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Yesterday the rally extended to new highs, then we saw a sudden and sharp reversal, the FTSE 100 lost nearly 1% in the afternoon. During the morning session we had the opposite scenario, the FTSE was very strong, even the declining oil price failed to stop the rally. And when the pound started to rally the FTSE rallied too. This behaviour is abnormal, so what could have caused this complete change from strength to weakness? Stock markets in the Europe and the US were firm, the Dax was rising at the same pace but this alone does not explain the behaviour of the FTSE.
I think this volatility has something to do with the oncoming general election. I warned to be more cautious and to reduce trading size until the election next week. As the polls are released the pound and the FTSE will become more volatile. What is clear is that the FTSE has been very strong in May, the index was up more than 4%. It could be that investors are betting on a win win situation which means whoever wins the election the market will go up.
A similar situation occurred in the days leading to the Brexit referendum, the FTSE was very strong because investors assumed a remain win would create a relief rally and a leave win would push the pound sharply lower and this would boost the FTSE. I note that each time Labour gains in the polls the pound goes down and the FTSE rallies. However this time is different, the pound is not going to collapse if Labour wins. Chances are the Conservative will win (based on the latest polls) and the pound will be trading higher next week.
This win win situation suggests that the FTSE will continue to rally in the short term, this is confirmed by the wave count, a final move up above 7600 is expected. Today we have a new developments, the 34-day BTI is overbought. This overbought indicator identifies a major top, it has a good track record so when it is overbought you don’t want to be long (unless you are a day trader). When this indicator is overbought we are expecting a multi-week or multi-month decline depending on which trend we are looking at. The fact that the indicator has become overbought at a time when the wave count is nearly complete adds weigh to the bearish case.
The 34-day BTI is not a timing indicator, it does not tell us when the decline will start. It tells us the FTSE will peak sometime in the next two weeks, it could before or after the election. Therefore in order to get the timing right I use the wave count and the wave count is telling me the peak should come sometime next week. Elliott wave analysis suggests we are now in wave 5 which is the final wave up in the sequence. The larger picture is that of an ending diagonal [1,2,3,4,5 (circle)] starting in 2003. The final wave up [wave 5 (circle)] started in February 2016, this wave subdivides into three waves [(A),(B),(C)] and wave (C) is in five waves [1,2,3,4,5] which is a complete structure. Upside is limited, the FTSE should be trading significantly lower in July.
Thierry Laduguie is a mentor from the e-Yield Traders Community
