FTSE 100 (UKX)

 

Chart of the Week: The real reason the FTSE 100's heading south

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Chart of the Week: Is the FTSE 100 breaking down?

Is the FTSE 100 breaking down?

Since I returned to the world of trading after spending many years running a few real businesses (including being a greetings card publisher!), I decided to try to find a methodology that could help explain how market turns could be understood - and, more importantly, how to predict where they might occur in the future. After all, what investor/trader doesn’t want to know where markets will make major highs and lows?

I am pleased to say my road to enlightenment has been advanced considerably by working with Elliott waves and the idea that the wave patterns - and market highs and lows - are determined in advance to certain degrees of probability. No longer do I see waves on a price chart as just random events determined by the news.

Of course, no way of seeing the markets and making forecasts can be 100% accurate. But if you can make enough great calls in a year based on your method - and keep losses on the losers small - you will rank in the top 5%. The key is to stay with your winning trades as far as possible and to exit at an opportune time. And that is no easy task.

Knowing when to cash in on a great trade is never easy - it is the hardest part of trading/investing. Of course, most investors take the easy route and hold their investments either forever (and bequeath them to their successors), or cash out when they have fallen a long way (at the worst possible time) or when they need the cash.

I believe that traders who have a solid method and follow it with discipline deserve all their hard-won gains. Their profits are certainly not "unearned income". They are truly professionals in the best sense.

So, with insights provided by Elliott Wave Theory and my understanding of basic chart patterns such as trendlines, triangles, support/resistance zones and so on, I have two strings to my bow. The third is my tramline concepts.

So many pundits make forecasts based only on their personal feelings that this or that will happen with no evident underlying analytical basis. Yes, I realise most readers want an exciting story they can believe in that augments their own views, but this approach can lead you very much astray.

For instance, with the FTSE 100 (UKX) index in a solid bull run, many are projecting a continuation of the trend. After all, that is the laziest position to take. But, using my methods, I believe the immediate trend has likely turned - and here is my reasoning (and it has nothing to do with North Korea!).

This is the daily chart:

From the Trump election low of below 6,800 in November, I have a complete five waves up to the 2 June high at the precise 7,600 print inside a magnificent wedge pattern. This is a well-known up-sloping pattern where the highs line up along the upper line of resistance and the lows line up along its line of support.

When this wedge formation (also called an ending diagonal) appears after a lengthy bull (or bear) run, it usually signals the trend is about to turn down. But what makes this an especially powerful reversal signal is the brief overshoot above the upper line and a smart pull-back under it. An overshoot can be thought of as a buying exhaustion.

So, when that overshoot occurred in early June, I was highly alerted to a move down into June. That duly appeared and helped confirm the reversal. But I was not quite ready to place maximum shorts - I need to see a little more chart action.

When the market hit the lower wedge line in early July and bounced back up, what I wanted was a three-wave pattern in the rally because three waves are always counter-trend and would add even more confirmation of the new downtrend. And I was not disappointed. Here is a close up of the action:

This A-B-C is about as textbook as you will find in the FTSE 100. When the C wave was put in (on a Fibonacci 78% retrace), the way was clear for a resumption of the downtrend and the market closed hard down last week into Friday’s close and broke below the lower wedge line on Thursday.

With all the above clues, I can state with some confidence that the trend is now down and it would take an unlikely move above the C wave high at 7,550 to change my mind. Of course, we could see a small bounce towards the lower line in a typical kiss, but that should be about it. But a kiss miss would suggest big declines immediately ahead.

Forget North Korea - just trade the patterns. They hold the key to market action.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.