Nikkei to struggle after Monday's massive session

A pedestrian walks past an electronic stock board displaying the figure of the Nikkei 225 Stock Average.
Kiyoshi Ota | Bloomberg | Getty Images
A pedestrian walks past an electronic stock board displaying the figure of the Nikkei 225 Stock Average.

Japan's Nikkei had a huge day on Monday, surging 4 percent to stage its biggest rally in 16 months, as investors scooped up bargains after a rout last week caused a 5 percent slump in the index.

The market also rallied on news that Japan's Government Pension Investment Fund, the world's largest public pension fund with some $1.21 trillion in assets, is working on raising its portfolio allocation devoted to domestic stocks to around 25 percent.

But is the positive momentum for the market, which has lost some 10 percent since its year-to-date highs in September, here to stay?

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If the charts would have their way, the answer would be no.

The Nikkei is dominated by a series of historical support and resistance lines. The placement of these areas is calculated by projecting the width of the historical trading band. This method of trading band projection has been very useful in defining targets during the uptrend. It will also help define the support targets for any market retreat.

The critical lower level is 14000. This area was tested as support several times between February and May this year. The rebound comes off a fall towards this historical support level.

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There is a weak resistance level near 14,800, which also acted as a minor support level. The most important resistance level is near 16,200, which was tested in January and most recently in late September.

The rapid retreat from 16,200 to towards 14,000 indicated a severe weakness in the economy. Throwing a whale into this bathtub will push the water level back up, but it doesn't signal a fundamental change in the economy. It's a short term solution.

Traders will catch the wave as the market moves towards 16,200 but the smart money will sell as this resistance level is approached. Pension fund activity provides a floor for the market. It does not provide an incentive because the support is Government directed rather than created by market forces.

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This, and the pattern of support and resistance, suggests it's a good time to take profits rather than join the buying in the hope of a prolonged uptrend.

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.