The Dow Jones Industrial Average — which we like to trade via the SPDR Dow Jones Industrial Average ETF (NYSEARCA:DIA) — is made up of just 30 stocks. And yet, for much of the financial media, the Dow Jones remains a simple barometer for the U.S. stock market.
My personal preference lies with broader indices such as the S&P 500, but the Dow Jones nonetheless can be used for technical measures. Because when this index breaks above or below important levels, it tends to represent important inflection points for the broader indices as well.
Currently, the DIA ETF has one very well-defined area of support, which if broken would likely lead to a significant spike of market volatility ahead.
I frequently say that markets that rise too quickly and too steeply have a strong tendency to eventually lead to a spike in volatility as a violent mean-reversion move lower takes hold. A similar fate is often shared by markets that tread higher with little to no volatility for an extended period of time, such as what we’ve seen in the major U.S. stock market indices in recent years.
As this central banking-focused market continues to grind higher with marginal gains, trading ranges this year have tightened more and more. Historical and implied volatility continue to track at their lows.
DIA ETF Charts
The severity of the low-volatility environment for the DIA ETF can best be seen on the multiyear weekly chart below.
After an initial V-shaped rally off the early 2009 lows, the Dow Jones — like the rest of the U.S. equity indices — saw a 20% correction in late summer/early autumn 2011. There have been a few 10% corrections along the way, but nothing much beyond that as the uptrending range began to tighten and volatility dropped.
This brings us to present day, where the Bollinger Bands (blue lines) are now at such tightness last seen in the early 2000s. Quite simply, the longer the Bollinger Bands remain at such tight levels, the more severe the eventual move will be. While a break to the upside is entirely possible, the path of least resistance ultimately is the downside.
If we then slide over to the still cozy confines of the daily chart, we see the negative divergence between price and momentum that I have repeatedly pointed to in other indices in recent months.
Specifically, note that while momentum — as represented by the Relative Strength Index (RSI) at the bottom of the chart — topped last December and has since formed a series of lower highs, the price of the DIA ETF continued to meander higher until the top in May.
This negative divergence ultimately should weigh on price as well; the question remains one of timing.
The levels that active investors and traders could circle on the DIA ETF at present is horizontal confluence support around $176, which is made up of the rising 200-day simple moving average (red line) as well as horizontal support from the March lows. A drop below there would likely confirm a medium-term top in the index and see a move down toward the $160 area (the October 2014 reaction lows).
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Successful trading and investing starts with a plan. Download Serge’s essential trading plan, The Essence of Swing Trading e-book. As of this writing, he did not hold a position in any of the aforementioned securities.
