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Why you shouldn't ignore key reversals

Lesley Beath  |  08 Aug 2016Text size  Decrease  Increase  |  

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No chart pattern is infallible and in the case of key reversals they can be nullified very quickly, but while they are intact they should not be ignored, technical analyst Lesley Beath says.

 

The Australian share market hit a brick wall last week, as it tested significant resistance. That resistance was the July/August 2015 peak.

If we look at the weekly chart of the All Ords, that resistance, at first glance, doesn't seem that important, but I think it holds more significance than first meets the eye.

And that is because a weekly key reversal was registered on the index on the week ending 7 August 2015.

That was also the week that Australian and New Zealand Banking Group (ASX: ANZ) announced a capital raising. The ASX Banks Index broke its 2011 uptrend the following week.

So that period set the scene for the decline that followed.

Last week, the All Ords declined after testing that resistance on the Monday. The ASX 200 did not make it up to test its August 2015 high, stalling below that level.

Interestingly, or perhaps ominously, the ASX 200 registered a weekly key reversal last week.

Key reversals were also registered on a number of indices, including the ASX 20 Leaders, ASX 50 Leaders, ASX Financials, ASX Banks, ASX 100 Industrials, ASX Industrials and the ASX REITS.

Key reversals were not evident on the resource side of the market.

For those newer readers, let me give a very quick description of a "key reversal".

Basically, a key reversal, in an uptrend, occurs when a stock's (or index, or currency or commodity) high price and low price for the session exceed those of the previous session, and price closes below the previous session's low.

They can also be described as "outside reversals". The "session" can be daily, weekly, or monthly, depending on the timeframe of the chart.

Weekly and monthly key reversals are not that common and when they occur they signal an abrupt change in sentiment.

In an uptrend, they are not necessarily sell signals but they do suggest caution is warranted; they are often associated with at least a short-term peak. (Key reversals also occur in a downtrend).

When they occur at significant resistance, and on a number of varied stocks and sectors, their importance intensifies, in my opinion.

In the last report I noted the resistance on the ASX Banks Index, the All Ords, the ASX Materials Index and the ASX 100 Resources Index.

So last week's inability to push through that resistance comes as no real surprise.

I think the surprise is that the resource side of the market held up as well as it did. Both the materials and the resources indices remain below their key resistance levels but the chart action is not suggesting a near-term reversal at this stage.

As for the banks, Westpac (ASX: WBC) and National Australia Bank (ASX: NAB) also posted key reversals. Commonwealth Bank of Australia (ASX: CBA) and ANZ stalled at resistance.

Long-term buy signals are evident on all four of the banks but caution is warranted in the short term.

A break above last week's high (in the major indices) is required to render the key reversal redundant.

Before we move on the US equity market, I'd like to follow up on something that was highlighted a couple of weeks ago.

I am referring to the relative-performance charts of the ASX Healthcare and ASX Utilities indices.

When we looked at those previously, both the ASX Health Care/All Ords ratio and the ASX Utilities/All Ords ratio were facing resistance.

The former had pushed through that resistance in the Monday trading, and I had thought the break would hold. I also said the important ratio to watch was that of CSL Limited (ASX: CSL)/All Ords.

The latter remains below resistance, and the ASX Health Care/All Ords failed to hold its topside break. I think the sector will struggle to outperform in the near term.

I was more worried about the relative-performance chart of the ASX Utilities. Recent action does nothing to dispel my concern. I think the sector may lag the broader market in the near term.

Okay, on to the global equity markets.

The S&P 500 posted its best day in almost a month on Friday, adding some life after the monotony of the past few weeks.

In reviewing the largest components of the index, there is nothing to suggest a major reversal to the downside is imminent.

But until the Dow Transports can push above resistance, and confirm the end of its bear market, upside in the broader index is likely to be muted.

I also draw attention once again to the US S&P Banks Index, which last week tested its 2015 downtrend.

That is an important barrier which needs to be overcome before we can assume the overall market has the strength to push substantially higher.

The VIX remains at the lower levels of its recent range. The US T-Bond/S&P 500 ratio is not giving any strong signals, but it is approaching an important support level, which if broken would imply continuing upside in the equity market.

All in all, there are still no strong signals in the US. The main thing to watch in the near term is the downtrend on the banks and the resistance on the Dow Transports. The outlook would take a dramatic turn for the better if those were overcome.

In Germany and France, the downtrend we have focussed on is still intact, and it is in close proximity. This is an important test for both markets.

There's no point second guessing either market at the moment. Wait for a resolution.

On the commodity front, copper remains trapped in its range, while aluminium and nickel continue to trend higher. Gold is below its breakout point, as is gold in Australian dollar terms.

Oil is in an interesting position so we will take a look at that. Let's take a longer-term view by starting with the monthly chart.

As you will see, price dipped beneath long-term support levels in January and February, but importantly, the close for each month held above that support.

Price hit a low of $26.93 in February and then rallied to $51.61 in June. It then declined in a steady fashion and by last week oil had retraced almost 50 per cent of the February to June rally. That offered support, as did the 200DMA.

Price bounced in the latter part of last week, acknowledging that support. Whether or not this is the beginning of a rebound is unclear at this stage as medium-term momentum indicators are not yet in buy mode.

However, it is a level which could usher in a reversal, so we will monitor the situation closely.

The US Oil & Gas Index and the ASX Energy Index have support at current levels but there is not much to suggest a major turn to the upside at this stage.

Lastly, the CRB Index also tested its 200DMA last week--not surprising given the energy weighting in the index.

It also posted a weekly key reversal--in contrast to the Australian equity market this was a key reversal that came after a price decline. Another reason to keep a close eye on the oil price.

Don't forget that no chart pattern is infallible and in the case of key reversals they can be nullified very quickly. But while they are intact, they should not be ignored.

 

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Global equities     |      Australian equities     |      Commodities

 

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More from Morningstar

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To the extent that any content below constitutes advice, it is general advice (or, in New Zealand, a "class service") that has been prepared by Lesley Beath as a Morningstar authorized representative (ARN 469614) without taking into account your particular investment objectives, financial situation or needs. If necessary, you should consider the advice in light of these matters, consult with a licensed financial advisor, and consider the relevant Product Disclosure Statement (Australian products) or Investment Statement (New Zealand products) before making any decision to invest. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria. The author does have an interest in the securities disclosed in this report.

© 2016 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written content of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.