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Nikkei upside may be limited: Charts

A man is reflected on an electronic stock quotation board outside a brokerage in Tokyo, November 17, 2014.
Issei Kato | Reuters
A man is reflected on an electronic stock quotation board outside a brokerage in Tokyo, November 17, 2014.

Surprise easing from the Bank of Japan (BOJ) at the end of October fueled gains in the Nikkei, but data Monday showing Japan unexpectedly entered a technical recession interrupted the uptrend and charts indicate further upside may be limited.

The BOJ surprised markets at the end of October by expanding its stimulus program, while the Government Pension Investment Fund readjusted its target allocations, increasing the amount of domestic stocks that it buys. Together, the initiatives pushed Japan's Nikkei to fresh seven-year highs above 17,000.

Growth data released on Monday damped optimism about further stock gains, however. The economy contracted an annualized 1.6 percent in the third quarter following a 7.3 percent contraction in the second, putting Japan in a technical recession and calling the effectiveness of Abenomics – Prime Minister Shinzo Abe's over one-year-old plan to kickstart the Japanese economy – into question.

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A month ago we noted the limits for the Nikkei rise; these targets have been achieved. These same methods are used to define the downside limits for the Nikkei's retreat and the future upside limits for any recovery rebound rally.

The Nikkei is dominated by a series of historical support and resistance lines that define activity in the rising trend and how the index consolidates. The support and resistance levels create a series of trading bands; the width of the trading band is projected upwards to determine the next upside target. This trading band projection has been very useful in defining targets during the uptrend and for setting the support targets for any market retreat.

The most important support level is near 16,200. This level was tested as a resistance in January 2014 and most recently in late September. The rapid breakout above 16,200 in early November had a calculated upside target near 17,600. The rally did not reach this level; it fell short, reaching 17,520. The upside target was calculated by projecting the width of the trading band upwards.

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Additional upside resistance is provided by the value of trend line A. Any move above 17,600 has additional resistance from the value of trend line A. From April 2013 to February 2014 trend line A acted as a support level. When the Nikkei fell below this trend line in February 2014 it then acted as resistance.

The Nikkei has good support near 16,200 but it has strong resistance features near 17,600 and from the value of trend line A. Traders will watch for rally and retreat behavior.