% retracement).

Conclusion:

Dr.Reddy’s declared a whopping net profit of Rs.1177 crores for financial year 2006 – 07 as against Rs.211 crores, Rs.65.5 crores and Rs.283 crores for the previous years. The stock reached a high of 889 in December 2006. So this performance was already discounted by the market.

We have seen that the short, medium and long term trends are bearish. So, we can arrive at the following conclusion.

• Long term investors, particularly those who bought the stock 10 or 15 years ago, can safely exit the stock at higher levels.
• Medium term trend, though yet to be confirmed, is not likely to favour higher levels; so it is wise not to pick this stock as an investment choice.
• Short term traders need to avoid the stock as it is bearish in short term charts.

INDIAN STOCK MARKET – AN OUTLOOK

In this article let us analyze the current market scenario, how Nifty has performed during last 4 years and comparison of index vis a vis some of the individual index stocks.

Current Scenario:

As of now, there is no significant threat to the indices. No major reversal sign has been observed in the monthly charts of Nifty. Watch the reversal patterns displayed in the chart below. Bearish “three outside down” pattern occurred in April 2000 and bullish “three outside up” pattern was seen in June 2003. Since then, Indian markets are on a high.

In the absence of strong reversal signs, it may be concluded that markets will continue their uptrend.

Wave analysis:

The following table illustrates the wave count and their retracements:

Wave	Low	High	Gain
1	920	2015	219.02%
3	1292	3774	292.11%
5	2596	4291	165.29%

This means that after the completion of the 5^th wave (which needs a confirmation) a downtrend is likely to begin.

The longer term target for the Nifty, when calculated from a low of 920, works out to 4600. This will give wave 5 a gain of 177.20%.

What is the reason behind this huge rise in index?

Like all other financial markets, Indian markets are also governed by the fundamental principles of demand and supply gap. When interest rates were lowered, stock market looked an attractive option and investors began to look for opportunities. Huge foreign funds are another reason for the upsurge. Liquidity is one more factor – one can easily transact with a click of a mouse unlike the old days when physical share certificates were in use.

Whatever be the reason behind any move, it is always reflected in the charts. All other factors, namely, business conditions, economy growth etc. are always discounted when analyzing the market technically.

How many stocks got benefited from this nearly five fold rise in index in the last 4 years? Let us analyze some of the index stocks.

Scrip	Industry	Close 1 31/03/03	Close 2 25/05/07	Gain
ABB	ELECTRICAL EQUIPMENT	286.25	4493	15.70
ACC	CEMENT	138.5	858.05	6.20
BAJAJAUTO	AUTOMOBILE 2 & 3 WHEELERS	480	2171	4.52
BPCL	REFINERIES	221.95	364.8	1.64
BHARTIARTL	TELECOMMUNICATION	28.2	834.3	29.59
CIPLA*	PHARMACEUTICALS	57.1	205.05	3.59
DABUR*	PERSONAL CARE	11.88	96.1	8.09
GAIL	GAS	74.9	294.75	3.94
HDFCBANK	BANK	234.55	1069	4.56
HINDALCO*	ALUMINIUM	53.46	144.15	2.70
HINDLEVER	DIVERSIFIED	148.35	203.15	1.37
HDFC	HOUSING - FINANCE	331.35	1817	5.48
ITC*	TOBACCO	44.88	166.8	3.72
INFOSYSTCH*	SOFTWARE	379.95	1986	5.23
LT**	ENGINEERING	387.35	1739	4.49
MARUTI***	AUTOMOBILE 4 WHEELERS	235.4	810.3	3.44
ONGC*	OIL EXPLORATION	237	907.4	3.83
REL	POWER	215.45	555.4	2.58
RELIANCE	PETROCHEMICALS	278.1	1728	6.21
SAIL	STEEL	8.85	148.15	16.74
ZEEL*	ENTERTAINMENT	37.38	317	8.48

* Adjusted Close 1 due to stock split / bonus / rights issue

** Close 1 as on 31/07/2004

*** Close 1 as on 31/08/2003

It can been seen from the above table that not all the index stocks have performed in the same manner. ABB, BHARTIARTL and SAIL have outperformed when compared to the overall index.

It should be noted here, that the ‘performance’ in stock market by a scrip has nothing to do with the financial performance of the company. It just implies that the investors have chased this stock more strongly compared to the rest.

We can see no direct relationship between the overall index performance and the individual stocks’ performance. This indicates the demand and supply gap scenario for the stocks discussed.

What could be the reason for the uneven performance?

The price of a particular stock on a given day is decided by the market participants. They are

FII’s or the foreign institutional investors

FI’s or the financial institutions

MF’s or the mutual funds

Long term investors

Medium term investors

Short term investors

Day traders

Speculators

Punters

Derivative traders

When thousands of people are trading a particular stock, no one can be very clear of what the other trader thinks. This leads to volatility and uncertainty in the markets.

When one person buys a stock, obvious reason is that he thinks that it will go up. The person who sold the stock thought that it would either go down or he had enough profit or loss.

In a complex scenario like this, price fluctuations happen regularly. The investor needs to take advantage of the situation by buying when the demand just starts picking up for the stock and sell when it just starts diminishing.

Having said that it is difficult for an ordinary investor to completely understand and assess the market status.

What can the investor do now?

Ideally, one would like to take some money home. If one has remained a long term investor and likely to get some profit, he can book it.

Remember that the chance of the profit going down may increase with the time a stock being held.

For the one who wants to invest for long term in stocks, he has to be cautious, as can be seen from the charts and tables provided.

Some thoughts on investing in stocks:

Not too many people understand the stock market dynamics. So take professional advice, consult a qualified and experienced person. He may charge you a little, but it is worth taking the risk than worrying later.

Invest the amount that you can afford to lose. There are only probabilities, no certainties in financial markets.

Keep doing your research. Observe prices at least once a week. If you think you gained a reasonable amount, book your profits at least partially.

Last but not least, never borrow money to invest in stocks thinking that prices will always go up!

Good luck.