The bullish sentiments on the sharemarket earlier this year have been challenged by a correction that has taken the All Ordinaries Index down about 10 per cent from its May highs. Many investors are now asking how deep the current correction is likely to be.
This week's analysis by Robert Brain, a director of the Australian Technical Analysts Association, examines this with reference to past experience. His chart shows that during the past four years, between January and May the market has been volatile but trading in a consolidation range from which it eventually broke to the downside.
The index peaked in April or May of each year and then fell at least 10 per cent from its highs in the following weeks. Although this weekly chart shows a 9.4 per cent fall in the present year, using a daily chart the market has been down 10 per cent at some points.
Two of the three previous falls were, technically, corrections with the market down between 10 per cent and 20 per cent. One, in 2011, is defined as a bear market with the index down more than 20 per cent.
So how far can we expect the market to dip before recovery? Brain says one way of calculating the likely decline is to use the height of the consolidation range between January and May and project that downwards from the breakout point.
This range has its peak at 5202 on May 14 and its low at 4900 (which could itself become a support level in event of a market recovery) experienced in April. That leaves us with a distance of 302 points, which, if projected down from 4900 gives us a potential market bottom of 4598. If that support level doesn't hold the market, then Brain says the next thing is to use a Fibonacci number ratio across the range from the 2011 low to the May 2013 high.
That range, from the September 2011 low of 3928 to the May 2013 high of 5202, is 1274 points. If the market breaches 4598 then the first Fibonacci number retracement level after that would be at 50 per cent between the high and low point, or 4566 points. And if that breaches, the next stop is a 61.8 per cent Fibonacci retracement at 4415 points.
Another prism to use is to look at it in comparison with the recovery from the 1987 crash. That recovery took a decade and took in two subsequent bear markets and one correction. That, Brain says, raises the possibility of another bear market before we achieve a real recovery.
This column is not investment advice. firstname.lastname@example.org
Past performance points the way — but where to?