This pattern in the Dow points to higher prices

For the second day in a row, the broad market experienced a slight gap up at the open which went on to fill and push the market lower throughout the trading day. Similar to Tuesday’s action, the Nasdaq was little changed at the close of trade, gaining 0.11 (closing at 2232.82), but the S&P and Dow registered stronger losses with drops of 8.00 (closing at 1249.48) and 82.29 (closing at 10805.87) respectively. Sector action was mixed and contributed to the divergence between the closing figures on the three major averages. Nasdaq’s relative strength was due to a decent showing by internets, semiconductors, and
biotech’s, all three of which managed to close above their opens even as the Dow
was battered. Weakness in listed issues was represented by mining stocks
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(down almost 3% from open), banks
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Under the hood, internals closed relatively flat but it’s important to note that they began the day in a much more positive light which would indicate deterioration over time and an increase in the number of real sellers as the day wore on. Both the NYSE and Nasdaq advance decline lines closed at just negative 85 (85 more decliners than advancers at 4pm), but both registered values close to positive 1000 in early morning trade. Breadth was divergent, mirroring the price action in the closing figures with the NYSE running at a negative 1.72 to 1, while the Nasdaq breadth stayed positive all day and closed at 1.30 to 1 positive. Overall volume increased evenly over both exchanges, however, with total turnover on the NYSE increasing by 12% and by 9% on the Nasdaq. This would be a firm distribution day for the Dow and S&P although not for the Nasdaq since it managed to close slightly positive on the day. Although all distribution days should be read as negative, obviously some leeway needs to be given to a market that has run so hard in one direction in just a short amount of time. One of the reasons for the increase in selling today in the Dow and S&P is due to yesterday’s price action being the first break of a daily trendline that has been in place for 22 trading days! The daily chart of the Dow below illustrates the just how strong November has been for the market.

Now that the trendline has broken there will obviously be an increase in momentum to the downside at least in the very near term as bulls take profits and bears begin to initiate short positions. As we know that old resistance becomes new support, it would follow that the 10,700 area in the Dow should be a relatively safe bet for a target for those of you short either the broad market or closely correlated stocks. The weekly chart of the Dow below illustrates this key pivot approximately 100 points below current market levels.

Notice in the weekly chart above, the potential cup and handle pattern forming in the weekly Dow. The left side of the cup would be the decline that formed between March and April of 2005. After some sideways action during the summer and early fall, the right side of the cup has now formed with the advance that started in the first week of November. Sideways price action from this point forward between key resistance of 11,000 and key support of 10,700 would be extremely healthy for the market as a whole and would complete the “handle” portion of the pattern which would then be construed as bullish. Cup and handle patterns generally lead to higher prices as the handle pattern begins to break out over the highs of the cup area. Time will tell of course, and we must remember that trading in anticipation of major moves is never as consistently profitable as simply waiting for moves to begin and then joining in on the momentum just slightly later. Prices that are in motion tend to stay in motion.

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PowerRating) (regular subscribers to Deron Wagner is the head trader of Morpheus Capital Hedge Fund and founder of Morpheus Trading Group (morpheustrading.com), which he launched in 2001. Wagner appears on his best-selling

services, visit morpheustrading.com or send an e-mail to deron@morpheustrading.com