Last week started a volatile period for Nikkei 225. As we noted on May 24th, there are two opposing forces acting on the Japanese economy. One is Abenomics and the other is formed by a combination of fundamental reasons, namely –1) Weak closing of S&P 500 following confusing testimony of Chairman Bernanke; 2) Volatility in the JGB market; and 3) Weak Chinese PMI figures raising concerns about Asian growth.

Abenomics wants the Japanese economy to grow, which means Nikkei 225 needs to rise. The fundamental reasons mentioned above are trying to put a damper on Abenomics if not killing it outright, which means downward pressure for Nikkei 225. Along with these opposing fundamental forces acting on Nikkei, the index is also facing few technical forces that we mentioned in our May24th post.

Since then four more days’ of market action has happened and few things are becoming clearer. One is that the technical resistance – the lower bound of the horizontal channel formed in 90’s – is turning out to be a strong one. Nikkei is finding it difficult to break above it at the moment.

Second is that the busted chart patterns are quite powerful. On December 17, 2012, Nikkei 225 broke above the upper line of a descending triangle (see weekly chart below). Descending triangles are bearish in nature with an anticipated downward break. An upward break makes it a busted chart pattern. The resultant move off this pattern was approximately 187% of the height of the pattern.

The third is that this time the index is showing more signs of a pullback than previous few attempts – this is turning out to be first significant pullback of the rally that started in early November 2012.

Fourth is the emergence of a bearish ABCD pattern.

On May 23rd and May 24th, Nikkei traced the AB leg of the pattern. Then for the next three days it made the BC leg of the pattern. This was only slightly more than the 25% of the down move (AB), which makes it not-a-classic pattern. Today, May 30th, Nikkei has broken below the low of candle that was “C” and also below the low of AB leg. The measured move target – CD = AB – is estimated to take the index to 12550.

In between there are more support levels.

1. 38.2% and 50% Fibonacci ratios create support levels at 13130 and 12261 respectively
2. A shallow pullback in mid-April created a support at 13004 – the low of April 16th
3. April 5th was a gap up day – the support created by the upper and lower limit of the gap are at 12831 and 12634 respectively
4. A shallow pullback occurred in early April too creating a support at 11805 – the low on April 2nd

There are other support zones below these levels too but they will come in play only if some of the higher support zones are broken.

So the technicals have started to make their move. Now the question is who or what will arrest this downward slide. Will it be more ammunition from the Bank of Japan or Abe government, the enablers of Abenomics? or is it driven by profit-taking and will finish when all short term profit-takers are done? Or is it the beginning of something more ominous? Keep in mind that if the index reaches 12750 – a level within some of the above mentioned support zones – then it will enter bear market territory, which is 20% retracement from the high. A 20% drop does not necessarily mean that the downward move will continue but it does increase that likelihood.