Stocks on Wall Street had an impressive run in 2013 amid a backdrop of ample central bank liquidity, with the NASDAQ rising 38.3 percent for its best year since 2009. However, with the Federal Reserve set to reduce its asset purchases this month investors can't help but question the likelihood of a repeat performance in 2014. Down 1.5 percent in the first few days of the New Year, charts suggest that the NASDAQ may face a pullback, but ultimately the environment remains bullish.
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Charts show that the NASDAQ index has a steady and strong uptrend with an up-sloping trading channel. Best seen on a monthly chart, there are three features: the trading channel, potential upside targets and the position of long-term uptrend line A.
The trading channel: Trend lines A and B are the lower and upper edges of the trading channel, respectively. The NASDAQ has moved above the upper edge of the trading channel, thus there is an increased probability of a retreat.
Upside targets: Between 2010 and 2011 the NASDAQ moved in a narrow sideways trading band with the lower edge near 2360 and the upper edge near 2920. The first NASDAQ breakout target near 3520 – calculated by projecting the width of the sideways trading band upwards – has been achieved. Applying the sideways trading band projection again, a second target is set near 4100 and a third near 4620.
There is a high probability the market will consolidate near the 4100 resistance level. This is a solid uptrend that has accelerated very quickly since March, 2013, thus a breakout above resistance near 4100 and the value of trend line B is not sustainable. Investors should wait for a pullback to inside the trading channel.
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Line A: Long-term uptrend line A defines the extent of any large fall in the NASDAQ that is still consistent with a continuation of the uptrend. A fall below the long-term uptrend line would signal a change to a new downtrend.
Thus, the NASDAQ could fall to near 3300 and still remain in a long-term uptrend trading channel. From the current high near 4200 this would represent a 21 percent fall – a major market correction similar to the 19% fall from 2920 to 2360 in July, 2011 when the lower edge of trading channel trend line A and the 2360 level acted as support.
The NASDAQ's behavior around the 4100 resistance level is critical. There is a high probability of a retreat to inside the trading channel followed by a rebound. The steadily rising NASDAQ trend is defined with the up-sloping trading channel. It continues in a bullish environment with 4620 as the next upside target.
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.