MARKETS SPECTATOR: Breakout blues
Sentiment seems to be subtlety changing on a daily basis at the moment and today has been no exception. Yesterday I wrote that on a short term basis I was at the bullish end of neutral. Today, I’m going to do a complete U-turn on my short-term view and sit more towards the bearish side of neutral.
I took a step back from the screens this morning and asked myself some key questions that I hadn't asked for a while. The answers helped me reassess my views short-term, as has today’s trading action.
So far today, we’ve seen a rejection of higher prices which we have not seen for a while, especially following the big down day we had yesterday and the much better than expected price action on overseas markets last night. Recently, sentiment has all been about ‘buying the dip’ but today it looks like we’re seeing a little bit of ‘sell the rally’ creeping in. There’s no doubt that over the last three to four weeks, we’ve seen the demand-supply balance shift more towards equilibrium.
Looking at the weekly chart above, we’ve got a number of very interesting developments occurring. Momentum has shifted significantly over the last week with the market breaking down below the short-term uptrend line.
For the first time since November 16 last year, the weekly chart has made a lower high and lower low (first LH and LL label), which reverses the recent uptrend. This is significant because for 17 straight weeks the market has made higher highs and higher lows, which is the underlying structure of an uptrend.
Even more significant is where this change in trend has occurred. The resistance/support zone I have labelled above represents the major highs of 5025 on April 12, 2010 and 4976 on April 11, 2011. This zone has capped prices for more than four years, hence the importance.
When the market broke up through this resistance zone, many participants bought the breakout as it’s usually a sign the market is heading higher. However, as I wrote about and warned of a few weeks ago, many breakouts (around 78 per cent according to academic studies) tend to fail, trapping those who have recently bought. This is especially true for breakouts of big levels, where everyone is watching it. The market has an uncanny knack of doing the opposite of what everyone is expecting.
Assuming the breakout does fail and the market moves lower, it is highly likely we’ll see the selling accelerate for a period as those who bought the breakout panic and sell as they can’t face watching their positions quickly move into the red.
This acceleration in selling drives the market correction until it slows, the market moves back towards supply-demand equilibrium and a bottom in the correction is formed. From there, with all the ‘weak longs’ shaken out of the market, it tends to rally as the buying moves back in.
From what I am seeing at the moment, this looks to be setting up like a classic failed breakout.