The Aussie market has basically been trading sideways for the past three years, and is currently at the same level as it was back in July 2009. No wonder investors have become frustrated.
If you have been actively trading this market in the past six months, you will no doubt have found it challenging to hold on to gains, particularly if you have been trading the large cap stocks (say ASX top 20). The 4300 level remains a major resistance level.
The Aussie market has been underperforming in relation to other global markets for some time. There are a number of factors that have contributed to this:
• The high Aussie dollar, which is providing a headwind for overseas investors who want to trade in our market, as well crushing the returns of our companies with overseas earnings.
• The two-speed economy (east versus west), which is impacting growth in the various states, and employment.
• The sluggish housing sector, as investors wait for that next rate cut.
• Disillusioned retail customers, who are ditching the bricks and mortar retail suppliers for online shopping.
• The political environment generating uncertainty.
Chart: Aussie SPI Futures
A chart of the Aussie SPI futures index shows why it has been so hard to generate consistent returns. The term SPI is an abbreviation of ASX SPI 200™ Index Futures contract, which is a composite index over the Top 200 ASX stocks.
The SPI is in what is called a “symmetrical triangle” formation. This type of pattern generally forms in a period of consolidation, before price builds up enough momentum to move beyond one of the identified trendlines.
A break below the lower trendline will signal weakness and often triggers a move lower, while a break above the upper trendline signals buying strength and a move upward. As you can see from this chart the sharp moves within the triangle have been predicated by a sharp increase in trading volumes. The stochastics indicator also defines overbought and oversold.
Edwards and Magee in their book “Technical Analysis of Stock Trends” concluded that approximately 75% of symmetrical triangles are continuation patterns and the rest mark reversals, however these reversal patterns can be especially difficult to analyse and often have false breakouts. They also said that you should not try to anticipate the direction of the breakout, but rather wait for it to happen, and utilise additional technical indicators for confirmation of the breakout (such as trading volumes and/or stochastics).
For the patient investors prices sometimes return to the breakout point at the apex of the triangle in a reaction move, before resuming in the direction of the breakout. If this setup occurs it can offer the trader a second chance to participate in the move, often with a better reward to risk ratio.
Planning the Trade
In order to trade the index you must evaluate the current symmetrical triangle pattern and be prepared to react to any breakout.
Trend – As stated earlier the Aussie SPI is trading sideways, so this symmetrical triangle cannot really qualify as a as a continuation pattern, in an established trend. The index is at the same level as it was back in July 2009.
Pattern – As highlighted on the chart we are in a symmetrical triangle pattern, which has been in place for the past six months.
Volumes – Trading volumes have been anemic in the most recent run up of the index. This can be interpreted in two ways: 1) there is a lack of conviction in this move, or 2) volume may surge with a confirmed move higher (due to the lack of participation in the current market, and investors find themselves under invested in equities and move to chase performance).
Duration – This pattern has been in place for many months.
Breakout Time Frame – The ideal breakout point occurs ½ to ¾ of the way through the pattern’s formation. Ideally you look for a break between the ½ and ¾ way point as a break too close to the apex may be insignificant. As you can see this breakout for the SPI will occur close to the apex and therefore may lack momentum to provide a significant move.
Breakout Direction – Can only be determined after the break has occurred, and it is dangerous trying to predict the direction prematurely.
Breakout Confirmation – A valid breakout requires a close above/below the trendline. More conservative traders will require a greater than 3% price break and/or the break is sustained for at least three trading days.
Return to Apex – After the breakout (up or down), the apex can become future support or resistance. The price sometimes returns to the apex or a support/resistance level around the breakout before resuming in the direction of the breakout. If this does occur it offers a substantially improved reward and risk trade setup.
Price Target: You can calculate a price target either by taking the widest distance of the symmetrical triangle that can be measured and applied to the breakout point, or by drawing a trend line parallel to the pattern’s trend line that slopes (up or down) in the direction of the break, and the extension of this line will mark a potential breakout target.
Conclusion
Our market is setting up to break in either direction, possibly near term. The 4300 level is crucial for a break to the upside and a break below 4180 could prompt a retest of the recent lows. Last week Jeff talked about overbought markets and this is well worth a read.
Our reporting season has triggered some major short covering rallies of late, e.g. Onesteel, particularly in the mid cap companies. So watch to see whether momentum in these stocks can translate into buying of our larger caps.
Look to trade stocks outside the Top ASX 100 in order to outperform the market index and utilise options strategies to boost the returns from the large cap ASX stock. MDS Financial Advisory Service offers general advice on trading options to generate consistent steady income on your investment portfolio. For further information please call 1300 610 024.
There are also a number of positive catalysts from overseas that may help our market, including:
• the final agreement of the second Greek bailout fund
• China easing up on bank reserve requirements
• the US markets trading at multi-year highs.
However we still face the headwinds of political uncertainty and a high Aussie dollar.
Remember to plan the trade, then trade the plan.
By Michael Hevern
MDS Trading Desk
This report was prepared by Michael Hevern. It represents the views and opinions of the author. It is not intended for use by any third party, without the approval of Michael Hevern. While this report is based on information from sources which are considered reliable, its accuracy and completeness cannot be guaranteed. Any opinions expressed reflect my judgment at this date and are subject to change. Contracting Hevern Pty Ltd is a Corporate Authorised Representative No. 408868 of MDS Financial Services Pty Limited ABN 28 088 190 283 AFSL No. 333298 (MDS), and Michael Hevern has been appointed as an Authorised Representative of Contracting Hevern Pty Ltd. Opinions, conclusions and other information expressed in this report are not given or endorsed by MDS Financial Services Pty Ltd, unless otherwise indicated. The information contained in this Report is General Advice only, as the information or advice given does not take into account your particular objectives, financial situation or needs.
