Sunday, December 09, 2007

Failed Moves and the Major Indexes

I've noted here before that failed moves often lead to quick counter trends. A good strategy with the dow jones over the past few months would have been to take a position after a breakout or breakdown fails. The two most recent glaring examples are at the high in October and the low in November. The down broke above 14,000 to make record highs in late October but after it slipped back below 14k it dropped like a rock, 10% actually. More recently, the dow broke down when it closed below it's closing low made in August and also below its February high. Then in the following days the dow moved back above this level (which acted like support) and then we got this quick rally from the Thanksgiving low.

In order to trade this strategy you have to first establish where the significant price levels exist, then after a break watch for these levels to fail. Just as an example, lets say the dow broke it's high at 14,200. I would watch for the a move back below 14,000 on good volume then get aggressively short. These reversals suggest that big players took advantage of the obvious chart break to load up on or dump stock. When a major support level is breached many investors will exit their positions and traders will go short, this provides a huge supply of stock for institutions who may want to load up. When the break fails, the newly short get squeezed and investors who got shaken out may jump back in thinking they made a mistake. There are sound reasons why these failed moves would lead to fast movements.

You could also use this strategy with the 50 and 200 day simple moving averages. Since many investors watch these averages and expect them to be price support and resistance they can be considered significant price levels. Take a look at what happened the last two times the nasdaq 100 broke below it's 200 dma. Within a few days it reversed and that would have been the ideal time to go long:

You can also similar action on the dow jones chart up top back in August when it first broke below it's 200 dma.

Here's a look at the S&P 500. Theres not much to say other than that its been range bound for the past 6 months. A small inverted head and shoulders has formed which has a price target near the top of the range and hence new all time highs. Unfortunately for the bulls there are a number of resistance levels on the way up there and given the weak follow through on the 50 dma break last week, I doubt the S & P 500 will be able to hold on to recent gains.

You know I can't do index charts without including the small caps with a Russell 2000 plot. There is nothing bullish at all whatsoever about this chart. I've highlighted a few of the obvious points below like the down sloping moving averages and the lower highs and lows:

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