Nikkei: An imminent correction or a mere hiccup?

On Friday, the Nikkei index managed to make back some of the losses it had suffered in the previous session when global markets tumbled, though it still closed down 0.9% at 16229. The Nikkei future has continued to push higher, undoubtedly due to short-covering and also some "bargain hunting". Still, sentiment remains downbeat and more losses may follow later on in the session or early next week. Admittedly, the fundamentals still point to higher levels for the Nikkei, thanks above all to the BOJ’s extremely loose policy stance, while the weaker currency should in theory continue to boost profits of Japanese exporters, and in turn, their stock prices.

But like most other major global stock indices, the Nikkei is looking a little shaky from a technical point of view. In truth, this is hardly a surprise given the extent of the rally we have seen since the start of the summer. For some, it makes sense to liquidate at least part of their long positions that had been opened over the past months, or even before, at these extreme levels. One of the worst things a trader could do is give back what they had worked so hard to accumulate; there’s never a guarantee, despite all the optimism, that the markets will push higher and higher for the foreseeable future.

Indeed, the most recent price action on the Nikkei has been somewhat bearish. For one, the index has failed to hold above the previous 2014 high of 16375 on a daily closing basis. This apparent lack of conviction to push further higher is the first sign of a fatigue bull market. On top of this, the index has already reached a Fibonacci exhaustion point at 16422 – the 161.8% extension of the last major downswing before the onset of the breakout i.e. from point A to B on the chart. (On a side note, traders may also want to watch for potential resistance around the 161.8% Fibonacci extension level of the other notable downswing, from point C to D, at 16475.) What’s more, the RSI has started to head south after reaching the overbought threshold of 70 and beyond a few days ago. Not only that, but it has made a higher low at these extreme highs, while the underlying Nikkei index has made a lower high. In other words, they have diverged negatively, which is a bearish development as it suggests the momentum may be shifting into the bears’ hands.

The bullish trend would end in the short-term if support at 16050/5 is taken out. But even then the bulls will not be entirely discouraged for as long as the key support, further lower, around 15780/1580 remains intact. However if that also breaks down then we could see the start of a more significant correction.

At this stage, I cannot say with a high degree of confidence that a major correction is looming; but what I can say is that some of the technical indicators are starting to look weak. Whether or not this will translate into, what I think, a correction remains to be seen. Indeed, the Nikkei could just as easily rally and post a close above the previous 2014 high, which would all but invalidate my short-term bearish view.