…and one more thing

When it comes to inter-market analysis, there’s something I always think of: Bear Stearns Company. More specifically than the company, I think of the letters BSC as a reminder of a very common phrase: Bonds lead stocks lead commodities.  Typically this would be leading as in higher and lower. Could it also lead inversely?

I have recently written (2) Chart School newsletters in regards to potential breakdown of the stock market. These newsletters highlighted a very long-term Dow channel and a very important support line for the S&P. Well, if bonds lead stocks, could bonds give us a heads up?

Please review the TLT (iShares 20 Year Treasury Bond Fund) ETF chart below with my notations:

While the stock market has rallied higher over the last 6 months, bonds as illustrated by the TLT have sold off. This same inverse correlation also existed when the stock market sold off from April to August, while bonds rallied during that same time frame. If you notice the TLT above, you will see it has been stuck within a downward channel. Yesterday, the TLT broke out through the topside of this channel indicating potential higher prices for bonds.  Summing up, if bonds and stocks are moving inverse to one another, and bonds lead stocks, then could the TLT’s breakout signal and eventual stock market breakdown?

The Tale of the Tape: Yesterday I wrote about a very important channel resistance that has come into range on the Dow and today I wrote about a very important S&P support line. Bonds and stocks have been moving against one another and bonds can tend to lead stocks. Yesterday’s breakout of the TLT seems to be signaling a move higher in bonds, which in turn would signal a potential move lower in stocks. Already knowing that the Dow was at a very important resistance, we could be seeing a major move unfolding.

What to do? If you like what you see in my charts, buying the TLT or UBT would make sense. You could also short the TBT. If bonds move higher, I’d expect rates to move lower which should favor the dollar and hurt the euro. So, you could also buy the UUP, short the FXE (euro) or buy the EUO. Upon purchase/short, make sure to set a stop below the breakout/breakdown point in case the market still has some steam and is faking us out yet again.

No matter what your strategy or when you decide to enter, always remember to use protective stops and you’ll be around for the next trade.  Capital preservation is always key!

Good luck!

Christian Tharp, CMT

Follow up to Dow channel article.

As a follow up to yesterday’s Chart School newsletter about the long-term Dow channel, http://www.themeshreport.com/2011/02/potential-stopping-point/, I just wanted to give readers a heads up as to what to watch for in case the stock market sell-off yesterday does turn into something bigger.

Please review the S&P 500 chart below with my notations:

The trend line I have drawn should be a formidable one. However, if we break it, I would think that if nothing else a correction would be in order.  The Dow channel resistance area that I wrote about yesterday lies somewhere within a range of 12,400 and 12,700, but we could even go higher than that without actually breaking through it. Rather than try to pin a top on the channel, I’d look for the support line that I have drawn above to breakdown.

The Tale of the Tape: Yesterday I wrote about a very important channel resistance that has come into range on the Dow.  It is difficult to say where the resistance line on the channel actually lies, but the point is simply that we are within its range.  The first sign of trouble would be the break of the S&P trend line I have illustrated above. When that line eventually breaks, which it will at some point, we could be seeing a top of some importance in the market.  Be cautious on long positions and look for shorting opportunities with stocks as well as the indices when this happens.

No matter what your strategy or when you decide to enter, always remember to use protective stops and you’ll be around for the next trade.  Capital preservation is always key!

Good luck!

Christian Tharp, CMT

Potential stopping point?

As everyone has seen over the past several months, the stock market simply goes up.  Sometimes it seems borderline comical. No matter what the news, no matter how sluggish the economy, no matter what the start of the day looks like nor what the technicals look like, up we go.

So, weeks ago I began telling the students that I coach that I had given up on the idea that a resistance for the market exists since the market never seems to resistance anything. As the saying goes, “Resistance is futile”.  Instead, let’s just let the market play out and eventually it will tell us when it’s going lower. After all, let’s not loose sight of that fact: The market will pullback, it will correct, and it will eventually enter a bear market again. These are the facts of the stock market. What isn’t a fact is when any or all of these things will happen?

Last week, I noticed a trend line moving into range that I had not looked at for years.  I don’t look back more than a year or so very often, but with the market going up, up, up, an important potential resistance came into play. So, please take a look at the long-term, quarterly chart of the Dow I have shown below:

This channel has been forming for decades, so it’s importance is paramount.  As I tell my students, any (2) points can start a trend line, but a 3rd or more confirms it. If you notice my notations, you will see how often the channel resistance (red) and support (green) have been tested.  Remember, after the 2nd test of these levels, the market decided they were important levels, not me. You will also notice how often the 50% mark (blue) between these levels has acted as either support or resistance, such as with the 2009 low.

