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There are some very appealing arguments for the long term growth of the global economy. Although there are signs that the recovery is waning somewhat in the US, Asia is going great guns whilst Europe and the UK are tentatively making some headway. This will, no doubt, assist the US over time as risk appetite returns and investors put sidelined cash back into the markets. In the very near term, however, the market is technically poised for a pull back. It may take some weak piece of fundamental data to instigate a selloff, or bad news from the corporate world, but it is price action and price structure which signifies a near term top. This article will look at the Dow Jones industrial 30 index (INDU:CBOT) and investigate how that top may come about.
The bigger picture Elliott Wave Theory suggests that a pull back is due according to the current projection. A full 5 wave impulse pattern and a, b, c correction can be seen starting from March last year and ending in July 2010. The new 5 wave impulse has already begun and there is (if the wave 3 begins to lose energy) the chance of a pull back. As students of Elliott’s theory know, Wave 3’s are typically very strong and resilient so appropriate patience and caution needs to be exercised to establish certainty to this count, before money is put into action.
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By zooming into the more recent price action and smaller scale, there are a couple of technical reasons to support a ‘pull back argument’. First of all, the resistance level in price around the 11,275 point mark and the (as yet unconfirmed) double top formation. Markets will tend to fall away after a double top has formed and this pattern is often cited as one of the more reliable/recognisable technical patterns. Closing profitable long positions or looking to establish a short position around this juncture would be quite an aggressive trading approach and depend very much upon your chosen entry signal. Confirmation in the guise of a first lower top for SITM students or a new low breakout could provide an adequate level of caution and thus safety for those with a smaller acceptance of risk.
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Underlying volume in the recent rally also adds evidence to the case that a sell off is due. This final piece in the puzzle can be seen in the chart below. Using OBV (on balance volume) to look at the momentum of buyers compared to sellers on positive and negative days, it appears that the last few months of price action have not been supported with much gusto by the investing public.
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Despite the rally in price beginning in July, OBV initially fell and has subsequently failed to keep up with the price rises through September and October. This indicates that relatively few people are actually participating in the rally – obviously not a good sign for the bulls. This level of disequilibrium cannot be sustained over the medium term and will inevitably change. Either price needs to back away or volume needs to increase. With the reasons cited above, the former prospect looks more likely at this point.
Of course, although the market is finely balanced at a potential sell off, should the resistance and double top break there is plenty of scope for OBV to catch up with price and a very sharp rally to occur. This has the usual implications to all traders – be aware of the market structure but only trade your plan. Set ups give you the lay of the land like a map, how you plan to traverse that land is the most important consideration. Entry, exits and risk management are what count.
Stay Sharp,
John Jeffery
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