The 700 point drop in the Dow Jones Industrial Average on Wednesday took some people by surprise. Stocks can actually go down despite what Dave says. But seriously, it is a good time to take a look at the status of the index charts and get a feel for what they are trying to tell us.
The daily Dow chart shows the text book four month stair-step rally. It began in late March with the formation of a morningstar candle pattern and has climbed back up to its horizontally trending 200 day moving average. If, in fact, it turns out that the Dow has made a top of some duration then the island grouping of four stock made earlier this month may have been a sign. Island reversals are considered important technical indications.
Over the last two weeks the industrial average has been trading in a 1000 point channel range. Topside resistance is being supplied by the 200 day moving average and support by an intersection of trend lines and the 50 day moving average. During this two week period the relative strength index has dropped below its 21 day average and its center line. This suggests a loss of positive price momentum. Chaikin money flow moved below its signal average and is heading lowering, reflecting a loss in positive money flow.
So, on one hand, the Dow average is losing some of its positive momentum, but on the other hand, there is reinforced support in the 25000 area which could be a platform for a bounce.
The action on the S&P 500 daily chart has been playing out very much like that of the Dow chart and the technical picture is about the same. It’s the NASDAQ Composite chart that requires the most attention.
The daily NASDAQ chart shows the composite index climbing steadily off its March low above a strong rising trend line. It began with a bullish morningstar pattern and now, just this week a bearish eveningstar pattern has formed on this time frame. The positive technical take-ways are that the rally has taken place within the confines of the upper Bollinger bands, as well as the strong uptrend line, and the price and money flow momentum indicators look stronger than their Dow counterparts.
But the NASDAQ Composite chart is particularity important to watch because of its leadership role. The indicator at the bottom of the daily chart measures the percent difference in the performance between the NASDAQ and the S&P 500 over the charted period. We all knew that the Composite index was making new all time highs and that the other major market indices were lagging well behind. The graph at the bottom of the chart shows that since March the Nasdaq index has outperformed the S&P by nearly 13%. This diversion between the broader market and the NASDAQ composite cannot be sustained. The averages will return to a more natural alignment. This has the effect of the broader market pulling down the tech heavy NASDAQ. This then reinforces the weakness we see on the Dow and the S&P charts, and there is a sudden and swift correlated pullback.
The bottom line is that five large technology stocks cannot support this market forever. They will yield under the weight of their own market cap and take down a vulnerable looking broader market with them.