Caution: The Dow Jones is Flashing Signs of Technical Exhaustion

Last Thursday, many market participants were already enjoying their long holiday weekend when the Dow Jones Industrial Average quietly pushed past the psychologically important 17,000 mark and scored a first-ever daily and weekly close above there.

The rally came on the back of a better-than-expected June jobs report, with quarter-start influences (i.e., new money being put to work on the part of mutual funds) also helping the bid.

Last but not least, the holiday-shortened week was rather quiet, and thus the saying “never short a dull tape” once again flashed its charm.

On a year-to-date basis, the Dow Jones is now higher by more than 4%, while the S&P 500 is up 8.54% and small-cap stocks — as represented by the Russell 2000 — are also well in the positive, up 4.5%.

In other words, the trend remains up as stocks still get chased higher … and despite the bears’ continued table-pounding, an uptrending market in and of itself is no reason to cash all out of stocks or even go short this market.

Good traders and investors have learned to respect the trend and stay the course until it ends. Along the path higher, however, the situation must continually be reassessed and risk/reward must be measured.

When it comes to the DJIA, a simple rule of thumb is that at every thousand-mark, taking a little off the table and taking a step back is sound risk management.

Dow Jones Charts

On the below multiyear weekly chart, note that the strong uptrend off the higher low in 2011 remains well intact. At the same time, however, the relative strength index topped in April 2013 and continues to trace out a series of lower highs, thus flashing some significant negative divergence vs. the price action of the Dow Jones.

While I do see the use of momentum oscillators for trading purposes, my favorite way to use them is by spotting divergences between momentum and price on longer-dated charts. More often than not, price eventually catches up with momentum, which in the present case of the Dow Jones would mean the index should run out of steam sooner rather than later.

On the daily chart, the Dow Jones’ run off the February lows and its 200-day simple moving average (red line) are clearly visible. With last Thursday’s push, the DJIA has once again reached the upper end of its multimonth wedge, which is not a good spot from which to chase the index higher, particularly for those investors that have missed a good part of the monster rally off the 2011 lows (or worse yet, the 2009 lows).

The trend remains up, but with the Dow Jones having toppled the 17,000 mark on waning momentum and also arrived at near-term trend resistance, odds of a straight shot toward 17,500 or even 18,000 are slim here. Active traders might consider significantly raising cash levels here and watch how the market unfolds in coming weeks as earnings season arrives.

— Serge Berger

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Source: Investor Place