U.S. equity markets had a stellar 2013, posting their best performances in years, and while they've gotten off to a lackluster start in New Year not all hope should be lost.
The S&P 500 rose 29.6 percent in 2013, while the Dow Jones Industrial Average gained 26.5 percent, marking their strongest performances since 1997 and 1995, respectively. However, their 2014 performances have been lackluster thus far; as the first month of the New Year draws to a close the S&P 500 is down 3.5 percent, while the DOW is down nearly 4.4 percent. Still, investors should not lose hope.
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While the DOW's retreat is sudden and large, it is not unexpected. A 10 percent correction in the DOW is consistent with a continuation of the long-term uptrend, and a test of technical support near 15,000 would present a buying opportunity.
The breakout above the resistance level near 16,400 created by the upper edge of the trading channel had a low probability of continuing to move upwards. Thus, there was a high probability for a retracement below 16,400; this has developed.
The significant feature of this DOW chart is the up-sloping trading channel defined by three trend lines. The most important of these is trend line A which forms the middle core of the pattern; it is also the most well-defined. This trend line starts in February, 2011. It acted as resistance in July, 2011, and again in April and September of 2012. The DOW broke above this resistance level in February, 2013.
Starting in February, 2013, trend line A has acted as a support level. The general market environment has been bullish with the DOW staying above trend line A. As mentioned, the breakout above trend line C was an unsustainable rally, hence the current retreat. Support for the DOW is near 15,000, a 9.6 percent fall from the high at 16,588. A successful test of trend line A as a support level is critical for the continuation of the general market uptrend.
The lower edge of the trading band is shown by trend line B, which was confirmed in June and November of 2012. The width of this trading band is used to calculate the potential height of the resistance breakout in February, 2013. Trend line C defines the upper limits of the breakout, the current retreat from which is no surprise.
This series of trend lines provides the analysis framework for the retreat, rebound and continuation of the uptrend.
The introduction of tapering by the Federal Reserve will keep the DOW trading between trend line A and trend line C as the market adjusts to the impact of less Government bond buying. The DOW's longer-term upside targets are defined by the resistance level created by trend line C. This has a projected value of around 17,000 in December, 2014. Trend line A has a projected value near 15,600 in 2014 December.
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A fall below trend line A will use Trend line B as a support level; the current value is near 13,700. A fall to this level would represent a 17.4 percent retreat from the high near 16,588. Currently this is a low probability event. Investors should watch for support to develop near the value of trend line A as a rebound from trend line A would present a buying opportunity.
— Disclosure: The writer holds an open position in the S&P Asia 50 Exchange Traded Fund.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.