Think About Taking Profits on Japan

Is there anyone who doesn't like -- or even love -- the Japanese market?

The Financial Times reported on Oct. 19 that a monthly Merrill Lynch poll of the global investment community found there was a "growing investment aversion for U.S. equities, countered by equally strong enthusiasm for Japanese equities, in spite of the gains of recent months." Some 63% of respondents to the poll were overweight Japanese equities; only 9% were underweight.

As some readers may know, the Japanese are widely considered to be the founders of technical analysis, as they applied it to rice trading back in the 1600s.

If you visit an investment company in Tokyo, you will likely see all sorts of chart machines all over the place. And no matter what chart you pull up, it will most likely have the five- and 25-day moving averages plugged in.

The Japanese believe that you must look at these two moving averages on everything -- stocks, indices, bonds, currencies -- and you should act when they cross. There is one major caveat though: The two moving averages must be going in the same direction. So for a buy signal, or golden cross, the five-day must be rising and must cross through an also-rising 25-day moving average. A sell signal, or black cross, must find the two moving averages heading downward.

If the five-day is heading up and the 25-day is heading down, there is no signal, and vice versa.

So, let's take a look at the moving averages on the Nikkei as of the close of trading Wednesday. The five-day MA (in blue on the chart below) has already started heading down, but unless we move through 13,000 -- and stay there -- in the next few days, it will likely flatten out. The 25-day is still rising.

However, my "what-if" calculations say that if the Nikkei doesn't start making higher highs within the next week or two, the 25-day moving average will "catch up" to the five-day and they will both roll over and head downward. And that would be a black cross sell signal.

Of course, the uptrend line says that we can come all the way down to 12,500 and still keep the uptrend intact. But take a look at the very long-term chart of the Nikkei and you will see that we are nearing some serious resistance levels -- from here all the way up to the 14,000 level.

Black cross sell signals do not tell us the magnitude of the move, only the direction, but it seems to me that the sentiment is leaning way too far to the bullish side based on that Merrill Lynch survey and the moving averages have the potential to give us a sell signal soon. Couple that with all the overhead resistance and I would not be adding to this trade -- I might consider taking some money off the table.

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Helene Meisler writes a technical analysis column on the U.S. equity markets and updates her charts daily. Meisler trained at several Wall Street firms, including Goldman Sachs and SG Cowen, and has worked with the equity trading department at Cargill. At time of publication, she held no positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. She appreciates your feedback; click here to send her an email.