Written for First Post
August 6, 2011: The wild gyrations of the US equity markets pushed the Sensex and NIFTY outside their consolidation patterns, increasing the possibility of a further sell off in the Indian markets. All the asset classes moved wildly last week, except for gold which stayed relatively steady.

Click here for the charts of  Sensex and Nifty

In a symmetrical triangle, price moves in a continuously narrowing range as buyers and sellers battle to give the market direction. The narrowing range forms a symmetrical triangle when the peaks and valleys in price are connected.

Once prices break out of the triangle they usually have explosive moves in the direction of the break. Hence a break to the downside can push prices lower and vice versa. Professional traders tend to avoid asset classes moving inside a symmetrical triangle and take positions only after prices close outside the triangle.

Fundamentally speaking effects of the debt crisis in Europe and the sharp growth deceleration in the US is expected to chill markets around the world. India and China have been applying the brakes on growth for sometime. Now with the spreading of the Euro debt crisis and falling demand in the US, the deceleration story is global. The western countries seem to be out of ammunition to fight the market sell off. However, additional stimulus might reverse the sell off at least temporarily.

The strategy to adopt now is to look for rallies to sell into. Aggressive market players can short the Indian indexes and stocks in the futures market. In our July 2 article, we had mentioned that the Sensex could fall as much as 3700 points if it broke below the symmetrical triangle. However, we are not sure if the index would fall by 3700 points as it stayed inside the triangle for the long time. The longer prices stay inside the triangle lesser the chances of a strong move on the break.

Right now we'd wait for the Sensex to rally to the 17,500 level before shorting. If the index continues to rally the next level to short is 17,950. Some traders would wait for confirmation that the market is falling before going short. The level of confirmation is a close below 17,000. For the Sensex to continue falling it has to clear 15,990, 15,600, 15,200, 14,700 and 13,260. Similar levels on the NIFTY are 4800, 4677, 4547, 4370 and 3900. These are areas where the Sensex could catch a bounce and levels where traders short on the index can book profits. If the 13,260 level is broken the Sensex can go all the way down to 10,500. In case of the NIFTY if the 3900 level is broken  the index can fall all the way to 3150.

Note that both indexes have a lot of levels to clear on the way down, which means that the downtrend is expected to be slow. 

In previous articles, we had mentioned several factors that were giving negative signals for the equity markets. First was the fall in copper prices. Equities often follow copper prices with a lag. There was also the continued rally in the gold market and a rise in US treasury bond prices, indicating a flight from risk. These were early signals to reduce exposure to the equity markets.

Gold

The precious metal fell slightly following the steep drop in the global equity markets. However, it has held on and closed positive for the week. There is a possibility of traders taking profits on gold to reduce losses in the equities, but the chart of the precious metal is still bullish.