For many traders and long-term investors who track sentiment indicators, the National Stock Exchange's benchmark Nifty is precariously perched.
The benchmark index is just above the 200-day moving average (DMA), a popular technical measure used to analyse long-term trends. Broadly, a fall below 200 DMA is a bearish sign; a rise above this is considered positive.
Analysts said the Nifty's 200-DMA was at 5,624, less than one per cent below on Tuesday's closing of 5,641.60. The index fell below this mark mid-way through the session on Tuesday but recovered towards the trade closing.
Traders and long-term investors watch this level closely because it is a strong support for the market in weak times. Once this support is broken, the market usually falls rapidly, analysts said. "In the past, whenever the 200-DMA has been broken for three days in a row, the correction was swift. The fall is in the six to eight per cent range," said A K Prabhakar, senior vice-president, Anand Rathi Financial Services.
Analysts said traders go short, while long-term investors shuffle their portfolio, when benchmark gauges fall below the 200-DMA. "Many traders will square off their long positions if the level is convincingly broken, which could result in the market drifting lower," said a derivatives head of a foreign broking firm.
Some analysts are betting on the benchmark indices falling below this crucial support next week. "The 200-DMA might not sustain if we look at the amount of put options accumulated by FIIs (foreign institutional investors)," said Siddharth Bhamre, head-derivatives, Angel Broking. "Also, some of the stocks such as Reliance Industries, Larsen & Toubro, and Bharat Heavy Electricals, which have predominantly been with strong hands, have seen short position build-up," he said.
However, indices or stocks usually do not close below the 200-DMA in a hurry. "The possibility is high that the Nifty will bounce back soon because this could be a strong support," said Prabhakar.
Analysts said the previous occasion the Nifty broke below its 200-DMA was in the first week of May 2012. The benchmark indices fell close to eight per cent over the next two weeks after the breach.
What's a moving average?
A simple moving average shows the average value of an asset's price-an index, stock, commodity--over a period. The most widely tracked are the 15, 50, 100 or 200-day moving averages by technical analysts. While 15 and 50 are short-term trend indicators, the 200-DMA is a long-term trend indicator.
What is the significance of 200-DMA?
Around 200 trading days exist in a year, after deducting weekends and holidays. If an index or a stock closes below the 200-DMA, it is said to be in a long-term downtrend. This means a new buyer of the index or stock is willing to pay less than the average price paid in the earlier 200 days. When it trades above the 200-DMA, it is in a long-term uptrend. If it closes below, it is said to have entered a bearish phase. The 200-DMA acts a major support in a bull market and as a major resistance in a bear market.
How do market participants use the 200-DMA?
It is tracked by knowledgeable investors with long-term stock portfolios. When an index or stock conclusively breaks below or out of its long-term average, investors churn their portfolios to suit the market conditions.