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Mar 29, 2021, 10:52 AM GMT

German Stocks Poised to Test Breaking into Uncharted Territory

The German DAX index received a major boost last week from the country's overwhelmingly positive manufacturing and services numbers for the previous month. Germany continues to grapple with the coronavirus pandemic because of persisting problems with its vaccination plans; however, the biggest economy in the Eurozone benefits from a global pickup in economic activity.

European stocks have shown some resilience in the midst of a massive selloff in the U.S., but it remains to be seen whether the DAX would be able to continue probing further into uncharted territory while investors' sentiment in the U.S. continues to diminish. The rout was prompted by reinvigorated fears of rising yields, even though the Federal Reserve pledged to continue with its accommodative monetary policy stance.

There could be a spillover in European markets, though there are no indications of any imminent danger just yet, given the relatively uneventful economic calendar for this week. An unnerved market could, therefore, drive the price of the index to the closest support level, even though the underlying market sentiment looks ostensibly bullish. That is why today's analysis examines the likelihood for the emergence of a new bearish correction before the broader uptrend gets ready to resume climbing higher.

1. Long-Term Outlook:

As can be seen on the daily chart below, the continuation of the rally seems more probable following the successful completion of the Bullish Triangle. The decisive breakout above the major resistance (currently support) level at 14100.00 underpins this. The subsequent consolidation of the price action past the psychological support level at 14500.00 provides further justification to the expectations for continued price appreciation in the foreseeable future.

Notice that the recent throwback to the 14500.00 support also represents a rebound from the 20-day MA (in red), which serves the role of a floating support. The resulting Hammer Candlestick can be perceived as a likely confirmation of the existing bullish bias and a potential precursor to further price appreciation.

Nevertheless, the strength of the underlying uptrend is not yet decisive. As can be inferred from the ADX indicator, the market is technically range-trading. It has been doing so since the 10th of December, which was the last time when the indicator was threading above the 25-point benchmark. The current reading of the Average Directional Index implies two things. Firstly, the DAX has been rising at a moderate pace for over two months now, and secondly, the underlying bias is suitable for the emergence of abrupt corrections.

The DAX is consolidating above 14500.00 after a recent bullish breakout

The Stochastic RSI confirms this by examining the latest changes in the underlying buying pressures. The indicator shows that selling pressure has been rising over the last few days, though this has not yet been reflected in the price action. This means that the potential development of a bearish correction in the short-term seems highly plausible.

The 14500.00 support seems like the first most likely target for such a dropdown. This is substantiated by the fact that the 20-day MA is currently converging with the psychological barrier. A deeper correction could target the resistance-turned-support at 14100.00, given that level's previous role as a major turning point. Even though there are strong indications underpinning potential dropdowns in the short-term, market bears should keep in mind that the longer-term outlook remains positively bullish.

2. Short-Term Outlook:

The possibility for the emergence of such a correction is examined in greater details on the 4H chart below. The price action has been developing an Ascending Wedge, which is a type of pattern that typically is taken to represent likely bearish reversals, since the beginning of March. This would be inlined with the broader forecasts for a bearish correction, provided that the price action manages to break down below the lower limit of the Wedge.

Notice that the latter is currently converging with the 50-day MA (in green), which also serves as a floating support. Therefore, a decisive breakout below the lower band of the Wedge would be subject to a penetration below the moving average as well. As can be seen, a bullish rebound occurred the last time the price action tested the 50-day MA, which makes it an even more prominent turning point.

The DAX is developing an Ascending Wedge pattern, which could be a precursor to a bearish correction

The close proximity between the lower border of the Wedge, the 50-day MA and the psychological support at 14500.00 is what makes the latter so important. That is why it would represent a crucial test, showcasing whether the price could continue to depreciate towards 14100.00 or the market bulls should gear up for an immediate trend-continuation.

Bears will be hoping for an immediate correction because the price action is currently trading near the previous swing peak, which also marks the all-time highest price. As shown on the hourly chart below, they will be preparing to use contrarian trading strategies around the current market price, in the hopes for a reversal from the lower edge of the Uncharted Territory (at 14800.00) towards the lower limit of the Consolidation Area (at 14500.00).

The 200-day MA (in purple) is nearing the latter, which is why bears should keep an eye on it. Meanwhile, if the Bullish Test fails and the price breaks below 14500.00, the correction could be extended towards 14100.00.

The 1h chart demonstrates the possibility for a bearish correction on the German DAX index

3. Concluding Remarks:

Contrarian trading from the latest swing peak would involve a high degree of risk, which is why bears should consider using very narrow stop-losses (just above the peak itself). In contrast, bulls should not buy into the market at the current price. Instead, they would be better off waiting for an eventual dropdown, even if one does not emerge right away so that they can use trend-continuation strategies at the resulting low. They should be looking for an opportunity to go long, around 14500.00, bearing in mind that the correction could dive lower.

Profit & Loss
Short Term Long Term Net % Gains
+ - + -
0 109 BPS N / A N / A
Short Term
+ -
0 109 BPS
Long Term
+ -
N / A N / A
Net % Gains
Journal Entries
Mar 31, 2021 - Entry 1
The German DAX index continues to appreciate in a bullish uptrend
  • Even though the analysis was quite right in anticipating continued price appreciation, it was wrong in its expectations for an initial bearish correction. Despite the successful longer-term forecasts, however, there was still an incurred loss.
  • In hindsight, the correct decision would have been to buy immediately instead of eyeing a potential dropdown. The most important takeaway here is the need for correctly evaluating the strength of bullish/bearish markets. Even more precisely, it is not enough for contrarian traders to enter just at any swing top/bottom in an existing trend.

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