German DAX could soon turn bearish

German DAX - YTD Performance
German DAX – YTD Performance

The German DAX along with major world equity indices plunged the last week. For the week, the German benchmark index fell -9.35% after enjoying a strong first half of the year. The DAX index gained a total of 30.69% from the start of the year rallying from the yearly open at 9719 to test the highs of 12416 largely fuelled by the ECB’s quantitative easing program. The rally continued on until April which was when the index started to post lower highs. To date, the DAX has wiped out -18% of the total gains made this year and looks poised for further downside in the near term. Since this year, the DAX has formed a strong inverse correlation to the EURUSD and the highs and the lows in both the currencies coincided strongly. With the view that the DAX could push lower in the near term outlook, it could potentially point to a rally in the EURUSD as well. The decline in the German DAX comes amidst fears of a global slowdown which was fuelled by investor concern in light of the Chinese stock market plunge a few weeks ago followed up by weaker economic data from China pointing to a slowdown in the world’s second largest economy.

The markets also had to come to terms with the US Federal Reserve expected to hike rates anytime in the remainder of this year. Most of the DAX components are made up of German car manufacturers and financial service providers who have a significant market share in China. In light of the recent volatility, some large hedge funds have reduced their exposure to some selected industries such as car manufacturing companies including Daimler AG and BMW AG.

The DAX so far enjoyed a rally as the risks of a Greece default, during the near three months of stalled negotiations prompted the markets to start pricing in a Grexit. However, with the risks now abating, the other regional indices including the French CAC40 and the Italian MIB were seen to have found favor among investors.

DAX – Technical Analysis

DAX - Technical Levels
DAX – Technical Levels

From a technical perspective, the German DAX has broken its short term support at 11030 earlier in August this month. This support had initially offered some hope to the bulls as prices bounced off the 11030 support earlier in June this year. However, the bounce was short lived as prices failed to break past the previous highs. The current break of this support has seen a sharp decline to the next main support in the DAX at 10002 – 10000 region.

From the current levels, we could either expect a further decline to test the long term trend line or expect a sharp reversal off the current support. In any case, we could anticipate a turnaround in the DAX in the next few weeks as prices are more likely to attempt to test the broken support at 11030. If this level turns to resistance, it would mark a fresh major lower high in the DAX index.

Focus will likely shift back to the 10000 level of support which could sustain prices for a while. However, comparing the DAX to the 13 week RSI, we notice a strong bearish divergence in play at the moment. This could indicate an eventual correction down to 8769 region of support.

While it would hard to speculate beyond that, traders could look for potential short selling opportunities on a rally towards 11030, which could offer some good risk/reward opportunities while targeting the currently established support at 10000 and eventually down to 8769 regions. Expect to see similar converse movements in the EURUSD as well.