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Support Must Hold or We Are in Trouble

If major Dow indices fail to hold at crucial levels, overall bull market may be in question


A new Moody’s downgrade of Ireland’s debt, a deadlock between the White House and Congress over the U.S. debt limit, and Fed minutes that hinted at new stimulus (QE3) but were later squashed, resulted in a late-day sell-off with financials leading the way lower in the last half hour. Investors are confused and uncertain. And that uncertainty led to a rush to sell late yesterday, when several Fed members said that a new stimulus program was “only discussed” at the June meeting rather than a firm proposal for another round of quantitative easing. Then a weak earnings outlook by Novellus Systems (NASDAQ: NVLS) and Microchip Technology (NASDAQ: MCHP) and a surge in the May U.S. trade deficit to its highest levels in two and a half years pushed stocks off of a cliff.

Today, we will examine two charts because of their importance to Dow Theory followers. 

Dow Chart

Trade of the Day Chart Key

Yesterday’s late selling led by the financials and some tech stocks drove the Dow Jones Industrial Average into its first important support zone. That zone begins at 12,390 and runs to 12,450. Just below it is the 50-day moving average at 12,364. This pullback is slightly in excess of 33.3% of the rally from the June 16 low to the July 7 high, and the first Fibonacci number to be breached by sellers. The recent decline by the industrials confirms its inability to make a new high on its last move up.

Since the Dow Jones Transportation Average made a new high, the industrials’ failure is called a “non-confirmation” and a serious negative to followers of the Dow Theory.

DJT Chart

Trade of the Day Chart Key

The Dow Jones Transportation Average ran to a new high on July 7, reversed, and now is approaching support at the conjunction of four significant technical lines: the 50-day moving average, the 20-day moving average, the support line at 5,333, and the downward sloping breakout line at 5,330.

To theorists, this zone must hold since a penetration of it, along with the failure of the industrials to make a new high, would confirm that both indices had broken down and that the chance of a test of the overall bull market was about to occur.

Conclusion: Waiting and observing the market’s reaction to the complexities of the world’s economic crosscurrents is highly recommended. Dow’s Theory is not perfect, but over a long period of time and under a variety of world events, it has proven its worth. If the two major Dow indices fail to hold at this crucial level, then the next test will no doubt come at the 200-day moving averages of both. 

Today’s Trading Landscape

To see a list of the companies reporting earnings today, click here.

For a list of this week’s economic reports due out, click here.

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