DAX forecast: European markets edge higher but caution prevails

European stocks traded mixed with Spain’s Ibex rising to a fresh weekly high and Germany’s DAX off its earlier lows at mid-day in London as government bond yields eased off their earlier highs. Earlier, UK’s gilts were sharply higher across the board, triggering a sell-off in domestically focused stocks and the pound, all to suggest that investors are losing faith in the government’s ability to keep a lid on the national debt and/or to control inflation. We also heard cautious outlook from top UK retailer Tesco while Marks and Spencer warned of “uncertain” economic growth. Similarly, German bond yields were also sharply higher, tracking US yields, before easing from their respective highs. Rising borrowing costs and weakness in economic growth both across Europe and in China all point to a bleak economic outlook. Against this backdrop, investors may struggle to maintain a bullish view on the DAX forecast, after the index’s stellar 18% rise last year, which came on the back of a 20% rally the year before. This year, we may see a bit of a pullback if valuation concerns take centre stage now with bond markets offering competitive yield advantage over falling equity yields.

Technical Signals Point to a Possible Correction

From a technical standpoint, the DAX remains in a robust long-term uptrend, having weathered only two significant corrections since its October 2022 bottom. These corrections, both around 10%, were met with strong dip-buying activity, propelling the index to new highs. However, warning signs are emerging again. Let’s start with looking at the weekly chart of the DAX.

DAX forecast: Weekly chart enters key resistance zone

In December, the DAX tested resistance at the upper boundary of both its long-term bullish channel and a medium-term channel established since 2022. This dual resistance, coupled with negative divergence on the Relative Strength Index (RSI), suggests momentum may be waning. The RSI, having peaked above the overbought threshold of 70, is now making lower highs despite the DAX reaching new all-time highs in December. Such divergence often precedes a correction. We have seen a similar pattern on major US indices such as the S&P 500.

If history repeats itself, a 10% pullback could bring the index down to the support trendline of its medium-term channel. Unless a major bearish catalyst emerges, this scenario would likely set the stage for another leg higher. However, traders should remain vigilant for signs of deeper corrections.

Key Levels to Watch on the Daily Chart

Zooming in on the daily chart, the DAX has shown resilience after finding good support around the October high of 19,680, turning prior resistance into a floor. Currently, it is retesting 20,330 resistance zone, a key level where bears may look to regain control.

For bearish momentum to gain traction, however, a decisive break below the psychological 20,000 level is essential. This area previously acted as resistance in late December. Additionally, a daily close outside the rising wedge pattern observed on the chart could signal a shift in sentiment.

While the bulls have consistently defended key levels, any failure to hold support could invite stronger selling pressure. But if you are a bearish trader, be warned that until a clear reversal signal emerges, caution remains warranted given the DAX’s strong performance last year despite macroeconomic challenges.

Source for all charts used in this article: TradingView.com

-- Written by Fawad Razaqzada, Market Analyst

Follow Fawad on Twitter @Trader_F_R

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