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Oct 26, 2020, 10:50 AM GMT

Gloomy Times Ahead for the German DAX Index

The German stock market was not even able to recuperate fully from the initial coronavirus crash, and now, the second epidemic wave is already knocking on the door of the biggest economy in Europe. By all accounts, it looks as though it is going to be a very long winter indeed, with the number of confirmed cases expected to continue surging into 2021.

Eventually, the German Government is going to be compelled to tighten the containment measures in the country once again, which would most likely discourage European investors even more.

The recently released industry numbers in Germany mostly disappointed, given that the Services PMI tumbled more than it was initially expected, which encapsulates the impact of the coronavirus fallout on the tentative economic recovery in Germany. The reintroduction of more stringent lockdown measures is likely to exacerbate this adverse impact further.

The upcoming meeting of ECB's Governing Council on Thursday would be of crucial importance for the future of the DAX, given that the underlying monetary policy of the central bank could cushion the coronavirus-related ills of the index. Whether or not the Council would decide to intervene further remains to be seen. At the present rate, the fundamental outlook does not look too good for German stocks, as the DAX could find itself in the early stages of establishing a new downtrend.

1. Long-Term Outlook:

As can be seen on the daily chart below, the price action of the DAX is currently concentrated within the boundaries of a broad range. It spans between the major resistance level at 13800.000 and the 23.6 per cent Fibonacci retracement level at 12501.104. The ADX indicator confirms the range-trading sentiment, as it has been threading below the 25-point benchmark since the 18th of June.

The range itself serves the role of a Distribution segment in a broad Wyckoff cycle. In the wake of the initial coronavirus slump, the cycle was restarted with the establishment of a major Accumulation. The subsequent recovery process manifested the Markup stage. It follows that the price action might be due to develop the next logical segment of the cycle – a Markdown (downtrend). Such expectations are supported by the above-mentioned fundamentals, which look increasingly bearish.

So far, each of the three throwbacks to the three psychologically significant Fibonacci retracement levels was followed by a new upswing. Following the conclusion of the last throwback to the 23.6 per cent Fibonacci, however, no major upswings were developed next. Instead, the price action consolidated just above the 12501.104 support, which substantiates the aforementioned projections - chiefly, that the market is currently preparing to transition from the Distribution into a new Markdown.

Over the last several weeks, the price action has been establishing a massive pattern, which is increasingly looking like a pennant. This entails two possible scenarios. The price action could either break out above the descending trend line, in which case the next goal would be the major resistance at 13800.000, or it could decisively break down below the 23.6 per cent Fibonacci. Its subsequent target level in the latter scenario would be the 38.2 per cent Fibonacci at 11689.562.

Looking back to the ADX, notice that the DMI- segment of the indicator has been steadily outstripping the DMI+ since the 17th of September. This relationship between the two is illustrating the increasingly bearish commitment in the market.

Finally, the Stochastic RSI indicator is currently threading within its 'Oversold' extreme, which could induce the establishment of a minor bullish pullback. Keep in mind that while the range-trading environment is still prevalent, the Stochastic RSI could be used to determine potential turning areas. Its projections, however, should be perceived with caution given that the broader expectations are for the following establishment of a new downtrend out of the existing range.

2. Short-Term Outlook:

As can be seen on the 4H chart below, there are even more pieces of evidence demonstrating the rising bearish pressure in the short-term. The price action is no longer trading within the confinements of the ascending channel (in light blue). Moreover, one of the last bullish corrections was exhausted before the price managed to reach the lower edge of the channel, which is quite exhibitive of the mounting selling pressure.

Notice also that the last bullish pullback was terminated below the three moving averages, which represents yet another bearish signal. At present, the price action is concentrated below the 20-day MA (in red), which is positioned below the 50-day MA (in green), which, in turn, is placed below the 100-day MA (in blue). This perfect descending order represents the final major confirmation of the rising bearish sentiment that warrants close attention.

If the market goes on to conclude the aforementioned pennant, then the price action could potentially test the descending trend line one more time (point B) before a decisive breakdown develops next. Accordingly, the price action could rebound from either of the three MAs yet again before turning south (point A).

While the DAX continues to be ranging, appropriate range-trading strategies should be applied. However, given the longer-term anticipations for the emergence of a new Markdown, traders should look for opportunities to utilise trend-reversal strategies.

As can be seen on the hourly chart above, the market opened with a massive gap at today's open. Since the price action is currently trading below the range's lower boundary, the bears could start placing short orders immediately. Nevertheless, the alternative seems more plausible at present. The market is likely to pullback towards the upper limit of the test area 1 or even the upper limit of test area 2 before a decisive rebound takes place.

Should the price action break out above 12705.499, however, this would mean that there is still quite a strong buying pressure remaining, which should discourage the bears from prematurely entering into the market on the hopes for the immediate creation of a new downtrend.

3. Concluding Remarks:

Given the confluence of the observed technical and fundamental pieces of evidence, the German DAX seems poised to go down in the future, which should not be interpreted as a signal for selling immediately. Instead, the bears should continue monitoring the behaviour of the price action around the above-mentioned levels on the hourly chart, and look for an opportunity to join the market at the next swing high.

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