The defining feature of the Dow Jones Industrial Average is the extended support/resistance trend line, which is a projection of the head and shoulder pattern that developed in the middle of 2011. This is the support feature, which will help define the nature of the continued rise in the Dow.
The Dow developed a head and shoulder pattern between April 2011 and July 2011. The lingering influence of the head and shoulder pattern neckline has proven to be very powerful. This line acted as a resistance level and limited the rally rise.
The breakout above the value of the trend line now changes the function of the trend line. It is now a support level. We expect to see the index rise above the trend line, then retreat and use the trend line as a support level. This is a change in the polarity of the trend line from resistance to support. This confirms the strength of the rally, which can now be described as an uptrend.
This changes the nature of the question about the Dow so the focus is on how to establish upside targets for this trend. The head and shoulder neckline exerted a long term influence on the market and it is long term historical activity that helps define the initial upside targets for the Dow. The previous intra-day all-time high for the Dow was at 14, 198 in October, 2007.
A small resistance level developed near 13,900. This is the first upside target for the Dow. Many will focus on the psychologically convenient round number target of 14,000 but the historical resistance behavior is at 13,900. This is around 8.5 percent above the Dow peak near 12,820 over April 29 and May 4 2011.
Technical analysis has two main tasks. The first task is to identify trending behavior. This includes changes in the nature and the direction of the trend. The influence of the trend line helps identify these changes in trend behavior.
The second task is to help establish upside or downside targets. This is most easily achieved when chart patterns develop which allow for the calculation of measured moves. If these patterns are not present then, the historical support and resistance levels can provide guidance for targets. With the Dow there aren’t any chart patterns that assists in calculating or verifying upside targets. The first target is based on the small resistance level created in 2007.
However the U.S. market has another broader index in the S&P500 and the behavior in this market can be applied to the Dow. The S&P 500 has also moved above the rally peak created in April 2011 at 1,370. The all time high for the S&P 500 is near 1,550 created in 2007 October. This is a 13 percent rise above the April 2011 rally peak.
The S&P behavior is leading the behavior of the Dow so traders will watch this index for clues about the best trading strategy for the Dow. Traders will also get better returns from trading the S&P as it moves towards the resistance targets created by the all time high in 2007.
The NASDAQ remains a long way below its all time March 2000 high at 5,132. The behavior of the NASDAQ breakout above the April-May 2011 rally high at 2,887 provides important clues about the sustainability of the Dow and S&P breakouts. The NASDAQ breakout is also a move above the double top high created in October 2007 and April-May 2011. This has a potential longer-term target near 3,600. This is calculated using the width of the trading band between 2,200 and 2,900.
Establishing upside targets for US indexes is difficult because no well defined chart patterns exist that will assist in these calculations. Traders wait for these patterns to develop. Until then we use broader resistance levels to set initial targets and watch the comparative behavior of each of these index measures of American market activity.
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's 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.
CNBC assumes no responsibility for any losses, damages or liability whatsoever suffered or incurred by any person, resulting from or attributable to the use of the information published on this site. User is using this information at his/her sole risk.