This article was written exclusively for Investing.com.
European stocks skidded sharply this morning on news of the Austrian lockdown. The losses were led by the Spanish IBEX 35 and Italy’s FTSE MIB, which lost around 1% each, while the German DAX was impacted less severely.
While all the indices were bouncing off their lows at the time of writing, I reckon we may see further losses for the DAX. Given the weekend is approaching, there is risk of gaps at the open next week should the COVID-19 situation deteriorate, and more lockdown measures are introduced elsewhere.
Indeed, the coronavirus has made an unwelcome return in the last few weeks, with cases rising to record levels in Germany and Austria, despite the ongoing vaccination efforts.
In response, the Austrian government has reimposed a full lockdown and has made vaccination mandatory. Meanwhile, the German health minister, Jens Spahn has also refused to rule out a return to lockdown in Germany.
Concern that similar lockdown measures might be introduced to other parts of Europe has weighed on sentiment. There is now a risk for at least a short-term correction as investors wake up to the risks facing the Eurozone economy, after the major stock indices hit repeated all-time highs in recent weeks.
Granted, more lockdown measures mean that the European Central Bank will now have even more reason to keep its current policy in place even longer. This, in turn, should mean the downside risks for stocks are going to be limited. What’s more, with the euro weakening, this should be good news for European exports.
Still, ahead of the weekend, investors will have very little reason to buy this latest dip. Therefore, there is a good chance we will see further weakness heading to to the European close and possibly further losses to follow in the early parts of the week ahead.
Following today’s sell-off, the DAX is in the process of forming a bearish engulfing candle on the daily time frame, which, if completed, would be a key reversal sign:
On an intra-day basis, if we see acceptance below Thursday’s low at 16,193, which I think we might, then expect to see further losses heading into the close. The losses could accelerate if and when the bullish trend line breaks.
The main objective for this bearish outlook is the shaded region on the chart, between 15,985 to 16,030, the previous resistance-turned-support zone. While it is possible that we will see an even deeper pullback, we will first have to see how the index behaves in the above support area if and when we get there. The subsequent bearish target is around 15,690.
It is also worth pointing out that the Relative Strength Index (RSI) has been in a state of negative divergence at “overbought” levels north of 70 for a few days already. So far, this has merely been a warning sign that the tide could be about to change. But now that a bearish engulfing candle could be forming at the highs, the bears might get the confirmation that they were waiting for.
Thus, in addition to long-side profit taking, short selling from the bear camp is an additional pressure that could be introduced as more and more short-term support levels break down.