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Trader's Corner

Dow Theory Update, Potential Index Resistances and Key Reversals

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I wrote my last article in this space a week ago on how the Dow Transportation Average (TRAN) was badly lagging the Dow Industrials (INDU) and would have to rally substantially to join the Industrials at a new closing weekly high. Due to my missing a publishing deadline, that Trader's Corner column didn't get published until Monday of this week and by then the relevant chart published with my commentary was a bit out of date.
So, my first topic here is an update of the two Dow charts in question and to add a short comment on what Dow Theory could add in gauging the long-term prospects for the market and the economy.

For those that might want to backtrack to this initial article on Dow Theory, you can review it on Option Investor website by clicking here.

There have been a number of times that failure of BOTH Dow Averages to both rally at some point to new weekly closing highs, has turned out to predict future trouble for the economy; in the extreme, an economic recession. You can see from the chart below that, on a weekly closing basis (and today's close is not yet the WEEKLY close), TRAN has some distance to go to exceed it's prior weekly closing high.

TRAN can of course join INDU at a new high in time of course. The point to make here is to use the Transportation stock Average as a reality check as to when or whether it exceeds it weekly closing high to date at 5370. While 'economists' were more bullish today as reported by the Wall Street Journal, I would point out that that some recessions were determined to have started at around the time that the market made new highs. Economists were pretty bullish then also. I started using technical analysis back in the late-70's after losing my shirt a few times following the bullish recommendations of fundamental analysts. What the market and its different components actually DO can be a saving reality check.

Not only does do the Transports have to really start to gain some ground at some point, but the TRAN Average is in danger of falling under its long-term up trendline as can be seen above and which would demonstrate a loss of long-term upside momentum. Stay tuned on that!

HAVE THE MAJOR INDEXES HIT TECHNICAL RESISTANCE?

A couple of weeks back (see my Trader's Corner article in the 9/26 OI Daily newsletter) I discussed a possible 'measured move' target in the Dow 30 (INDU) for around 14300.

However, resistance implied by the upper end of INDU's weekly chart uptrend channel was suggesting that that technical resistance was more like 14200, close to today's high. This resistance is highlighted at the red down arrow at the upper channel line on the weekly Dow chart below.

That there was resistance in this area was also suggested by the key (downside) reversal seen today in the S&P, Dow, Nasdaq and Russell 2000. More on key reversals further on. I'll show more of the weekly chart channels in other indexes next.

The price target in the S&P 500 (SPX) that I've laid out in my last two Index Trader's (Saturdays, OI web site only) has been to the 1580 area as both an objective and anticipated strong resistance. On my next chart, that of the weekly SPX, the red down arrow points to where the upper channel resistance line intersects this week, at 1579. Today's SPX high and the weekly high so far this week, with one day to go, was 1576.

The key downside reversals today in SPX, as well as the Nasdaq, which has been leading this rally (reality check anyone!), suggests that significant resistance and selling interest may be coming into play. The other chart aspect to note here is the question of whether SPX can hold above its 1553 prior weekly closing high of year 2000, as well as the cluster of daily highs in the 1555-1556 area from mid-July. If the S&P reverses in this area, it's going to make more than a few fund managers nervous!

Contrary to the Dow falling a 100 points shy of my technical objective, the Nasdaq Composite (COMP) came within 1 point of reaching my 2835 technical objective, but didn't exactly hit its upper channel line in today's sky shoot. Very close though, within about 5 points.

Trendlines arent so precise that prices won't fall a bit shy of a resistance trendline or OVER-shoot them, as was the case with the Nas 100 (NDX), which is my weekly chart following the weekly COMP chart just below.

I would note also that COMP finally got to an 'overbought' reading on the 8-week Relative Strength Index (RSI) as seen above, but the RSI didn't make it to a 'confirming' higher high unlike what happened with prices. This non-confirmation, depending yet on Friday's close, could be a secondary bearish sign pointing toward at least an interim top here. The idea that indicators should 'confirm' price action came primarily from the original idea Charles Dow had about his averages following each other to new highs or new lows in order to 'confirm' the major trend.

As I mentioned and which is apparent in the weekly chart channel below, the Nasdaq 100 (NDX), which has been on rip roaring bull move, overshot resistance implied by ITS upper channel on a weekly chart basis but then fell back sharply. Such action possibly or probably marked a type of exhaustion for the bulls as they pushed prices ever higher but ran out of money to throw at stocks after some concerted selling/resistance developed. I'm reminded of the old saying that bull markets 'fall' of their own weight. It's not surprising to see resistance develop as NDX got near another even-100 milestone. Last gasp of the bulls for a while? Stay tuned on the next chapter of this story!

KEY REVERSALS

A downside reversal is when prices rally to a new high for a move, but then close below the prior 1-2 days' close. An upside reversal is the opposite as prices fall to a new low for a move, but close below the prior 1-2 days' close. Such chart reversals are quite common.

Much LESS common and tending to be more definitive for a significant trend reversal is what I define as a KEY upside or downside reversal. A key downside reversal was seen today in the lead S&P index, the 500 (SPX) and in the Nasdaq Composite. There was a new high or decisive new high, followed by a Close below the prior 1-2 days' LOW. Such a key downside technical reversal suggests strongly that the stocks comprising the index finally got overvalued relative to their underlying fundamentals; values 'collapse' to some degree and adjust. The market of course has a habit of swinging from undervalued to overvalued and back again.

There's not too much more to say on the Nasdaq Composite (COMP), which is seen next. The same downside KEY reversal pattern developed as in SPX; i.e., a new high for the move, followed by a close that was under, in this case, the lows of the prior 3 days. Next stop, a test of support at 2725-2700?


GOOD TRADING SUCCESS!
 

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