Keeping an eye on the Dow stocks
Posted by Danny on January 27, 2014
Weakness in stock markets is evident now. I already warned last week not to trust the current lunar green period, because some important targets have been reached and too many of my indicators are flashing warning signs. With a lunar red period coming up in early February there may be more downside action in store.
This week I will take a look at the Dow Jones Industrials Index. In a post last July ( Why Dow 16000 will be sold ), I presented a number of target calculations that pointed to 16400 (+/- 200) as a major level where selling was likely to kick in. While we didn’t reach that target in August, the Dow rose to a record 16588 in late December and is now pulling back below the 16000 level.
Here is an up to date chart for the Dow Jones (click for larger image):
The Dow is coming close to the early December lows, where some support is to be expected. I think we will see an attempt to regain the 16000 level this week, but the more important test will come in February. Will the January lows hold or not? If the market breaks lower then we can start watching for the 15000 level.
I am showing the Dow index this week, because I want to share a little method that can keep you at the right side of the market most of the time. The weekly key reversal levels for the 30 Dow stocks, which shows what stocks are bullish (green) or bearish (red), is a good indication for the general health of the market. I post them on my Twitter account every weekend. This is the current situation for the 30 stocks in Industrials average:
Six stocks have gone bearish last week, leaving now only 17 Dow Industrials stocks with a bullish setup on the weekly level. This is the lowest number of bullish stocks since December 2012. We got several pullbacks in 2013, but the number of bullish stocks in the Dow never dropped below 20. The current downturn appears to be of a more serious nature. The market will have to turn up really quickly, otherwise we will soon have more bearish stocks in the Dow than bullish ones, and that would imply the start of a bigger correction.
For a better perspective, this chart displays the number of bullish stocks on the Dow since 2012 (click for larger image):
Generally speaking we have a healthy bull market when 20 or more Dow stocks are bullish. When less than 15 stocks are bullish we are in a correction if not a bear market. For a conservative investor, a good way to stay out of trouble is to go underweight stocks when the number of bullish stocks in the Dow drops below 20 (or buy some options for protection), and get out completely when the number drops below 15. Then, get back into stocks when the number of bullish Dow stocks climbs above 20 again.
This chart shows how that basic approach would have done in the 2007-2009 bear market (click for larger image):
As the market started going down from record highs in 2007, the number of bullish stocks quickly fell below 20, and by early 2008 it dropped below 15. So, that was a clear sign to get out. It briefly rose back above 20 in May 2008, so one would have bought at that point. But that didn’t last long and soon the number of bullish stocks was back below 15, so out of the market again. In April 2009 the number of bullish stocks rose back above 20, and this proved to be a more profitable buy signal.
It is a simple method and only takes a few minutes per week. It isn’t perfect, but one can use it to avoid the major pitfalls and will always be on board whenever there is a strong bull market.