Sentiment in Europe remained positive as the major stock indices extended their recent gains, with the DAX hitting yet another record high to become even more technically overbought. The gains were led by shares in defence companies on the likelihood of greater military spending in the EU, which could force governments to raise borrowing in the coming years. Hence, bond prices fell as yields on German, French, and Italian bonds climbed noticeably. With the US out for a holiday, the focus remains firmly on European markets today, where stocks have been surging lately thanks to Trump pushing for a swift resolution to the Ukraine war. But have the markets got ahead of themselves with all this optimism? This DAX analysis shows the German index is now at extremely overbought levels, which calls for caution.
Technical DAX analysis: weekly chart
For now, the DAX remains in an impressive long-term uptrend. The Germany index bottomed in October 2022, and it has since only had two serious corrections in the pursuing years, both of which only shaved off 10% before dip buyers stepped in to drive the market to new all-time highs. All other pullbacks haven been quite shallow of around 5-7 percent. As a result, the DAX has remained mostly above the short-term 21-week moving average. Price action has been very impressive indeed.
However, as the index has now reached long-term overbought levels, there is a risk now that we could see a long overdue correction in the days or week ahead. The Relative Strength Index (RSI) is at severely overbought level of 80+ (81.3) n the weekly time frame. The last time the index was this overbought was back in March last year when the RSI reached 81.0 before easing back down. The index went on to hit a new high in May of that year before dropping 10% until the markets bottomed in August.
If history repeats itself and we do see a correction, a 10% drop could send the index back to the levels it was trading at the end of December of around 20500, where the 21-week exponential average would come into play.
Given the market has repeatedly respected this moving average, we could then see the resumption of the bullish trend again there, unless some major bearish catalyst emerges to cause a more severe correction. But our bearish scenario base case is only a 10 or so percent correction – if it happens.
Monthly RSI is nearly at 80 – a rare occurrence
On the monthly chart, the DAX is now on its 4th monthly gains, and up in the last 7 out of the past 8 months. Unsurprisingly, the RSI on this time frame has surged to extreme levels, too – nearly at 80 (79.0). The last time the index was this overbought was back in March 2015 – nearly a decade ago! Then, the DAX topped in early April, before slumping some 30% in the pursuing months, until bottoming in February 2016.
DAX analysis: Key levels to watch on daily chart
On the daily time frame, the DAX was testing the top of its bullish channel and a new all-time high between 22720 to 22800. The RSI was at 83, slightly below the January levels of 84-85. In other words, the RSI was in a state of negative divergence on this time frame. Put another way, the RSI has made a lower high at overbought levels of above 70.00, when the underlying DAX index made new all-time highs. This divergence suggests that the strong momentum could be losing steam.
A correction is needed to move the RSI back to neutral-to-oversold levels again.
The bears will need to break down some key support levels to make a serious dent in this rally. Short-term support now comes in around the 22500 area. Then, there is nothing significant seen until the support trend of the bullish channel around 21950. Below that area, January’s high of 21803 will come into focus, where the 21-day exponential average also converges.
Only if and when we see the breakdown of the abovementioned support levels, will things look and feel interesting. The bears must await a clear reversal signal given how strong markets have been last year, despite all the doom and gloom out there.
Source for all charts used in this article: TradingView.com
-- Written by Fawad Razaqzada, Market Analyst
Follow Fawad on Twitter @Trader_F_R