As the market has rallied over the last 6 months, you can now see why the upper trend line resistance came into my view.  However, here’s the problem: It is very difficult to pin an exact number on where that resistance lies. I’d look at it as more of a range, somewhere in the general 12,500 area. Again, depending on how/where the individual draws this channel, that target price can have a several 100-point variance above or below.

The Tale of the Tape: A very important channel resistance has come into range on the Dow.  In the long run, if you believe the market is still in a secular bear market that will return, this range around 12,500 could be a potential turn around point. This level is of more importance to you if you are the long-term trader or investor. For you, make sure protective stops are in place, or feel free to lock in some great gains at your discretion. For short-term traders, the trend is still up, but be on the look at for a reversal. If the trend were to change from up to down, you would obviously want to adjust your trading strategy.

No matter what your strategy or when you decide to enter, always remember to use protective stops and you’ll be around for the next trade.  Capital preservation is always key!

Good luck!

Christian Tharp, CMT

Don’t sleep on the dollar!

I just wanted to do a follow up on the US dollar. In the past, I have analyzed the dollar to gauge the possible movement in various markets. Not only can the movement of the dollar warn us of potential moves in commodities, stocks and bonds, but also trading the dollar itself can be an option.

So, let’s review an updated, long-term chart of the DXY dollar index.

As you can see, the DXY has created a long-term support line that accurately gave the dollar a bounce back in November. Here recently, the dollar approached that same trend line. Although the dollar may have already tested this trend line and begun a move higher, watch to see if it is tested again soon. If so, I would obviously expect the bounce higher for the dollar at that time. This could be a negative for commodities such as gold and other currencies such as the euro. A bounce in the dollar might be problematic for stocks as well.

Lastly, don’t assume the DXY will hold that support line. What if it breaks rather than provides a bounce? That could be a positive for gold, the euro and stocks.

The Tale of the Tape: The DXY may have tested its long-term support and started to move higher. On a move higher, expect the exchange trade fund (ETF) UUP to rise as well, while the ETF FXE would move lower. Protect any positions in gold if you haven’t already. On a DXY break of support, look to go long on commodities like gold, currencies like the euro, and possibly stocks as well.

No matter what your strategy or when you decide to enter, always remember to use protective stops and you’ll be around for the next trade.  Capital preservation is always key!

Good luck!

Christian Tharp, CMT

Dow Theory 101

Well, the Dow seems to be moving above the 11,750 area that I referenced a couple of weeks ago. It’s been a struggle, but the Dow has slowly inched higher. However, I do think there are some major red flags starting to pop up.

First, it is very concerning that while the Dow has been moving higher, the secondary indices have been struggling. For example, after reading this article, take a minute and review the charts of the Russell 2000 and the Nasdaq. Even though the Dow held it’s ground, and actually grinded higher last week, those two indices have moved lower. In a healthy market, we’d like to see everyone moving higher together. With the “risk-on” stocks like those contained in the Russell and Nasdaq selling off, it wouldn’t appear that the markets are NOT healthy. Rather, they seem to be falling apart a bit.

More importantly, let’s stick with the Dow. More specifically, Dow Theory. Investopedia probably sums it up best: “A theory which says the market is in an upward trend if one of its averages (industrial or transportation) advances above a previous important high, it is accompanied or followed by a similar advance in the other. The theory also says that when both averages dip below previous important lows, it’s regarded as an indicator of a downward trend.” Those that follow Dow Theory will look to the Dow Jones Industrials (DJI) and Dow Jones Transports (DJT) to gauge the “health” of the trend in force, based on the criteria set out above.

So, take a look at the following charts of the DJI and DJT (closing prices):

As you can see in the first chart, the DJI has in fact continued higher. Unfortunately, the transports have turned lower. This appears to be one of the first steps in the unfolding of a move lower, to one extent or another. Of course, if the DJT reverses and confirms the DJI’s high, then all will be well again, for now.

The Tale of the Tape: Although the DJI has continued higher, and may be on it’s way to 12K, the DJT has failed to take part. In addition, other secondary indices such as the Russell 2000 and Nasdaq have also “peeled away”. While the DJI seems dead set on marching higher, the overall market does not seem to agree. Keep an eye on the DJT and the other secondary indices.  The DJI cannot go it alone. Be prepared to adjust your trading and/or investing strategy if the markets finally turn lower. OR, look to see if the DJT, Russell and Nasdaq eventually confirm the recent DJI’s move.

No matter what your strategy or when you decide to enter, always remember to use protective stops and you’ll be around for the next trade.  Capital preservation is always key!

Good luck!

Christian Tharp, CMT