One characteristic of the modern market is the high level of volatility. It manifests itself as very fast moves, particularly on the downside and with large intra-day ranges. The result is that pattern projection targets are often achieved very rapidly.
There are two features to note about the fall in the Dow. The first is that the fall is entirely consistent with the pattern analysis and the targets discussed several weeks ago. The speed of the fall is consistent with the volatility behavior of post-Global Financial Crisis markets.
The second feature is the overall degree of the fall. The pattern downside target near 12,000 is 9.7 percent from the peak of the Dow on May 1 at 13,338. A fall of around 10 percent qualifies as a technical correction rather than a change in trend direction. This makes the 12,000-target level particularly important.
A rebound from this level confirms a continuation of the general uptrend in the Dow that started in 2011 October from near 10,650. Failure of support near 12,000 shows that this correction has developed into a change in the direction of the trend. That calls for the calculation of new downside targets.
Lets take this analysis step by step.
The first step in analysis is to note that the Dow has been dominated by a rounding top pattern. The current Dow pattern of behavior developed a small rounding top pattern over the past 10 weeks. The pattern development time is short, and the height of the pattern is small. These are the features that suggest a minor technical market retreat rather than a full scale market collapse that repeats the falls in 2008.
The base of the rounding top is near 12,750. The peak of the pattern is near 13,400. The downside projection has target near 12,000. This level has acted as a support level in the past so there is a high probability it will act as a support level again.
The second step in analysis is the behavior of a technical correction after a fall of around 10 percent. There is a high probability of developing a consolidation pattern near the 12,000 level. This consolidation may include a temporary and fast dip below support near 12,000.
The consolidation should include a reduction in volatility and a sideways movement using the 12,000 area as a support level. In this situation traders look for evidence that a rally rebound can develop. The objective is to trade the rebound with upside targets near the previous Dow highs.
The third step in analysis gives targets if the target support near 12,000 fails. The downside target is near 11,300. This is calculated by extending the target projection from the rounding top. In a bear market downtrend the rounding top target projection is doubled. This gives a provisional target.
The target projection is confirmed when the new downside target level also matches a previous historical support level. The Dow long-term historical support is located near 11,300. This acted as a support level in 2011, November. This historical support confirms the rounding top double target projection.
Over the next few days the market attention will focus on the ability of support to hold near 12,000. Success at this level marks this recent fall as a technical correction within the context of a long-term uptrend. Failure of support near 12,000 confirms this is a significant change in the direction of the trend. It confirms the Dow retreat is part of a new downtrend with initial downside targets near 11,300.
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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