Chart of the week: will bank’s rally continue?

High-street bank shares are improving - especially Lloyds. Our chartist says investors may be able to ‘buy the dips’.

When I posted my bullish comments about banks in my recent August and October articles I was definitely swimming against the tide of opinion.  

The shares were plumbing new depths as loan margins – the lifeblood of banks’ earnings – were squeezed wafer-thin as interest rates were destined to “stay lower for longer”, or so the story went.

And in recent days even the Bank of England has been publicly hinting that their policy rates may become negative, and they advised retail banks to prepare for this.

Adding to this mixture of negatives is the widespread belief that the economy will be heading lower next year. Part of this is that unemployment levels rising again, with major disruptions in the travel and hospitality sectors especially.

So did buying bank shares make any sense when there were so many “obvious” reasons not to do so?

But as my long-time readers will know, this is precisely the time when major reversals can pop up, since major lows occur when sentiment has reached extreme despair.  

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Most of the “known” bearish factors have been in the market for some time and only a small degree of buying power (from bargain hunters?) can set off a decent rally phase.

And these situations present very attractive reward/risk scenarios. There is little danger of the major banks going bust, and with long-term yields now on the rise, short-term rates will follow – and boost loan margins, which is contrary to the common view.

That seems to be what is happening now.  In my column of 5 October I posted this chart, which acts as my road map:

Source: interactive investor. Past performance is not a guide to future performance.

I concluded that there was a very high probability for a new rally phase off the “new low” of 24p. That print qualified as the termination of wave five, and given the large momentum divergence there was a likely prelude to a sharp recovery.

As of Friday, the market has traded higher to the 35p mark, which is a handy 11p (46%) gain off the “new low” and at a five-month high.  

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Even small moves often result in large percentage gains – and that is one of the features of trading low-price shares. Of course, it works both ways!

Early birds now have very good long positions, and the question is this: is there any more upside or is this just a bear market rally, AKA a dead cat bounce?

While I cannot give a definitive answer, it seems the odds favour a continuation of the rally, of course punctuated by dips, and these I suggest would be worth buying. 

An important gap has just been closed (just below the wave four high) and usually prices move lower after that. If so, that dip would be a great opportunity.

For more information about Tramline Traders, or to take a three-week free trial, go to www.tramlinetraders.com. 

John Burford is the author of the definitive text on his trading method, Tramline Trading. He is also a freelance contributor and not a direct employee of interactive investor.