DAX double bottom reversal or bull trap

There are contradictory technical signals to be observed when looking at the daily chart of the DAX index, which means that both the bulls and the bears should proceed with an extra degree of caution. The bulls for example would point to the fact that the index has refused to hold below the previous low of 9320/5 area, which suggests that a double bottom reversal pattern may have been created. What’s more, the long-term bullish trend line that has been in place since September 2011 has also been defended once again. In addition, the momentum indicator RSI has formed a clear bullish divergence i.e. it has made a higher low compared with a lower low on the underlying DAX index. This has so far correctly suggested that the bearish momentum was waning, hence the rebound over the past couple of days.

However despite the recent recovery, the near-term technical outlook on the DAX still remains bearish as so far no major resistance levels have been taken out. Indeed, what we have witnessed so far could easily have been driven by profit taking from the sellers and some short-term opportunistic buying, rather than aggressive buying pressure. The good news is that soon we will find out which of these scenarios is the case. Conservative traders may therefore wish to wait until the signal becomes clearer before jumping in or alternatively be more nimble in this market environment.

Traders may have also noticed that the last significant rebound from the 9320/5 support level ended at the relatively-shallow 38.2% Fibonacci retracement level (around 10500) of the downswing from this year’s record high, suggesting the buyers had lacked conviction in their trades and they therefore booked profit quickly and the sellers held onto their positions. Are we now witnessing a similar pattern unfold? The high of today’s candle is around 9780; in other words, just above the 38.2% Fibonacci retracement level of the most recent downswing (around 9765). If the previous price action is anything to go by, then a rejection at this shallow retracement level would suggest that the index may go for another test of the 9320/5 support area before deciding on its next move.

If and when the 9320/5 support area breaks down decisively then things could turn ugly for the German index fairly quickly.  It would be a psychological blow for the bulls, forcing more to rush for the exits while fresh sellers may also be tempted to join in. The fact that there are not much further short-term supports below this level means the bears may consequently aim for 9000 as their initial target in the case of a breakdown. Not only is this a psychologically-important level but here we also have two Fibonacci levels converging: the 38.2% retracement of the upswing from the post financial crisis low (at 9035/7) with the 127.2% extension of the most recent bounce (at 8995). The 161.8% extension level could be the next bearish target at just below 8580.

Conversely, if the bulls win control here, they would then also need to break several other resistances such as 10,000 and 10,500 before they grow in confidence and come back in force. So there’s more wood to chop for the bulls than bears.