Small gecko lizards defying gravity by scuttling along the underside of a ceiling are a common feature of living in Asia. The Dow Jones Industrial Average chart has the same characteristics, clinging to a powerful resistance level.
Several weeks ago the charts suggested that the market rise in the Dow was limited by a significant resistance feature that is derived from dominating chart patterns on the Dow Index. In the light of continuing strength in the Dow is this analysis still correct, or does it need modification?
This is one of the key characteristics of good chart analysis. Analysis is based on the information known at the time. Good analysis identifies the significant features that may develop in the future, which will trigger a change in the analysis, or dictate some specific action, such as a switch from long positions to short positions.
The first key feature of the Dow is the extension of the head and shoulder neckline and the way this line acted as a resistance level. This resistance slowed the rate of upward momentum. It doesn’t stop the upward trend, but it reduces the pace of upward momentum, and while it acts as a resistance level, it also limits the upside targets for the Dow.
The extension of the head and shoulder neckline continues to have this influence. The Dow is moving to new highs, but the upward move is constrained by this line acting as a resistance level. The move upwards towards 13,000 is slow.
There are several consequences of this restrained behavior. The bears point to the strength of resistance and suggest the loss of momentum precedes a market retreat. The inability to break decisively above resistance is a bearish feature but it does not indicate a major trend reversal.
A retreat from resistance has solid support near 12,200. This support area has been tested several times so there is a good probability it would act as a rebound point for an uptrend continuation. There are limited shorting opportunities.
Just because the bears are feeling less confident it doesn’t mean the bulls have an open field. Bulls are constrained by the index hugging the resistance line. The key bullish signal is when the Dow, on a weekly chart, is able to convincingly close above the extended head and shoulder neckline.
This will signal a change in the character of the line. It’s a shift from resistance to support. When the market sues this line as a support level then it provides a base for extended upside move.
At this point in time there is no chart-based method for calculating upside targets. The nature of the breakout and rebound behavior will provide these calculation tools.
The second key feature of the Dow is the very strong support and resistance level near 13,100. This was the base of the head and shoulder reversal pattern in 2007. It was the resistance level for the May 2008 failed rebound. This historical feature has the power to put an end to the upward momentum.
The slow upside move in the Dow looks set to continue but the momentum is reduced by the influence of the extended head and shoulder neckline. Targets at 13,000 and beyond are achievable. It’s the 13,100 level that provides a strong historical support and resistance level so traders will watch carefully for index behavior near 13,100.
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.
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