Will the Nikkei continue to fly? Charts suggest it will
Save for a few hiccups, the Nikkei's year-to-date performance has been stellar. Boosted by Abenomics – a series of policy measures aimed at reenergizing the Japanese economy – the Nikkei has risen over 50 percent year to date, ranking it among the world's best performing indexes in 2013.
With the year drawing to a close the question remains: will the index carry this momentum into the New Year? If chart patterns are anything to go by, the answer appears to be yes.
(Read more: Nikkei surges to six-year closing high)
Chart patterns are powerful trading tools because they point the way to high probability outcomes. Many chart patterns also allow for the calculation of price targets, although not the time frame for the achievement such targets. Thus, chart patterns provide a probability framework that allows traders and investors to take positions in anticipation of price movement.
The weekly Nikkei chart shows a well-developed upward sloping triangle. The triangle pattern has three essential elements. The first two are the resistance level near 14,800 and the up-sloping trend line that intersects that resistance level.
The third element is the triangle's base. The base is created by 1 to 4 candles which move continuously in the same direction. In other words, the candles are all the same color. The weekly Nikkei chart shows this pattern with the fall following the high near 16,000.
Although the trend line can be projected backwards to start near 11,800, the triangle patterns starts from the low near 12,500 that creates the trend line's second anchor point.
The base is particularly important in this pattern because it is used to calculate the upside breakout target. The height of the base is measured and that value is projected upwards from the resistance level. This gives an upside Nikkei target of 17,100.
(Read more: Goldman most upbeat on Japan, Europe stocks in 2014)
However, this doesn't mean the index will quickly move to this level. There is a high probability of a retreat and retest of the resistance level as a support level. This target time frame is between 8 to 20 weeks. What is significant is the way the chart pattern signals a shift in the balance of probability towards a continuation of the uptrend.
Patterns by themselves do not necessarily lead to consistent outcomes; rather the development of chart patterns alerts the trader that a range of outcomes is more likely than at other times.
As price moves towards a well-established resistance level the trader pays more attention to the stock, ready to place a buy order if prices move a few ticks above that level. He cannot buy until others have bought because he wants to follow the action, not create it.
(Read more: The verdict on Abenomics, one year on)
When prices retreat into the body of the support and resistance band, or another chart pattern, the trader shifts his attention elsewhere.
Daryl Guppy is a trader and author of Trend Trading, The 36 Strategies of the Chinese for Financial Traders – www.guppytraders.com. He is a regular guest on CNBCAsia Squawk Box. He is a speaker at trading conferences in China, Asia, Australia and Europe.