Forecast the rally’s top with chart patterns
IT HAS been all too easy to get caught up in the wave of enthusiastic stock market rallies over the past few weeks. At some point – and probably in the near future – indices will either look to retrace some of their gains or consolidate. Spread betters should therefore be looking to lock in their profits and prepare to make the most of the market’s next move. It’s all just a small matter of spotting the top of the market. And there, of course, is the rub.
Picking the top of the market is notoriously difficult and those who sell at the top often do so by pure chance. That said, there are a number of signs to look out for which indicate that the market is nearing the top of the current rally. Spot these and you ought to be able to exit your position without foregoing too much profit.
And some are already becoming evident. On Friday, the daily chart for the CRB commodities index showed its first decline in six days and the Shanghai Composite index – which was the first to signal the beginning of the global sell-off back in February 2007 – slipped below its support level and the US dollar trade weighted index – which tends to move inversely to equities – has successfully tested the key December support level of 77.30 and remained above it.
REPEATED TESTING
From a technical analysis viewpoint, spread betters could also be looking out for bullish reversal signals on the hourly and 30-minute charts as well as keeping an eye on the bigger picture shown by the daily charts. Key bullish reversal signals include repeated and unsuccessful testing of key resistance levels.
Simon Denham, managing director at Capital Spreads, said that the market had been sitting around the 4,625 to 4,700 level for the past week. But he adds: “The shorts can sit with the hope that the 4,700 level in the FTSE is still capping the buy side and new position builders seem to be running out of courage above this level.”
While lower volume in the summer months can distort and undermine technical reversal signals, spread betters should not ignore them. Whether you are looking to get out of a long position or enter a short one, technical indicators can help you determine the precise entry and exit points.
Tom Pelc, head of technical analysis at RBS, points out that the longer the existing pattern, the greater the significance of the reversal pattern and that tops are usually quicker to form and more volatile than bottoms.
PARTICULARLY WATCHFUL
This means that spread betters need to be particularly watchful at the moment for chart patterns such as head and shoulders reversals, or double and triple tops which are usually quite easy to spot.
Head and shoulders consist of three peaks, with the middle being the highest. The left shoulder should ideally be higher than the right shoulder and you should expect to see an increase in volume on the down move.
With double and triple tops the peaks are about the same level and the volume should decline on each peak. The reversal pattern is finished when both supports levels are broken.
But for the eagle-eyed chart watcher, V spike tops are also an important bullish reversal signal that might be particularly indicative in the current circumstances as they usually form at the end of a runaway trend with a steep trendline.
This is indicated by a stock closing at a high, followed by a close slightly lower, and then a subsequent close higher – known as an “island gap”. This points to a top in the market and a move lower. Pelc says that Fibonacci analysis suggests a retracement by 0.382 or 0.50 will occur following a spike.
For now though, the only certainty is that you should keep watching the charts.