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2012 forecast: Equities weak, look at US dollar and gold

Caveat emptor: Nobody knows where the market is going for sure in the next hour, let alone in a full year. One should, therefore, run away from experts who claim they know where the market is headed. The past few years must have proven that to you. So that said, how does one play the markets profitably in 2012?

This trader has been humbled many times, and has learned from the markets to look for trades with a high probability of making a big profit and low chances of making a small loss.

The savviest traders and investors take small losses and get out of a position when they go wrong. Conversely, one should stay in a position for a long time and let profits run when one is right. Successful investors and traders have a simple rule. Never take your opinions seriously and personally in the market. If the market proves you wrong, just get out of the stock and carry on.

Having said this, you'll realise that the headline of this article is a high-probability outlook and not a sure shot. And it's based on supply and demand points in the market along with the trend. As the cliche goes: the trend is your friend till the bend at the end. So our goal when looking at 2012 is to capture the trend and watch out for the probable bend at the end.

US dollar

If the dollar continues to rally it is generally bad for the equity and commodity markets. Getty Images

We will take a broad sweep of the financial markets to see where they are headed. The markets include India, China, Japan, US, Europe,the US dollar, gold and silver. The article will also identify the current trend of the market and spot high-probability turning points. Remember to always cut your losses when the market moves against you.

Themost obvious way to identify a trend is spot a series of lower lows and lower highs for a downtrend and a series of higher highs and high lows for an uptrend. A lower low is made when the latest low in price is lower than the previous low and a lower high is when a latest high in price is lower than the previous high.

Given the fact that the trend of the market is bearish, a conservative trading strategy would involve shorting the market at resistance levels and taking profits at support levels. Aggressive traders can go long at support for quick counter-trend profits. Remember that any of the support levels can stop and reverse a downtrend or can just lead to a small correction.

Since one can never be sure where the market will turn, it's always best to take at least some profits at potential turning points and hold some positions to benefit if the trend continues.

The BSE Sensex

A look at the Sensex chart shows that the index has made a series of lower lows and lower highs. (Click here for the Sensex chart). The horizontal lines above the current price are resistance levels and thosebelow are support levels. Prices often rally from support and sell off from resistance. Support levels are areas of demand as buyers exceed sellers and vice-versa for resistance.

In the case of the Sensex,it might go down to the 12,000-13,000 range as there is a gap at that level. The gap is shown by an arrow on the chart. Gaps happen when prices close at one level and open higher or lower the next day. In the case of the Sensex, the gap is huge, of nearly 950 points. Gaps happen because there is a huge imbalance of buyers and sellers.

In the case of the Sensex the gap was up, which means the number of buyers substantially exceeded the number of sellers. Gaps are also magnets for price, which makes us believe that the Sensex can reach the 12,000 to 13,000 level eventually, as the trend is bearish.

The US market

The S&P 500 index was basically range-bound in 2011 and is likely to stay so unless it breaks below 1,000 or rallies above 1,375. For the year as a whole, the index ended flat. As the global benchmark for equity markets, the S&P 500 has, over the past six months, been making lower highs, higher highs, lower lows and higher lows, which clearly signals a market in a holding pattern. But that's not bad as the trading range is wide at 375 S&P points, which can give some very good opportunities.

Based on price action, we have a bearish bias. A look at the chart shows that the index has quite a few resistance levels overhead in close proximity, making a strong rally difficult (Click here for S&P 500 chart). The support ranges, on the other hand, are wide apart. So a break of one can lead the index down much lower till the next level.

Traders in all countries should keep a close eye on the S&P 500 as equities globally have a close correlation to it.

What's up for Europe?

The trend in Europe is bearish, too, as prices are making lower highs and lower lows. We are looking at an exchange traded fund (ETF) called the Vanguard European Index Fund, which tracks the Morgan Stanley Europe index (Click here for the Europe chart).

The only factor casting doubt on the downtrend is that the fund made a higher low, as shown by the arrow on the chart. However, it has still not made a higher high, which is a prerequisite for prices to turn bullish. If the price goes above $45, the trend could have changed. The horizontal lines above the current price are resistance levels and those below are support.

We are still bearish on Europe as the price has touched the support level between $36 and $38 twice. The more the number of times prices touch a support or resistance level, the weaker it gets. If that level is broken, prices can go all the way down to $31.

There is a fundamental reason for bearishness in Europe. Even if the continent does not spiral into a debt crisis, growth is expected to be slow, at the very best. On the other hand, some expect a double-dip recession.

Continues on the next page

China's Year of the Dragon

To track China we are looking at the ETF with the symbol FXI, which follows the FTSE China 25 index. A look at the chart shows that after a strong selloff, China is consolidating (Click here for the China chart). The horizontal lines above current prices show resistance and those below show support. However, the unless FXI closes above $39 and below $26, it will be a range-bound market.

A continued tightening of monetary policy will keep China bearish and could take FXI all the way down to $19. However, an easing of money can lead to a strong rally, as inflation expectations come back on the table in 2012 - the Year of the Dragon.

Japan weighed down

The Nikkei 225 is a basket case as government intervention in the market has destroyed risk-taking. The Japanese hold cash and bonds - not equities - due to which one sees low interest rates, a strong yen and a weak equity market.

China

A continued tightening of monetary policy will keep China bearish and could take FXI all the way down to $19. Reuters

That being said, the index is near the low it hit during the tsunami, as shown by the arrow on the chart (Click here for Nikkei chart). This could provide it with temporary support. We, however, feel that the index is headed to its 2009 lows near 7,000, which is not that far. The trend is still down.

The blue horizontal lines show the support and resistance areas below and above current price respectively

The mighty US dollar?

The US dollar holds the key to equity and commodity markets (Click here for the dollar index chart). If the dollar continues to rally it is generally bad for the equity and commodity markets. Right now dollar is at resistance, but has been holding there for nearly three weeks. If the dollar breaks out it will go to the next level marked on the chart, which will be a negative for equities. We feel the dollar has some more to run up before a strong correction or reversal.

Remember, in a multi-year picture, the dollar index has been range-bound between 70 and 90, and given that history we don't expect an explosive long-term move in the dollar anytime soon.

Will gold shine?

The yellow metal entered a strong support zone last week and rallied strongly. The support zone is shown on the chart (Click here for the gold chart). Generally speaking, if the dollar rallies we may see gold reach deep into its first support zone or even fall lower to the second zone. However, if the rally in the dollar is driven by fear, gold will rally, too.

The gold chart is showing strong down moves after it peaked earlier in 2011. There have been two strong down moves and generally there are three. So it's possible that gold may rally some and then make one more down move, before continuing on its multi-decadeuptrend.

Silver's white future

Like gold, silver too bounced from near a support zone last week (Click here for silver chart). If the dollar rallies some more we could see the white metal go deep into the support zone between $23 and $25 and then rally. We feel that the white metal could come down to the $20 level, but will not have much of a downside after that.

Note that if gold rallies silver could follow in sympathy. Silver, besides being treated as a commodity, is a favoured alternative to currencies after gold. Monetary easing in China or US could lead to a rally in both gold and silver.

George Albert is Editor of www.capturetrends.com