Stock market correction indicates more turmoil ahead

After witnessing a breakout to the downside the stock indices have reached support levels which could lead to a move higher. But does this mean that the time to buy has finally arrived?

A closer examination of the charts shows that the recent declines could very well be setting up for something that may catch traders off guard. Daily charts are showing that the decline was an impulsive move. This means that compared to recent declines the current move is greater than previous ones. In other words the bears have the upper hand here and are likely to remain in control until the chart patterns change.

During the month of May we saw both stock indices and also Gold prices fall. The expectation was that Gold may have started a rally if investors felt that the need for a flight to safety. Instead we saw Gold do the opposite. And so it appears that maybe fear is not a key factor right now. But if the patterns emerge pointing to further declines then maybe Gold traders may see an opportunity to start a rally.

If we take the view from a longer term timeframe such as the Weekly and Monthly charts there are some worrying signs developing. As we enter the month of June the possibility of another move lower is increasingly building momentum.

Failing at the 6000 resistance level the FTSE 100 started its descent and has managed to break below each support level successively. Traders found that after reaching the lower target at 5580 the index bounced higher towards the 5820 resistance level. Finding a strong barrier to overcome the index then fell lower taking out 5580 and slicing through 5407 to reach the Extension support level at 5288.

The position at hand shows that the index will move upwards only if the support at 5288 remains intact. We see a consolidation forming between 5407 – 5288 and on a technical basis this could either be a pause to then break lower or a retracement to the upside. If we see a retracement then the FTSE 100 may reach to test 5540 before continuing lower into July and possibly into August.

The US Dow Jones also sports the same pattern as the UK 100 index in that it has confirmed an breach of an important support level.

Once key support levels have been broken, they can sometimes be re-tested from the underside and form a resistance level. If this turns out to be the case then we could see the Dow Jones reach the 12700 target.

The index did not quite reach the lower expected level of 12270 which would have been ideal but there is no reason why it cannot head lower to complete the move before reaching higher for the counter trend move.

Once the counter trend move has been completed we may then see a reversal back to the downside. Expectations are for the Dow Jones to move towards 12700 as the target. The bearish red bars have not shown any signs of reversing to bullish blue just yet.

One key aspect to watch for as we enter June is to see if the lows of the May period are violated. This would help confirm that there is further falls to be expected.

No doubt that the media focus on the Euro zone will continue in the weeks to come. Given that the news is already out that the economy is not in a healthy situation, could it be another catalyst that could trigger a serious market fall?

Whatever the catalyst, the fact remains that the longer term charts have turned bearish and until we can see stock indices reverse their current positions the opportunity to sell into rallies may be a tactical play for traders.

Gold has created a series of lower highs and lower lows. From a classical technical analysis point of view this is a downtrend that cannot be argued with.

Right now the price of Gold found support at $1,530 on two occasions. If this turns out to be a Double Bottom Pattern then at least for the short term we may see a brief rally in this commodity. This should not be confused with a Trend Reversal. We will have to wait and see if Gold can indeed move higher and then create a higher low followed by another high.

More importantly, the momentum should also turn positive and this will be followed by a breaking above $1,640 to help lift Gold back towards the $1,700 level which is where we had seen a consolidation take place for several weeks.

Whilst some commodity prices have seen lower prices, Gold has been widely traded by speculators and also considered to be an indicator of fear. If a sharp reversal does ensue in Gold then watching for further clues to catch the next wave down in the stock market may become essential.

No doubt that as long as the Euro Zone remains a cause of concern, traders can expect volatility to continue and as long as the highs of March to April have not been broken the trend in stock indices remains bearish and Gold could become the favoured commodity again.

Sandy Jadeja Chief Technical Analyst www.cityindex.co.uk

Sandy Jadeja is the Chief Technical Analyst for City Index a leading provider for Spread Betting, CFDs and Foreign Exchange. He has been involved with the financial markets for over 24 years and is a respected and widely recognized analyst and trainer in technical analysis and appears weekly on CNBC and other media channels.