Nikkei Suffers 9% Drop: More Downside Or Liquidity Vacuum? May 23

On Wednesday, the Nikkei 225 suffered one of its biggest % drops in a year, shedding over 1500 points via a 1-2 punch from the weak China PMI along with the Abe-nomics plan failing. The index lost two weeks of ground in a single day.

Normally in such cases, I’d be uber-bearish, but I don’t expect a major trend reversal just yet. In fact, after some short term selling, I’m expecting a resumption of the uptrend.

Why? 3 Reasons

1) Very much like in 1987, the index had an 89% rally over 186 days followed by a 9.1% correction over 6 months. This last run was 191 days over 7 months, and the drop yesterday was 9%. What followed the last drop – a rally that took out the prior highs. I suspect bulls will actually make a new high before we see topping and a reversal. Minimally, we’d likely see a LH (lower high) before the bulls give up control.

2) The trend leading up to the recent 16000 top was not parabolic. Although it was quite a prolonged non-volatile trend, it was not parabolic, which is a common climax price action formation before a sharp reversal.

3) Although there are likely medium and long term bulls taking profits – I suspect a short term liquidity vacuum will make it difficult for sellers to take out the selling lows from yesterday. This is because the move was so sharp and rapid, it will take time for the sellers to come back in sufficiently to create a ceiling to stop the bulls.

Normally such sharp moves are followed by a 2nd reaction from the bulls, so a pullback would be natural (to learn more about price action, liquidity vacuums and order flow, check out my recent video by clicking on the link).

Short term, I’m mostly bearish, and I suspect if the bears are going to take control, it will be via a shallow pullback of the days selling. For me, a good level to short would be at 14900 which is the 38.2% retracement of the heavily sell-off yesterday. Ten minutes into writing this article, selling has emerged off this level. It is certainly possible the last 20hrs were enough for the sellers to form a ceiling at 14900. If so, then more aggressive selling is in store.

The downside key level for bears to take out is the 14430 which opens up 14030, and probably means an end to the uptrend. If the bulls can take out 14900, then this sets up a test of 15000 and 15223 before the next round of sellers will enter. If bulls hold the first level, then they will likely re-attack 14900, so plays on both sides here.


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