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This dead cat has nine lives

All over the world, the economic news is not just bad, it's catastrophic; but the market ignores this. In fact, most markets have developed strong and apparently sustainable uptrends.

A MONTH ago, we worried about a dead cat bounce, but it turned out that this particular cat was able to use one of its nine lives.

The US market roared back to life in a manner most unlike a pussy cat. Even the Shanghai market made a new leap, and after a short stumble, has resumed the uptrend.

Is the market smarter than the economy? This remains a moot question as the debate, like the US civil disorder, continues to rage. The headwinds of economic disaster, high unemployment, Covid-19 deaths, widespread rioting and an un-ending trade war with China would seem to be enough to at least hobble the Dow but this hasn't happened.

Everywhere you look, the economic news is not just bad, it's catastrophic. Australia is in recession for the first time in nearly 30 years. The UK has the worst economy in centuries. Large sections of the European economy are devastated. China is staggering back from the brink, but its focus is on domestic growth.

The litany of economic travails seems endless and comes with warnings that things are only going to get worse. Yet the market ignores this. Most markets have developed strong and apparently sustainable uptrends.

This is not a dilemma for traders because they trade what they see on the price chart and not on what they read in the newspapers or brokers' notes.

The situation is more of a challenge for investors because taking long-term positions puts them at risk of a market collapse should the economic fundamentals prove to be stronger than the financial marker indexes.

On the other hand, investors look on with regret at the 30-per-cent-plus rises they have missed out on. Fear of Missing Out weighs more heavily as markets make new, and apparently unstoppable, highs.

The solution for investors is to take a leaf out of the trader's book and look at the price charts, but, like traders, be prepared to exit quickly if the market unravels.

Nasdaq as guide

The Nasdaq leads the Dow in terms of behaviour so it provides a guide to how the Dow may develop. The first feature to note on the Nasdaq weekly chart is the influence of trend line A. This is a long-term trend line starting in 2018. It offered brief support before it was violently broken with the Covid-19 dip.

The post-Covid-19 rally also paused around the value of the trend line, treating it as a resistance feature. This behaviour suggests that this is the most useful trend line to use in understanding the future behaviour and future support areas for the Nasdaq.

The second uptrend line B defines the rally. It is a steep rally and unusually prolonged. Rallies like this generally are unsustainable. How they collapse helps to define the longer term uptrend. A rally collapse here has support in the value of trend line A.

The end-of-rally feature is the potential for a double-top near 9,850. Traders carefully watch the market behaviour as the Nasdaq moves towards this level.

A retreat towards trend line A provides an entry opportunity for investors. A breakout above 9,850 calls for caution simply because such rallies are unsustainable.

The Shanghai index shows both what we feared in terms of a dead cat bounce and how the recovery may develop.

Shanghai experienced a fast and relatively long rally that turned into a dead cat bounce with a rapid collapse to retest the previous lows. That behaviour remains a possibility with the US markets.

The second Shanghai index rebound has a shallower degree of slope and this suggests a more sustainable recovery. Trend line A defines the potential behaviour of a longer-term uptrend with an initial resistance target near 2,980.

A rally consists of many days all moving in the same direction - a series of white candles. A trend consists of rally-and-retreat behaviour. The rebound points following each rally-and-retreat prov- ide anchor points for the trend line that is used to define the longer-term uptrend behaviour. The Shanghai Index has these characteristics.

A parallel trend line B uses the rally peaks as anchor points. The Shanghai Index is moving consistently within the confines of this upward-sloping trend channel. This is further confirmation of stable uptrend behaviour.

Preserving profits

We can try to outsmart the market, or the economy, with our analysis. To be sure, a few analysts will get this right, but most traders and investors will not enjoy these bragging rights.

Their challenge is to work with what they see on the index chart and, cats aside, balance this against their understanding of the economic situation.

Profits are preserved, not by being right, but by quickly recognising when you are wrong so you can move to protect profits.

  • Daryl Guppy is a financial technical analysis specialist, an equity and derivatives trader, and an author. He has developed several leading technical indicators used by investors in many markets.

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