Can This Indicator Predict The Dow Jones Next Move?

In yesterday’s Money Morning, Murray noted that the Dow Jones Industrial Average had clocked up gains for the past nine trading days. It was the best winning streak since 1996.

Well, last night the Dow went one better. It’s now 10 straight days of gains.

What does that mean? Is it something or nothing?

Look, Murray’s game is technical analysis. It involves studying charts and working out the probability of an event happening. You can check out Murray’s latest analysis and where he thinks the market is heading here.

This analysis played a big part in the trades he has recommended on the big Aussie resource stocks and Aussie banks.

And if one of Murray’s favourite indicators is anything to go by, it may not be long before the Dow’s glory streak comes to an end

As you may know, your editor isn’t much chop when it comes to technical analysis.

In fact, until we first met Murray nearly six years ago, we didn’t give technical analysis the time of day. It really was just squiggly lines and a lot of what we considered ‘Hindsight Harry’ analysis.

But after just half an hour of sitting with Murray and him explaining how he interprets the stock markets…well, it was as though we’d found the Rosetta Stone of technical analysis.

And we’re not kidding either.

Most share traders see a new high (or low) as a signal to join the momentum. The old saying is ‘the trend is your friend’.

But Murray takes the opposite view. When he sees a stock or index hitting a significant high or low, it rings alarm bells.

For Murray, a new high (or low) is a potential turning point. It’s where investors should look to bet against the trend.

But that doesn’t always mean jumping in straight away.

The breakthrough point is only part of Murray’s analysis. It’s what Murray commonly refers to as a ‘false break’. That’s where most traders believe the market will surge to a higher high.

However, instead of the market surging higher, what frequently happens is that it breaks through and then shortly afterwards does a complete reversal, heading back the other way.

This is a set-up that’s starting to take shape in one of the world’s most well known stock indexes…

Not Everyone Has The Dow Jones Going Higher

The Dow Jones Industrial Average has recently hit an all-time high. It has led some commentators to say the index will go even higher.

But not everyone is convinced.

For instance, if you look at one of Murray’s favourite indicators, the Relative Strength Index (RSI), it’s potentially telling a different story.

The RSI is just one of the indicators Murray uses to judge the probability of the market’s future direction.

Specifically, Murray looks for a key behaviour in the RSI…that isn’t what most people use it for.

Put simply, the RSI indicates when a stock or index appears to be under- or over-bought. However, the key word is relative. Just because the index is at a high point today (meaning overbought), doesn’t mean it can’t go even higher tomorrow.

Murray’s analysis involves looking for a particular set-up in the relationship between the stock or index price and the RSI. Namely, he looks for instances where the stock or index remains at a high point (if he’s looking to short sell) but where the RSI is falling.

This alerts Murray to a potential directional change in the price.

Understand that this is only one part of his analysis. He uses other indicators plus fundamental analysis to form a view on whether a stock or index is a buy or sell.

Is it Too Early to Sell?

But right now an interesting set-up is taking place with the Dow Jones Industrial Average as it trades above the old 2007 high. You can see this on the chart:

Click here to enlarge

Source: Google Finance

As you can see, the RSI (lower chart) is currently in overbought territory, while the index remains high. So right now, this wouldn’t trigger a short selling opportunity for Murray.

But, when or if the RSI starts going lower, that’s when Murray would combine this analysis with the other indicators he uses, and his fundamental analysis, to decide if the potential reward outweighs the risk of taking on the trade.

It’s also important to note that the falling RSI can pre-empt the falling index by several months – as happened from early to mid 2011.

That’s where other indicators can help with the timing of a trade.

But whatever happens, the US market is at a key level. Whether the market will keep rising or begin to fall is anyone’s guess. But it’s worth keeping an eye on this indicator over the coming weeks.


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From the Port Phillip Publishing Library

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From the Archives…

Why the Stock Market Boom is on Pause
8-03-2013 – Kris Sayce

Why the Dow Jones Record High Doesn’t Matter
7-03-2013 – Murray Dawes

Taking China’s Economic Pulse from Hong Kong
6-03-2013 – Dr Alex Cowie

Buy Gold When They’re Crying…Sell Gold When They’re Yelling
5-03-2013 – Dr Alex Cowie

Do You Want to Be Right About Investing, or Do You Want to Make Money?
4-03-2013 – Kris Sayce

Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

Money Morning Australia is published by Fat Tail Investment Research, an independent financial publisher based in Melbourne, Australia. As an Australian financial services license holder we are subject to the regulations and laws of Corporations Act and Financial Services Act.

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