Nikkei 225 Technicals – Seeking 14,000 after 14,450 break

Why does this look so familiar? Nikkei 225 has been trading lower for the past 3 sessions. If this trend continues for the next 3 trading session, we will most likely end July lower than when we started, despite holding gains for most part of the month, accumulating more than 1,200 points of gains in the process. Bears has since clawed back 1,000+ points from the highs, with current candlestick the 3rd hammer in as many months. This is a huge sign of extreme volatility, and suggest that market is highly unsure of where Japanese economy will go in the long run. Yes, Abenomics is good for the economy. But is it THAT good, and to be more specific, is it worth a 7,000 points gain in Nikkei 225 good? The market is still undecided on the verdict, as there was a huge speculative portion in the run up from ~8,000 to 16,000 between November 2012 to May 2013. As such, traders are all second guessing each other, wondering if recent rally is speculating driven or fundamentals driven. This is not the formula for sustainable directional movements.

Incidentally, latest inflation data from Japan was released this morning, showing that inflation is highest since 2008 June. Suggesting that Abenomics is indeed starting to rub off on the economy. However, Nikkei 225 totally ignored the good news, and traded lower significantly. The problem is that it is difficult to determine the reason for the bearish move. There are possible good fundamental explanations why a stronger inflation number is bad for stocks – prime reason being that BOJ is unlikely to implement further stimulus plan from here onwards seeing that the initial injection of stimulus is working its way through into the economy now. There are other weaker explanations such as higher inflation result in higher cost of production for Japanese firms and hence lower profits, resulting in lower stock prices. However, as we are really second guessing what the market is thinking, it is possible that the reason is not even fundamental at all, where market does believe that higher inflation is good for Japanese economy, but still decide to sell stocks in order to unwind previously made profitable positions, a “buy the rumor, sell the news” move if you will.

4 Hourly Chart

From a technical perspective, price has broken away from the mildly rising trendline which has been providing support for most of July’s rally. The soft 14,400 support has also been broken, exposing the 38.2% Fib retracement from the Jan – May 2013 rally. Stochastic readings is deep within Oversold region though, with readings not hitting this level since early Jun. Hence there are signs that prices are already overextended, increasing the likelihood of the Fib support holding.

Monthly Chart

However, it is important to remember that over extension via short-term chart can easily give way to longer-term chart’s momentum. By trading below 14,450, price has lost its bullish edge, while a break of the 61.8% Fib (close to 14,000) will invalidate the point of inflexion candlestick pattern, which actually suggest that price may accelerate higher quickly this month. Should price push lower even further and result in a bearish candle this month, we could see a potential top forming, and bearish acceleration may take place towards sub 12,000 levels if 13,000 and more importantly the 50.0% Fib is broken. The least helpful scenario would be a case where price close between 13,700 – 14,000 where price will appear to be uncertain once more, and given the uncertainty surrounding market drivers as explained above, we may need yet another month of price action before true directionality may emerge.

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