Since the crash in March, markets across the globe have staged a remarkable comeback, with some markets rebounding almost 30%. Here's why it is all going to come tumbling down, but this time, harder.
Welcome to Simply Economics. This article is going to provide an in-depth analysis as to why the stock market is in for deep trouble over the coming month and why investors shouldn't be become complacent over the gains being made over the past month.
“History informs us that we are in a period of complacency and a bigger drop is to be expected.”
Why does history matter?
No two crashes are the same. So why do we look back and try and learn from other recessions? It is because we can draw parallels between them and it is imperative that we learn from our mistakes.
In 1929, after the market dropped around 50%, there was a period where stocks began to climb and many investors thought the worst of the crash was over. This period is known as the 'bull trap'; a period when investors and the media become complacent over the recent gains in the market and believe a new bull market has begun, when in fact, the bear market hasn't even finished. It is an integral part of the market cycle.
As shown above, after the initial crash, the Dow rebounded over the following months and it led many to believe a new bull run had begun. However, the worst of the crash was yet come, the Dow saw gains from the past 4 years wiped out followed with record unemployment rates.
How do we know this is going to happen again?
Technical indicators and analysis show we are at this point of the cycle in the current moment with a reversal due to occur any time soon.
As shown by the daily candlestick chart above, the S&P 500 can retrace up-to the 61.8% Fibonacci retracement before breaking out of the bull trap.
On the 16th of April, an area of resistance was created around the 61.8% retracement and was tested again on the 28th. It was around this point, the candlesticks began to form a classic reversal pattern; a dark cloud cover followed by bearish conformation.
This price action shows signs of weakness appearing in the current bull trap and alongside the sell signal printed by the slow stochastic oscillator on the 28th of April it argues a strong case that another fall is imminent. In addition to this, trading volume is on the decline which shows that the upside swing is running out of stream, emphasising the fact that a reversal is on the cards.
On the weekly chart a similar story is told; volume is drying up and there was a big rejection of the 61.8% Fibonacci level last week, leaving the bears in control. And a look at the 4 hour chart shows rising wedge forming, giving further bearish bias to this upward move.
However, despite all these indicators showing that the market is staged for another downfall, it is better to wait for further confirmation by holding until old support levels are breached.
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