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Searching for signals

After a strong recovery, The Trader is on the lookout for signs of a reversal
May 9, 2019

Holidays have been coming thick and fast since late April’s Easter when Westminster politicians believed they deserved a proper break, allocating themselves a fortnight in which to escape Brexit – again. Then the Japanese were given an unprecedented 10 consecutive days’ worth of holiday in which to follow Emperor Akihito’s unusual abdication and the ascension of Crown Prince Naruhito, marking the beginning of the Reiwa era. 1 May saw labour day holidays in many countries, Ramadan started on 5 May, then the UK was off this Monday for a Bank Holiday.   

What with all this start-stopping I flat forgot to look at monthly candlestick charts last week, reverting to weekly ones on Tuesday. The discipline of looking at a vast swathe of markets on a timely basis in a consistent format is, I believe, very important. So I played catch-up on the Monday after President Trump Tweeted that as of midnight on Friday 10 May tariffs on Chinese imports valued at $200bn would rise from 10 per cent to 25 per cent – which promptly sent their stock markets and those around the world into a tailspin.

I was looking to see if I had missed any signs that would have hinted at things set to go pear-shaped. First, the FTSE 100, which had rallied for four consecutive months, undoing the damage done in the previous four, and becoming very overbought in the process – something we had been flagging for ages. Nothing untoward on the monthly candles other than that the 7600 area capped for much of 2017. The weekly chart was more interesting, with a series of very short candles, most of which had small bodies denoting instability. No screaming headlines here.

 

 

Similarly, the S&P 500, which inched up to a new record high and was overbought for months. Like the FTSE, it has a potential broadening top or megaphone chart pattern, mirrored in the small, unstable doji-style candles over the past four weeks. Subtle but not conclusive signs of instability.

 

 

The CAC 40 index of Paris’s top shares has far more interesting monthly candlesticks, a fairly solid horizontal resistance level at 5600 which has capped most of the time since early 2017. This too takes the form of an irregular potential broadening top chart pattern, its lower edge dropping like the previous ones, but the upper edge almost perfectly horizontal; you have had ample warning of the struggle at this point, so profit-taking should have been considered.

 

 

Chinese indices, some of which had rallied this year by as much as 40 per cent from last year’s trade-tension-induced depressed levels, reached measured targets at the start of April and we warned Asian readers that it was time to pause, review and possibly prepare for a correction. In typical style, the higher they climb the harder they fall, managing an impressive 5.5 per cent decline on Monday alone. The monthly chart gave you a strong warning sign, overbought since April Fools' Day and a shooting star candle. The market gapped lower in May, forming a potential irregular island top, a three-candle pattern that often occurs in overenthusiastic situations.

 

 

Other than the Relative Strength Indicator, most oscillators on these indices are fairly neutral, both on weekly and monthly charts. This suggests that rather than a sudden slump and rising fear, more likely is an orderly retreat and a decent correction to this year’s rally.