Is the U.S. market poised for a correction? If it is then investors must decide if they want to protect profits before the correction develops. Traders and investors will also prepare to take advantage of any correction to enter the market again in anticipation of a continuation of the trend. Technical analysis identifies the probability of a correction and also helps to identify how large the correction may be.
The most important feature the on the Dow Jones Industrial Average chart is the parallel trading channel. The lower edge of the channel is the support trend line. This support line uses the low of June 2012 near 12,090 and the low of 12,515 in November 2012 as the anchor points.
The upper edge of the trading channel is created by the up sloping resistance line. The line uses the high near 13,233 in March 2012 and the highs near 13,655 in September 2012 and again near 14,020 in February 2013 as the anchor points for the position of the trend line. Between October 2011 and March 2013 the Dow remained inside the trading band. This included regular rally and retreat behavior.
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In March 2013 the Dow broke out above the upper edge of the trading band and continued to move higher. This breakout has a new upside target near 15,400. This target is calculated by taking the width of the trading band and projecting it upwards from the point where the breakout occurred. This calculation provides both an upside target and also a value for any correction or reaction away from the target level.
Any retreat in the Dow has a high probability of using the value of the upper edge of the trading channel as a support level. The current value of the upper trend line is near 14,300. The trading band and the pattern of support and resistance levels help to define the future action of the Dow index.
The chart also provides some information about the probability of a correction. A retreat or correction in the market is usually signaled by an end of the uptrend pattern. This may include a rounding top or a head and shoulder pattern. Neither of these patterns is developing. The end of uptrend may include a steeple top where the market shoots up very rapidly and then falls very rapidly. There is no evidence this type of pattern is developing.
End of uptrend patterns may also include the development of a down sloping triangle pattern. The daily chart on the Dow shows an up sloping triangle pattern. This is bullish. The target for the up sloping triangle is near 15,210. The Dow is making new highs but there is no indication of an end of uptrend patterns. This means there is a lower probability of any correction in the short-term.
When the Dow moves towards the upper edge of the trading band projection target there is a high probability the market will consolidate near this level and use this as a resistance level. This is a repeat of the behavior between February 2013 and March 2013 when the Dow clustered near the value of the upper edge of the trading channel. In the future this has the potential to develop into a correction or reversal pattern. In the short term there is a low probability of a trend correction.
Daryl Guppy is a trader and author of Trend Trading, The 36 Strategies of the Chinese for Financial Traders –www.guppytraders.com. He is a regular guest on CNBC Asia Squawk Box. He is a speaker at trading conferences in China, Asia, Australia and Europe.
If you would like Daryl to chart a specific stock, commodity or currency, please write to us at ChartingAsia@cnbc.com. We welcome all questions, comments and requests.
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