Another big test for the Dow bears

Just to let you know, I’ll be taking a break next week and the week after. But not before I’ve brought you up to date with the incredible moves on the Dow!

Let’s get right to it. It’s thrilling stuff!

Following Wednesday’s big drop which I covered yesterday, the Dow staged yet another death-defying rally yesterday afternoon. 

Let’s look at the damage it has done to my bearish case.

Yesterday’s rally reverses the sell signals

On Wednesday, the market broke below my lower wedge trendline as well as the two chart support levels, where I had placed short trades.

But yesterday’s rally reversed these sell signals as the market moved back up through these levels. You can see that move here:

Dow Jones spread betting chart

(Click on the chart for a larger version)

At first glance, it seems that my bearish stance is wrong – again!

 

But not so fast – I have one remaining line of defence, and it is this:

Dow Jones spread betting chart

(Click on the chart for a larger version)

As of this morning, the rally has not made a new high above Wednesday’s 12,950 high. It has ‘only’ reached the Fibonacci 76% retrace of Wednesday’s decline.

Recall that the 12,950 level formed the end of the fifth wave of a bullish five-wave Elliott wave pattern. That level remains very strong resistance.

Also note the rapid turn-around in momentum readings as marked by the blue box. That was some shock to the system.

The market is now meeting strong resistance

Recall from previous Dow rallies which I have covered before that many of these rallies have stalled at very deep retracements – often above the 76% and closer to the 87% levels.

Can this be yet another very deep retracement before the decline is resumed?

If so, they are teasing us bears mercilessly!

Note from the above chart that this 76% retrace level at the 12,900 area is also the level that has repelled a few previous rally attempts. I have marked these by the yellow arrows. The market clearly believes this is a significant resistance level.

Also, the rally off the Thursday morning low can be treated as an A-B-C pattern, with the C wave a very extended one. If true, we are still in a down-trending market. The implication is that there is more downside to come.

The alternative view is that if the market can push above the 12,900 level, a five-wave pattern could be formed. That would weaken my counter-trend argument.

It’s still possible the Dow is forming a top

However, even if the market can push above the 12,950 level, a real top could still be imminent. The upper wedge trendline still passes through the 13,000 area, so there is room of about 100 pips above the current market for the market to finally top.

There’s no denying, though, that with yesterday’s development, it is now much harder for me to pin-point this elusive top.

If I were an aggressive trader I would be thinking of setting sell stops around the level shown by the purple bar in the chart below:

Dow Jones spread betting chart

(Click on the chart for a larger version)

If I was doing that, I would be relying on this Fibonacci 76% level to hold and the A-B-C rally pattern to be valid.

Naturally, I would employ my 3% rule to set protective stops in case the trade went wrong.

However, if I were a more conservative trader I would continue to wait and see if the Fibonacci levels will hold and to be ready to pounce if the market dropped below the lower wedge trendline again.

As I write this this morning, I can say that the market is displaying some topping action, but is less convincing than yesterday’s chart. At some stage, I will get a clearer indication, but the time is not quite yet.

Now as I mentioned at the start, I’ll be taking a break next week. My plan is to do one final post on Monday. But after that, I’ll be away until 29 February.

• If you’re a new reader, or need a reminder about some of the methods I refer to in my trades, then do have a look at my introductory videos:

The essentials of tramline trading

Advanced tramline trading

An introduction to Elliott wave theory

Advanced trading with Elliott waves

Trading with Fibonacci levels

Trading with ‘momentum’

Putting it all together

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