DAX surges on dovish ECB bulls not out of woods yet

The European stock markets have closed sharply higher today, led by a 2.7 per cent upsurge in the German DAX index. Sentiment has been boosted after the European Central Bank President Mario Draghi struck a particularly dovish tone at the ECB press conference today and signalled his willingness to take more action if needed. The ECB published lower forecasts for both inflation and GDP in the Eurozone, which is obviously not good news for the economy. However, the promise of more QE means the prospects of slower global economic growth and indeed the possibility of a Chinese hard landing have been put on the backburner for the time being. The European stock market bulls will also welcome the considerably weaker euro, which may fall further against the dollar if tomorrow’s US jobs report for August turns out to be stronger than expected. As well as a weaker euro boosting equities, energy stocks have also found some support thanks to rebounding prices of crude oil.  But if oil prices have indeed already found a base, the still-weak fundamentals point to only a moderate recovery.

As far as the DAX is concerned, the German index is not out of the woods just yet. While the momentum indicator MACD is suggesting that the bearish influence is weakening, this may only be true in the very short-term outlook. If the index manages to break last week’s high around 10400 then we could see some further gains, perhaps towards old support levels such as 10655 or even 11025. But while the DAX holds below this 10400 resistance, there is a risk that the index may pullback sharply and move below long-term support at 10,000.

But regardless of what the index may do in the immediate term, some of the longer-term technical indicators have turned bearish. The 50-day moving average, for example, has now crossed below the 200 to create a so-called “death cross.” When the moving averages are in this particular order, some momentum traders would be looking to sell the rallies rather than buy the dips. What’s more, a clear bearish trend line is now established. When long-term trends change, it is very common for the markets to stage deep retracements. This is because most people will still be looking for trades that had worked well in the past: “buying the dips,” in the case of the DAX and other major indices. These rebounds progressively get shallower and eventually the pressure gets too much and the long-term trend reverses. But the million dollar question of course is: are we there yet? Has the market already topped? While no one can answer this question with a high degree of confidence, the evidence in front of us certainly point to that direction. But as we already mentioned, expect sharp counter-trend moves in the short-term.

What this means from a trading point of view is that there will still be great opportunities on both sides; it is just that the bulls will have to be a bit more nimble. The bears will need to be extremely patient and ideally wait for deep retracements and confirmation before pulling the trigger.