Nikkei: double bottom reversal or just an oversold bounce?

As we reported earlier today, crude oil is currently driving almost everything at the moment. In particular, it has been correlating positively with the equity markets due to oil’s obvious impact on the energy stocks. So, when oil prices bounced back from the key $30 handle today, the severely oversold energy stocks jumped and global indices and index futures have correspondingly rallied. US markets have been supported further by forecast-beating earnings from JPMorgan, which has lifted hopes that the rest of Wall Street banking giants will also provide positive or at least better-than-expected numbers over the next several days.

But the key question remains: is this just an oversold bounce, or the start of a new upward trend? To answer that question, we will need to turn our attention to technical analysis. And since it has been a while we last covered the Japanese stock market, we are looking at the daily chart of the Nikkei today, below.
As can be seen from the chart, the index has bounced back sharply during the European and US sessions after closing down more than 2.5 per cent in normal trading hours overnight. As things stand therefore, Tokyo shares could gap sharply higher at the open.

Now, this is not the first time the Index has bounced from the technically-important area between 1935 and 17200. The last time it bounced there was at the end of the last bear trend in September, when it momentarily traded below 17200 to fall to a low of 1935 but only to close the trading day back above 17200. Consequently, it formed a clear reversal pattern: a false break down. From false breaks come fast moves in the opposite direction and so the Nikkei went on to climb all the way to 20000 before the rally stalled at the end of November/early December. December was a bad month and we all know what happened in the first week of 2016.

Today’s bounce however suggests it may have formed a double bottom around the September low of 16935. Either that or the sellers simply took profit here en masse which caused the index to bounce. After all, taking profit at this key level makes perfect sense, especially since the momentum indictor RSI is currently in a state of bullish divergence with the index and that it is also at the oversold territory of below 30. Speaking of 30, that is exactly where the two oil contracts have also bounced; again, that could just be an oversold rebound in the oil market.

So, at this stage, traders should proceed with caution, as the bear trend is still in play. The bulls will need to see some confirmation such as a break of a key resistance in order to grow in confidence that this is in fact a double bottom pattern being formed. So, for that reason, price action around the previous intra-day high of 17750 would be important to watch. A decisive break above here could see the index rally towards the next levels of resistance shown on the chart, including the Fibonacci retracements. Conversely, if the sellers re-emerge and the index falls below the 16935 area decisively then the next stop could be some distance away, possibly around the 127.2% Fibonacci extension level at 16090 or the psychologically-important level of 16000.