The Euro Stoxx 50, the leading blue chip index for the euro zone, has seen steep declines so far this year given the region's debt crisis. Based on technical analysis, it seems the index could fall a further 20 percent to test 2008 lows.
The Euro Stoxx 50 chart is dominated by trading bands created by well established support and resistance levels. The upper resistance level is near 3,050. It has acted as an effective cap since late 2009, trapping performance.
The lower edge of this extended sideways pattern trading band is near 2,500. This was a resistance level in mid-2009, and then retested as a support level in mid-2010. It failed to provide support in mid-2011 as this index fell straight through this level.
Trading bands are non-directional. Trading bands with intense volatility offer trading opportunities in the rallies and the retreats. The Euro Stoxx 50 chart is less volatile, with generally slower and more sustained trend behavior. That’s important because it helps to define the nature and character of the current activity.
The fall below 2,500 moved quickly to achieve projected targets. The targets are calculated by taking the width of the trading band and projecting it downwards. This is a very reliable method applied to well established trading bands. The downside target is near 1,980. This was achieved quickly and provided a technical rebound point.
This is a technical rebound point because the 1,980 level does not have a history as a support level. This also suggests this level could be broken in further retests of support, so traders use caution in buying anticipated rebounds. Historically the support level is closer to 1,800 and this is more significant when the current trend behavior is included in the analysis.
The break below 2,500 was part of a broader downtrend that was defined with the peak highs in early 2011. The rebound from 1,980 also used the region of the downtrend line as a resistance level. The reaction retreated from trading band resistance near 2,500, but the current reaction is retreating from the value of the trend line. The placement of the downtrend line is not exact on this weekly chart, but the influence of the trend line as a resistance level is clear.
This suggests continued downward pressure on the Euro Stoxx 50. The secular trend is down. Short term opportunities exist to trade rallies and retreats in the context of this downtrend. A retest failure of support near 1,980 has a downside support target near 1,800.
The key signal long-side investors watch for is a move above the value of the downtrend line, currently near 2,400. However, any upside breakout is limited by the initial resistance near 2,500. On balance, there is a high probability the Euro Stoxx 50 chart will retest the 2008 lows near 1,800.
Daryl Guppy is a trader and author of Trend Trading, The 36 Strategies of the Chinese for Financial Traders –. He is a regular guest on CNBC's Asia Squawk Box. He is a speaker at trading conferences in China, Asia, Australia and Europe.
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