Irrational market heading for correction

Indian stock market rallied for a third consecutive week. The hopes for potential Covid-19 vaccines in the very near future improved the sentiments among the traders. Nifty ended with 295 points or 2.1 per cent gain.

The BSE Sensex also advanced by 2.4 per cent. The broader market indices the Nifty Midcap-100 moved up just 0.5 per cent, and Smallcap-100 declined by 0.1 per cent. The overall market breadth was positive for the week.

The market gained over 41 per cent from the March 24 low and decisively closed above the 61.8 per cent retracement of the fall. It is also closed above the 200-EMA. These are the signs of the bull market.

As I keep advocating, a decisive close above 10,551 means, we are no longer in a bear market. As the Nifty making higher top and higher bottoms on a daily time frame, the trend is clearly on the upside. These pieces of evidence show that Indian market is in a confirmed uptrend.

The index is moving in an upward channel. The channel range is about 1,000 points. The momentum is waning for the last few days. The daily prices ranges are coming down. Interestingly, Nifty formed a Doji on the last two weekends.

But there are several bearish Dojis formed and failed to give expected results. The Nifty is forming a rising wedge currently. The channel resistance or wedge resistance line (10875) is target for now. Above this, if a channel breakout happens, the target is nothing, but the prior lifetime high.

Let us examine some bear case scenarios. A Doji at a swing high shows indecisiveness to move further high. This needs a closing below the Doji close for bearish confirmation. The benchmark index is moving up, but the speed of momentum is lagging at each swing high.

There is the hidden divergence in the daily hourly time frame on RSI. There is a negative divergence in MACD histogram. These are the bearish signs, but needs confirmation. The market may face pressure if any of these gets confirmation.

Firstly, if Nifty closes in red on Monday, then it is confirmation for the Doji. If RSI failed to move above 70, it is second confirmation. If Nifty closes below 10,223, it will be a first lower low or it could be a breakdown of a rising wedge pattern.

Unless these happen, there is no chance for markets to slip into bearish mode. When the daily range is coming down, it means there is some kind of distribution is taking place. Even, between November 2019 and January 2020, the market moved up, but the daily range was very narrow.

However, this rally is not supported by fundamentals, but a liquidity-driven one. The retail participation is the highest in recent times. The penny stocks are hitting circuits and some of them already not giving any chance to exit by reversing. Lastly, the underperformance of mid and small-cap is another sign to be cautious.

The Price-Earnings (PE) ratio of 27.78 has reached to the January levels and in a bubble zone. On these stretched valuations, aggressive purchases will be suicidal. The market is likely to be irrational for some more periods. It would be better to book profits slowly. A correction is inevitable at some point in time.

(The author is a financial journalist and technical analyst. He can be reached at tbchary@gmail.com)