Charting Asia

Santa Out of Puff for Dow: Charts

Investors who hope for a Santa Claus Rally in stock markets this year are still waiting. This is a typical annual occurrence when equities post modest, but reliable, gains in late December into the beginning of early January.

But so far, Santa's cheer has eluded Wall Street - the Dow Jones Industrial has traded flat for most part of December.

Investors should be mindful, however, that there has already been a rally, pre-Santa; one that's been in place earlier on this year - March to be exact. Since then, the Dow has risen from 6,500 to the current 10,500 level. Even investors who hopped on in July at 8,000 have had a good sleigh ride.

The question remains: where will the blue-chip index head from here? Will Santa continue to scale higher or will this sleigh ride come to a slow, or perhaps sudden, end in 2010?

The charts can provide some clues to the direction of the Dow.

The dominant pattern with the Dow is the inverted head and shoulder pattern. This is a long-term pattern that developed over nine months. The breakout in July 2008 above 9000 signaled a long term trend move towards 11,600. This trend target objective remains in place for 2010 although the ride to this level will include more bumps.

Santa’s exhaustion, or lack of it, is measured with the Relative Strength Index, (RSI) and where it lies in particular with RSI divergence. The divergence is the most important feature of this indicator  because it tells us when the market is lying.

We start with the RSI indicator. The most recent peak in the RSI was made in September. The peak was followed by a decline and the RSI is currently on its way to making a new peak. Here is the important bit. The peak in the RSI should co-inside with the peak in the DOW.

If the trend line between the two RSI peaks is down, and the trend line between the two Dow peaks is up, then we have divergence. It tells us Santa’s has run out of puff and that a market decline is developing. This does not necessarily mean a large change in trend, but it usually sets the scene for a short term downtrend.

Its too early to know if this RSI divergence will develop, but the initial indications are not good. The Dow looks to be rolling over. This will create a new peak in the Dow. The value of the RSI is well below the height of the previous RSI peak. This suggests a higher probability of an RSI divergence. Santa’s not quite what he used to be which is one of the reasons for no Santa Clause rally in 2009.

Which brings us back to the original chart pattern analysis. The 11,600 level is a chart pattern target level but it does not coincide with any strong historical chart features. The most powerful historical resistance level is near 12800. This is a small trading consolidation band stretching from 12800 to 13100. This is the long term resistance target for 2010. Santa needs a rest around the 10500 level before thinking about higher targets for 2010.

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