The pullback that we forecasted in January has commenced. Following its stellar 38.3 percent rise in 2013 the Nasdaq has lost momentum as the Federal Reserve further tapers its asset-purchase program. Down 3.4 percent year to date, the index suffered its biggest single-day drop in two-and-a-half years last Thursday underscoring the pullback.
This raises one key question for investors: is this is a temporary retreat, or a significant change in the trend? A retreat would present a buying opportunity for a continuation of the uptrend, while a change in the direction of the trend would be a sell signal to protect profits.
The Nasdaq has a steady and strong up-sloping trading channel which is best seen on a monthly chart. The chart has three analysis features: a trading channel; potential upside targets; the position of long-term uptrend line A.
The trading channel: The lower edge of the trading channel is defined by trend-line A, while the upper edge is defined trend-line B. The Nasdaq's move above the upper edge of the trading channel and resistance near 4100 increased the probability of a Nasdaq retreat.
Potential upside targets: The Nasdaq's first upside target near 3520 is calculated by projecting the width of the sideways trading band upwards; this has been achieved. Applying this projection method again we find a second target near 4100, which has also been achieved.
Using the same method, a sustained breakout above 4100 has a third target near 4620. This is the long-term target for a rebound after the current retreat.
The position of the long-term uptrend line A: This defines the extent of any large fall in the Nasdaq that remains consistent with a continuation of the uptrend. For instance, the Nasdaq could fall to near 3500 and still remain in a long-term uptrend trading channel. From the current high near 4370 this would be a 20 percent decline – a major market correction. It's similar to the 19 percent 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. A future decline to the lower edge of the trading channel near 3500 on trend-line A remains consistent with the long-term uptrend.
This is a temporary trend retreat and correction, not a trend change, thus investors will use the retreat as a buying opportunity. The U.S. tax year ends on April 30 so some of this sell-off is tax driven.
There is a high probability the retreat to inside the trading channel will be followed by a rebound. The Nasdaq trend is defined by the up-sloping trading channel 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.