Stocks: Resumption of new bearish or exiting long-term bullish trend?

European stocks are trading a touch lower. Following such a sharp rally yesterday, a little bit of profit-taking should not come as a major surprise. But is it just “profit-taking” that we are witnessing today or the resumption of the longer term downward trend? Obviously no one knows the answer to that but we will probably have a better idea by the close of play. Let me explain.

When major trends change, the retracements typically tend to be quite deep. This has especially been the case with the US indices thus far, which is probably due to some solid earnings results from the likes of Apple. Indeed, the S&P future has now pulled back to the all-important 61.8% Fibonacci retracement level of its recent correction. If the long-term bullish trend has indeed ended, the bears will need to show their presence now.

Meanwhile in Europe, the kick-back rally has been relatively shallow, with the FTSE and DAX each achieving only a 38.2% retracement so far. Significantly both indices are also holding below their old support levels. For the DAX, resistance is provided around 8960, which was the neckline of the Head and Shoulders pattern that was broken in equities’ slipstream a couple of weeks ago. The FTSE is correspondingly holding below the key 6400 level. For the downward trend to resume, the bears will therefore need to defend these levels. The risk is that these indices may follow their US peers higher, before possibly turning again. But a decisive break above 8960 for the DAX or 6400 for the FTSE would end the near-term bearish technical outlook. In that case, one should expect the indices to at least rally towards their 61.8% Fibonacci retracement levels, around 9300 and 6585, respectively.

The 4-hour chart of the DAX shows some potential short-term support levels in case the index does break lower. The 38.2% Fibonacci retracement level of the recent up move comes in at 8735/7, followed by resistance-turned-support at 8665. The RSI meanwhile is struggling to hold above the key 60 level, the threshold for bull trend confirmation, and is threatening to break its upward trend.

So, in a nutshell, by the end of today’s trading session, depending on how the markets will behave, we should have a better idea in terms of what to expect in the near future. If the key resistance levels hold, it would suggest that the second leg of the new downward trend has started. Otherwise, the markets, especially in Europe, could extend their gains and continue to recoup more of the recent losses. From a technical point of view, it is a very important day in the markets.