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Markets show it's a trader's festive season

By Daryl Guppy (China Daily)

13:40, December 12, 2011

Traders and investors look forward to the traditional Christmas rally on the Dow and it seems the Europeans have delivered a Christmas gift. They have promised little and delivered what they promised. It is not enough to power the market significantly higher, but the rally may continue to stagger weakly into Christmas. After a disconcerting plunge from 12179 to 11231 the Dow staged a massive rebound rally after five central banks combined to cut a couple of basis points from the US dollar rate.

The key question is to decide if this rally is part of a new trend, or just a continuation of the extremes of volatility that have characterized the markets. The answer comes from the dominating chart patterns on the Dow index.

The breakout above 11600 from the L-shaped consolidation pattern in October created a symmetrical triangle. This is a pattern of indecision created by two equally valid trend lines moving in opposite directions. One line moves down and the other line moves up. It is no coincidence that this is the perfect pattern to describe the current market situation in Europe.

The base of the pattern is approximately 745 index points. The breakout from this pattern is often very dramatic as the indecision is broken with the announcement of news. The downside target for this pattern was at 11150. This target was not quite achieved with the fall stopping at 11223.

This was followed by an equally rapid rally that has carried the index above the value of the apex of the symmetrical triangle. This is a new feature of this pattern of behavior. A rapid breakout and achievement of the pattern target levels is then followed by an equally rapid retracement. This snapback behavior provides excellent trading opportunities, but this volatility creates problems for long-term investors.

With the Dow, this snapback takes the market back to 12000. The momentum has disappeared from the rally and there is a weak continuation of the upward move. This rise is limited by another long-term feature on the Dow chart.

We need a bit of a history refresher. The Dow developed a head-and-shoulders pattern between April 2011 and July 2011. This is a trend-reversal pattern. The downside targets at 10600 were achieved and were followed by the L-shaped consolidation. The neckline trend line of the head-and-shoulders pattern is projected forward and this is now providing a strong resistance level.

The initial upside target for the first breakout from the L-shaped consolidation pattern was located near 12300. This was calculated by using the value of the head-and-shoulders neckline projected to the right of the chart pattern. The lingering influence of the head-and-shoulders pattern neckline proved more powerful and the market retreated away from 12300.

This line continues to act as a resistance level and this places a limit on the current rally. That is currently around 12450. The rally is already losing momentum. The current deliberations in the eurozone may push this rally a little higher because any sign of agreement, no matter how small, will lead to a relief rally. The upside target for the rally is defined by the value of the head-and-shoulders neckline trend line.

There is a high probability that a retreat from this resistance trend line will be rapid. Traders will be ready to close out profitable positions as the Dow moves toward 12450 and open short positions.

The author is a well-known international financial technical analysis expert.

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