Trade Setup: Nifty in extremely overbought zone; risk-reward ratio unfavorable

The domestic equity market continued to pile up gains for the seventh day in a row as it went on to end one more day with decent gains.

The opening for Tuesday's session was a modest one this time. However, Nifty stayed in the upper rising trajectory throughout the day. Except for a minor profit bout witnessed in the afternoon, the trend remained intact. The index did not slip into the negative even once for the entire day. Nifty soon recovered after a minor paring of gains, posted a fresh high and ended with a net gain of 170.05 points or 1.36 per cent.

From a technical perspective, Nifty's shape has made the risk-reward ratio absolutely unfavorable for any fresh chase of momentum. NIFTY PCR is above 1.85; this is an extreme overbought area for the market by any standards. The market is at one of the highly risk-prone zones and this was reflected in the volatility index India VIX that spiked 7.28 per cent to 21.5775.


Nifty also completed its classical target after breaking out from the broad trading zone above 12,000. Any more unabated up side will stay prone to equally sharp profit taking bouts. Wednesday's session is likely to see the levels of 12,730 and 12,790 as resistance points, while support would come in much lower at 12,560 and 12,480 levels.

The RSI on the daily chart is 75.52; it has marked fresh 14-period high. It is neutral and does not show any divergence against price. The daily MACD is bullish; it trades above the Signal Line.

The pattern analysis on the daily charts shows that Nifty has fully achieved the price targets that can be calculated using the classical methods in technical analysis. This also means that any unabated up move is now making the trade setup highly risky.

Overall, Nifty is in an extremely overbought territory. It would be very unwise and imprudent to chase the up move in its current form. We recommend to now stay away from making fresh purchases. Shorts may be taken cautiously as Nifty's rally is yet to show any sign of halting. However, that being said, purchases, if any, should be kept limited only to defensives even if they tend to underperform in the present setup as the market, in general, remains vulnerable to sharp corrective bouts.

(Milan Vaishnav, CMT, MSTA, is a Consulting Technical Analyst and founder of Gemstone Equity Research & Advisory Services, Vadodara. He can be reached at milan.vaishnav@equityresearch.asia)