Is the water safe for equity bulls?

The Dow Jones Industrial Average(CBOT:DJ) surprised many stock bulls over the last few weeks, with the index collapsing nearly 900 points to last week’s low. On the bright side though, the 30-company index has already rallied nearly 400 points from Friday’s intraday low at 16,260. But there are still a couple of high hurdles to clear before bulls will feel comfortable waving the all-clear flag.

At its core, technical analysis is about using historical patterns and tendencies to help anticipate future movements in the market. With that in mind, it may be instructive to revisit the two times the DJIA has set a lower low over the last year. Back in September 2013, the index fell about 1,000 points to set a new lower low at the 200-day moving average near 14,800. From there, stocks rallied strongly in 6 of the next 7 days and hit a new all-time high within a month of the low. Similarly, the DJIA shed over 1,200 points in January to a new lower low before eventually finding support at the 200-day MA and recovering to trade higher in 9 of the next 10 days.

Flashing forward to today, we can see many similarities with the previous pullbacks. After dipping 900 points to set a new lower low last week, the index found support off the 200-day MA on Friday and has now traded higher on 3 of the last 4 days, counting today. At this point, the uncanny similarities to the other two pullbacks over the year suggest that the recent drop may simply be another temporary setback within the longer-term bullish trend.

 

That said, bulls are not out of the woods yet. As we go to press, the index is testing its 100-day MA around 16,670. Perhaps more worryingly, the most recent pullback caused the DJIA to break conclusively below its 21-month bullish trend line. This raises two concerns for bulls: 1) It suggests that the pace of gains that traders have grown accustomed to over the last year and half may not be sustained and 2) it creates a strong area of potential resistance near 16,825 for bulls to navigate. The declining 50-day MA also comes in around this same area, strengthening the perception of resistance less than 200 points above current market rates.

Therefore, equity bulls may want to exercise a bit of caution until/unless the DJIA can climb back above resistance around 16,825. As a secondary confirmation, a move back to overbought territory on the RSI (>70) would go a long way toward assuaging any concerns with declining momentum in the market. Meanwhile, if stocks start to consolidate around current levels, it would mark a change from the historically bullish precedent and could serve as a warning sign that more weakness may be in store.

 

 

About the Author
Matt Weller

Senior Technical Analyst for FOREX.com. Matt has actively traded various financial instruments including stocks, options, and forex since 2005. Each day, Matt creates research reports focusing on technical analysis of the forex, equity, and commodity markets. In his research, he utilizes candlestick patterns, classic technical indicators, and Fibonacci analysis to predict market moves. Matt is a Chartered Market Technician (CMT) and a member of the Market Technicians Association. You can reach Matt directly via e-mail (mweller@gaincapital.com) or on twitter (@MWellerFX).

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