Markets Have Experienced A Lot Of Fake Breakouts Recently

• A few words on false moves
• US market experiences false upside breakout this week
• Whipsaws in the sectors
• European currency whipsaws

A few words on false moves

Prices in financial markets are driven principally by psychology. They effectively reflect people in action. The problem is, that people can and do change their minds. Markets do as well, and this shows up in the form of false breakouts, otherwise known as “whipsaws”.

I have noticed a lot of these whipsaws recently. Most are of a short-term nature but it is a rule of mine that whipsaws are usually followed by an above average move in the opposite direction to the whipsaw. In other words, if we see a false upside breakout that implies that the above average move will develop on the downside.  Why the above average move?

First of all, its important to understand that not every false breakout is followed by an above average move. Most are, but in technical analysis, because we are dealing in probabilities, certainty is not an option.  My theory, in the case of false bullish breakouts, is that many traders are encouraged to enter the market because of the breakout. Some may be covering short positions, whilst others may be entering new ones. Either way, the false nature of the breakout means that there is less support under the market. That’s because every short position eventually has to be covered, and therefore represents potential demand. Cover the short position and you remove that demand. In addition, those who bought on the breakout come home with a loss as the break fails to hold. These positions represent potential supply, which weighs negatively on the market. Finally, since the true trend is in the opposite direction to the breakout i.e. down, natural, or pro trend selling adds even further pressure on the downside.

Sometimes false breakouts develop, the price drops slightly, but within a few sessions, takes out the breakout high in a fairly decisive manner. That kind of action reinstates the legitimacy of the previous breakout, thereby returning the technical position to its previously bullish status. Because of that possibility, it’s always a good idea to make sure false breakouts are confirmed by a supplementary piece of evidence that the trend has well and truly reversed from that indicated by the breakout. Such confirmation could come from a trendline break, MA crossover, a price pattern completion, and so forth.

US market experiences false upside breakout this week

Take Chart 1 for instance. It features Wednesday’s false break by the S&P 500 ($SPX) above the two converging trendlines. I call it a “Pinocchio “ bar, after the Disney character whose nose grows larger every time he tells a lie. In this instance, the open and close are below the two trendlines, whilst the falsely bullish intraday activity, the Pinocchio nose, is above them. In this case we have a fairly strong potential confirmation line. I say “strong” because it is about four months in length and has been touched or approached (acted as support) on numerous occasions. Its violation, if it happens, would act as strong verification of this week’s false upside action. The declining KST is not encouraging in this regard.

Chart 1

Having said that, the situation is complicated because the bearish breakout was preceded by a false break to the downside on the Monday after the health care bill fell apart. The ability for the market to close more or less unchanged signaled its ability to shrug off bad news. That kind of response is usually followed by a lot more strength than the seven-day advance that has so far followed that false breakout. We are therefore left with two benchmarks, the 2322 level that marks the March 27 intraday low and the 2378 which was the high on Wednesday. Right now, the bearish Pinocchio has the upper hand.

Over on the NASDAQ ETF (QQQ) the chart characteristics (Chart 2) are slightly different, but Wednesday’s action is still bearish, as we see another false breakout above the March/April green resistance trendline. The KST is bearish, which suggests that confirmation is likely. That would come with a break below the red up trendline, which is currently at around $130.50.

Chart 2

Whipsaws in the sectors

A review of the various sectors suggests that things may not be as negative.  For example, Chart 3 shows that the financials (XLF) experienced a whipsaw move to the downside on March 27 but no false break this week. We are still waiting for confirmation of that bullish whipsaw, which would come with a break above the horizontal green trendline at just under $24. That’s important because a price drop below that March 27 low would complete a four-month top in the financials.

Chart 3

Metals and Mining ETF (XME) (Chart 4), also reflect a whipsaw to the downside, but in their case a break above the confirmation line has already taken place. Moreover, the KST has reversed to a bullish mode.

Chart 4

Energy (XLE), in Chart 5, also experienced a false double breakout above two green trendlines, but Thursday’s action is trying to invalidate it. Nullification would require a rally above Wednesday’s intraday high of $71.50. It could well happen, because the KST in the lower window, is in an early bull phase. Once again, confirmation would come from a break below the March 27 low, which would also succeed in violating the August/April up trendline.

Chart 5

European currency whipsaws

The other areas where false breakouts are appearing are the Euro (Chart 6), the Pound (Chart 7) and Swiss Franc (Chart 8). All three developed on March 27, but in these instances they were false upside moves. The Euro, even slightly exceeded its 200-day MA at that time, which adds to the signals importance a little. The KST is bearish, which suggests that at least a test of the confirmation line will materialize. However, there is a small unfilled gap just below 108 which may need to be addressed at some point.

Chart 6

The KST for the Pound is still bullish, which means that the currency has a better chance of invalidating its false March 27 breakout. However, I’d watch that $124 level as that would take it below previous lows and the confirmation line.

Chart 7

Finally, the Swissie ($XSF) experienced a double-false break above the solid and dashed trendlines. Moreover, it failed to hold a break above the 200-day MA. Not that that has been a great signaling device due to numerous whipsaws in the recent past (see the ellipses). However, the early November upside whipsaw through this average, is a stark reminder of what could be in store in the event of a downside penetration of the 2016-17 up trendline. That’s a possibility made more real by this week’s KST sell signal!

Chart 8

Good luck and good charting,
Martin J. Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group of Walnut Creek or its affiliates.