In a range-bound market, predicting the peak can pay
FOLLOWING substantial rallies back in April and early May on the back of green shoots, the blue-chip FTSE 100 has levelled off over the past month. Although the pace of decline is slowing, there are concerns that shares have risen too fast. The leading UK index has since been range bound between 4,300 and 4,500. But all traders are asking themselves if and when the FTSE 100 will break out of the range.
Predicting when a market will top out is enormously difficult – get it right and you’re seriously in the money, get it wrong and you’ll find your losses mounting up – but there are some key aspects to look for when making your decision to either enter the market or take your profits.
Of course, you could avoid the problem entirely by trading in the range. Plenty of spread betters have been successfully trading the 200 point range by identifying the key support and resistance levels. Once these levels are broken, then these traders will start to eye the next levels and they could well look to take their profits at this point.
The lack of momentum has meant that traders are now taking a step back and considering whether there is any further upside to the FTSE 100 beyond the current range. One way to do this is to look at whether stocks are fairly valued at the moment – some believe share prices have risen too fast.
Joshua Raymond, market strategist at City Index, says: “The last two to three weeks have seen an emergence of the feeling that the market is a bit overbought at current valuations.”
Given that the index has been range trading for a while, there is always the chance that it could break higher or lower out of the band. This was particularly so last week on both sides of the range, with Friday testing the upside, as Tuesday and Thursday tested the down.
Depending on your view of the market, this in itself offers chances to profit. Simon Denham, managing director at Capital Spreads, says: “Clients have become used to these bids for freedom and are selling heavily into the rally with stops set around the 4,520 level.” Alternatively you could look to buy at the 4,300 level, setting your stops just below that in case it breaks lower.
Technical chart patterns will indicate whether a top is forming in the market. Typical ones to watch out for are double and triple tops, head and shoulders patterns and if you’re into your Japanese candlesticks then hanging man patterns and gravestone dojis are ones to keep an eye out for when trying to pick the top of the market.
Your trading judgements should also take into account how much profit taking you think is happening – if you think that the index’s component stocks are overvalued then you need to decide whether the profit taking has reduced the index level to a fair value or if it still has further to fall.
Traders also need to take economic data releases into account when calling the top of the market. The index has been particularly sensitive to figures such as house prices, interest rate decision and quarterly GDP. If we are reaching that top in the market and you know there’s some data coming out, the figure could be enough to push through that resistance or test it and sell off. On the other hand, day traders and swing traders can make the most of the massive movements that are occurring on a regular basis and which have made trading the FTSE 100 over the past month far easier than normal.
However, Joshua Raymond says that there is a chance that the range trading could continue. “There tend to be low volumes over the summer so it could trade sideways for a number of months. We need this consolidation period to finish sooner rather than later. If it doesn’t, then we could see a continuation but in a wider range for the next few months.”
But for spread betters who like trading the sideways movement, a wider range will mean a greater movement in points and that means greater profits.