Bearish Divergence Between US and UK Stock Markets

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Two weeks ago I produced a chart of FTSE 100 with a yellow rectangle in the area 7550-7650, I called this area “Top area”. The reason I was expecting a top was twofold; the trend reversal indicator (34-day BTI) was overbought and the Elliott wave pattern was in five waves. Bull markets end in five waves, so when the trend reversal indicator is overbought and we have five waves up the odds of a trend reversal are high.

In this situation I follow my indicators, if the potential decline is substantial I will take a swing trade. The beauty of a swing trade is that if I am correct I won’t take small gains of 40-50 pts, I will take a big chunk of the decline. I am talking about 150-200 pts in one trade. Why bother with day trading when it is easier to trade with a wide stop loss and wait patiently for two or three days until the target is hit. You see, one of the issue with day trading is the tight stop loss. The tighter the stop the greater the probability the stop loss will be hit. Of course when you swing trade you have a wider stop loss, and this wider stop loss has a lesser chance to be hit.

The 34-day BTI was overbought and my sentiment indicator turned bearish. When sentiment is bearish investors interpret the new negatively. For example good news is seen as a ”problem”, I am referring to strong economic data. Investors will focus on the negative consequences on strong data like higher interest rates. This is why the market is more likely to fall than to rise when sentiment is bearish because bad news is bad news and good news is bad news.

Today we see the US markets pushing higher in pre-open, the resilience of the US stock market is incredible, but now that sentiment has turned bearish, the US markets will struggle to push higher. What is more incredible is that the Dow Jones and the S&P 500 are still trading near their all-time highs at a time when the 34-day BTI gave a sell signal more than two weeks ago. The FTSE declined as expected since 31 May but not the S&P. In fact the S&P is trading higher. This is a sign of market strength in the US. Given the strength of the US markets it is not clear if the Dow Jones will produce a large downward retracement before moving higher.

 

I still expect a pullback but this could be short lived, on the chart it would appear the current rally is wave iii (circle), the next move is wave iv (circle) down. A potential target is 21150. We will see in the next few days how far the decline can go. While the Dow is at record high the FTSE is well below it’s all-time high at 7599, this has created a bearish divergence, something we often see at market tops. Bearish because in general the FTSE leads the way, when the FTSE declines and the US markets continue to rise, the US markets are more likely to turn down to follow the FTSE lower.

Meanwhile the Bank of England committee is split about whether to hike rates. Some committee members voted to raise rates, this gave a boost to GBP/USD and the FTSE declined yesterday. Policy makers are not concerned by a slowdown which is strange given the recent weak economic data. UK house prices are falling, and yesterday UK retail sales were very weak. Expectations of higher interest rates will boost the pound, and this will weigh on the FTSE. Another reason to suspect that that the top at 7599 will remain intact.

Thierry Laduguie is Trading Strategist at www.ftse100trading.uk

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