Written for First Post
October 1, 2011: The equity markets in the US and India have been whipping both the bulls and bears around, confusing players about the direction the market wants to take. The markets may have confounded many but for the chart watcher prices are behaving rationally.

The US and European players have been watching the government throw a lot of remedies at the economy, but the resulting rallies never sustain. On the negative side, one sees a lot of news about the economic slowdown and hears that the Greek debt crisis will explode despite steps by the European Union. The market however refuses to fall as rapidly as the bear expect it to. In India too the bears have been frustrated as the sell off has paused, despite rising inflation and the continuously increasing interest rates.

The reason for the pause is simple and please let us explain. Markets move from one area of price equilibrium to another. In an area of equilibrium demand and supply are in balance. Once demand and supply are out of balance, price begin to rally or fall. For instance if supply exceeds demand, prices will fall in search of buyers. Prices will only stop falling once they reach an area of equilibrium where buyers equal the number of seller. 

Generally in an area of equilibrium prices tend to be range bound. Market players call this an area of congestion or consolidation. The reason is simple. When buyers and sellers are in balance there is no need for prices rally or sell drastically to find buyers or sellers. Sometimes these ranges are wide as it is now and sometimes they are narrow. But given the fact that there are enough buyers and sellers to satisfy each other, keeps prices with a range. Once either buyers or sellers are exhausted, price take direction again.

Now let's look at two market truisms. First, charts are footprints of what buyers and sellers did in the past. Second, price has memory. When buyers and sellers are in balance, the charts will move sideways as shown by the blue box in the SENSEX chart and by the white box on the S&P 500 chart. (Click here for S&P 500 Chart and  Sensex chart) When buyers exceed sellers one will see the charts move up. So looking at a chart one can say if prices moved sideways during a certain period of time or if they moved up. 

Now since price has memory, whenever the market comes back to an area of congestion, it tends to move sideways or rapidly bounce. Now the Sensex and the S&P 500 are moving sideways as we are in a bear market, which makes sustainable bounces difficult. From June 2010 to August 2010, the US index moved in a 100 point range of 1000 to 1100. That's where the index has been falling too and bouncing for the past two months. The market stayed in that range for three months and will hence take some to break below it. Only if all the buyers in consolidation level are not exhausted will the S&P 500 go down. We will know that the buyers are exhausted, once the index closes below the 1000 level.

It's also possible for the index to bounce from this level as it had done at the end of August 2010. However, most chart indicators have turned bearish, which increases the downside risk.

The Sensex had a much longer period of consolidation of nearly 13 months from the middle of 2009 to the middle of 2010. However, the Sensex has cleared most of the congestion area as prices are now near the bottom of the consolidation area as shown by the blue box. A look at the S&P 500 shows a slightly different picture, with the index at the top of the consolidation level.

Since the market does not take clear direction during a consolidation period it makes it difficult for long term players. However, traders can sell or short at the top of the consolidation range and buy at the bottom.