Tuesday, March 12, 2013

Time to Get Long the Dow?

The record setting pace in the Dow is grabbing headlines. On Tuesday, it closed higher for an 8th day in a row. On Monday, it closed above its upper Bollinger Band (BB) for a 5th day in a row. Time to get long the Dow?

The first chart looks at the Dow on a weekly basis since 1997. Over those 16 years, the weekly RSI (5) has closed over 90 only six times (marked in yellow). It closed recently at 92. Momentum tends to fade at these levels. The smallest subsequent drop was 5% and several where considerably larger (over 20%). In the best case, price moved sideways for next 6 months or longer.

The next two charts look at consecutive day closes over the upper BB from 2003 to present (green arrows).  When those events occurred after a consolidation period (2004, 2006), the market generally moved higher in subsequent months. Think of this as the beginning of a break out. However, when price was outside its upper BB after a long uptrend (as is the case at present), subsequent returns were very poor (all cases from 2007 to present).

The next chart looks specifically at closes over the upper BB of 5 consecutive days, from 1982-97 (yellow shading is the subsequent period). The conclusion is the same. 1986 and 1996 were consolidation years, and a strong move after these periods marked a break out (green arrows). All of the other times (which are analogous to the present), subsequent returns were flat or poor. 

The final chart looks specifically at 7 consecutive daily closes higher since 2000. Most of these occurred after a considerable drop, and marked the start of a new uptrend (red arrows). Subsequent performance was very good. But if the 7 consecutive higher closes occurred after a long uptrend (like the present situation), the Dow was close to an important top. 

The analogue for the Dow are those periods following a long uptrend.  Whether looking at consecutive days higher or consecutive closes over the upper BB, the likelihood of this being the start of an uptrend are small. Many of those periods in fact are close to tops. Combined with the weekly chart, the probability of this being the start of an uptrend drops further.