Expect More Chop, But Be Prepared To Buy Stocks

A Symptom Of An Ongoing Problem - December 26th. Breadth weakness in India and weak relative strength versus other Emerging Markets.

Nifty PSU Banks Remain Broken - January 13th. Avoiding this weak sector.

What Does Yesterday's Candle Mean? - January 20th. Bearish engulfing candle in the major indices suggests weakness ahead.

Two Stock's We're Avoiding - January 23rd. Why Havells India and Indiabulls Housing Finance look vulnerable to further downside.

Pumping The Brakes In These Gas Names (For Now) - February 12th. Why we're taking profits in some of the strongest Energy sector components.

Are Autos Ready To Accelerate To The Downside? - February 17th. Forecasting weakness in Nifty Auto and offering two short trade ideas to profit from it.

Breadth Concerns Weigh On India's Equity Market - February 18th. Downside participation across various sectors and stocks expands.

US Stocks Catch Down To The Rest Of The Globe - February 23rd. With US markets falling, further weakness in Indian stocks is likely.

Bulls Lack The Bandwidth To Push Nifty IT Higher - February 24th. Weak participation in the Nifty IT sector suggests fading these new highs.

That brings us to this week.

Our First Downside Objectives In Stocks Have Been Hit - March 2nd. Cover shorts and begin testing waters on the long side.

In the above post I mentioned the following, which I want to elaborate on today: "In a perfect world, it might make for a better setup if the indices do make new lows, test their lower levels of support as momentum diverges positively, and then put in a tradeable low from there…but the market doesn’t care what we want or what would be best from our perspective."

Here's the Nifty 50 as it hits our initial downside target near 11,100 and momentum gets oversold. While it might be tempting to view oversold conditions as a buying opportunity, the real opportunity appears to come after momentum diverges from price and works its way higher from there.

For example, in September 2018 and August 2019, it took prices three full weeks from the initial "pivot low" in the 14-Day Relative Strength Index to put in their final low and move higher.

That begs the question...is this time different?

Click on chart to enlarge view.

We think not. In fact, we think this initial bounce from 11,100 will likely be met with sellers that push prices to our next level of support sitting 4-5% lower at 10,600. It's at that point where we'd expect buyers to step in aggressively and likely see a higher low in momentum form, signaling that sellers are losing their strength.

Lower lows in price, higher lows in RSI, that's what we're looking for.

With that said, we have to remain open-minded to the fact that prices could bounce from here, stabilize above 11,100, and then continue higher towards 12,100. We think that's the lower-probability outcome given the weak breadth and lack of quality long setups out there, but that's why we're providing some individual setups today. In the event that we're wrong, we'll still own some of the strongest names and most attractive setups out there, albeit in smaller size than normal, and that's our cross to bear. We've weighed the evidence and this is our conclusion, so let's wait for more data and see if/how we need to adjust.

There are two types of stocks that look attractive in this environment.

The first are those like Colgate-Palmolive India, which has completed the process we're looking for in the Nifty 50 and other major indices. Prices have pulled back into support, momentum is diverging positively, and now the stock looks ready to head higher. From our perspective, as long as prices are above 1,285, the bias is higher towards 1,450.

The next type of stock are those like Torrent Pharma that have rallied in the face of market weakness, are seeing momentum confirm their recent highs, and are now pulling back towards support. Relative strength is indicating that these types of stocks have institutional support and are likely to continue leading higher if/when the broader market regains its footing.

As long as Torrent is above 2,030, weakness can be bought with a 3-6 month target up near 2,565.

To conclude, we've met our downside objectives in many major indices, sectors, and individual stocks, but history would suggest that the initial bounce from oversold territory is typically met with more selling followed by a retest or lower low in price. It's at that point when we see bullish momentum divergences in the major indices and across sectors/individual stocks that we want to step up and be aggressively buying stocks.

We think we'll get there over the next month, but for now, we're staying defensive by keeping position sizes small and being aware that whipsaws are more likely in this environment. Cash works too as we wait for more attractive reward/risk entries on the long side to develop.

If you need to be trading actively, we'd prefer to do it from the long side and in names like Colgate Palmolive and Torrent Pharma where our risk is well-defined and reward/risk skewed in our favor, but there's not enough evidence yet to suggest indiscriminately buying stocks as an asset class.

Remember, Indian stocks as a whole are not trending, they're sideways at best. This is not the time to be swinging for the fences. We need to pick our spots carefully as we wait patiently for the market to deliver us a fat pitch.

For Premium Members we've outlined a handful of names like Colgate-Palmolive India and Torrent Pharma that look attractive on the long side.

If you enjoyed this post and want to view that list of stocks along with all of our premium research, start a 30-day risk-free trial. Or sign up for our "Free Chart of the Week" to receive more free research like this.

Thanks for reading and let us know if you have any questions!

Allstarcharts Team