European shares ‘oversold’ but temptation holds risks

<p>After one of the most vicious global market sell-offs for months, European stocks are ‘oversold.’ At least that’s the term chart analysts use to describe […]</p>

After one of the most vicious global market sell-offs for months, European stocks are ‘oversold.’

At least that’s the term chart analysts use to describe the state of the market after stock selling this week extended beyond certain standardised levels.

The ‘fundamental’ backdrop to this of course is that the world’s stock markets have been falling hard in concert for the whole week.

Commodities (especially base metals) have loomed large, taking a further beating on Friday after a closely watched data release showed the sharpest contraction of Chinese manufacturing activity since 2009.

The apparent end of the ‘high-growth’ phase that prevailed in China at least since 2009, triggered investor flight from riskier assets, like stocks.

This pushed several major equity indices, like the Dow Jones Industrial Average, S&P 500, FTSE 100, Hang Seng and Shanghai Composite to their deepest weekly falls for months, or even years.

 

 

Shanghai – New York – Paris – London

One of the gauges used most extensively by specialist technical traders but which has now begun to filter out into wider market awareness is the 200-day moving average.

Regarded as perhaps the most significant moving average on charts using daily intervals, the fact that China’s main stock market, the Dow, S&P, and FTSE 100 have broken through their 200-DMAs is being interpreted as potentially more ominous.

However, from a technical perspective, for markets in Europe, and elsewhere, sentiment (AKA ‘momentum’) indicators like the Relative Strength Index and Stochastic-based gauges have slipped beyond boundaries generally regarded as excessively bearish (please see chart at bottom of page).

Among the region’s broadest indices, the FTSE Eurofirst 300 Index was one of the leaders in being ‘oversold’.

Its RSI had broken the nominal ‘30’ boundary, a level prescribed to depict the fall of an asset below its cost over the preceding averaging period.

 

Indicators can’t measure absolute value, but at times like these, that’s almost immaterial.

 

 

Too far, or not far enough?

The fact that a large swathe of traders has them on their radars gives indicators pragmatic weight.

When markets are ‘oversold’, expectations that they may soon bounce are higher.

Especially when corroborated by other types of indicators, like the ‘Slow Stochastic’ (also pictured).

For the FTSE Eurofirst aggregate, any relief will have to wait for next week, as it joined the further magnification of Europe’s sell-off to close more than 3% lower on Friday.

This took the index through a strong descending trend that has been in place since March.

Whilst bearish, the line has at least contained market falls since then.

It is also being bisected, and therefore perhaps strengthened, by another important marker for traders, a 50% retracement—this one relating to FTSE Eurofirst’s ascent between mid-October and mid-April.

 

shutterstock_196568720 EUROPEAN MARKETS

Bull and bear statues at the Frankfurt Stock Exchange, Frankfurt, Germany

 

 

But this is the first time the market has tested the trend line from March since it weakened sharply to fall beneath all major moving averages, 50 (yellow), 100 (dark gold) and 200-day (purple).

Should the trend definitively break, finding another support nearby would be problematic.

61.8% of the FTSE Eurofirst’s ascent between mid-October and mid-April is a fair candidate.

It is about another 3% from the index’s close on Friday.

 

On the one hand, current ‘over-selling’ argues against a further fall as deep as that.

On the other, common sense and recent experience suggest a higher-than-usual risk that this sell-off isn’t over yet.

 

FTSE EUROFIRST 300 DAILY 21ST AUGUST 2015

Please click image to enlarge

 

 

Join our live webinars for the latest analysis and trading ideas. Register now

GAIN Capital UK Limited (trading as “City Index”) is an execution-only service provider. This material, whether or not it states any opinions, is for general information purposes only and it does not take into account your personal circumstances or objectives. This material has been prepared using the thoughts and opinions of the author and these may change. However, City Index does not plan to provide further updates to any material once published and it is not under any obligation to keep this material up to date. This material is short term in nature and may only relate to facts and circumstances existing at a specific time or day. Nothing in this material is (or should be considered to be) financial, investment, legal, tax or other advice and no reliance should be placed on it.

No opinion given in this material constitutes a recommendation by City Index or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although City Index is not specifically prevented from dealing before providing this material, City Index does not seek to take advantage of the material prior to its dissemination. This material is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.

For further details see our full non-independent research disclaimer and quarterly summary.