Breakout? Top? Wait and See?

by: Barry Ritholtz

We continue to discuss the technical aspects of the Dow action in the office. There is a divergence of informed opinions, ranging from "Breakout over 1500 SPX was bullish" to "Let's wait and see" to "a major top is forming."

E.S. Browning's description of Wednesday's trading reflects this range of opinions:

"In the first minutes of trading, the Dow Jones Industrial Average surged as much as 271.75 points. The blue chips seemed on course to erase a 294.26-point decline Tuesday that resulted from disappointment with the Fed's quarter-point rate cut.

Instead, the industrials began sinking, finishing ahead just 41.13 points, or 0.31%, at 13473.90.

Before a late-day rebound, the Dow was down as much as 111.13 points, meaning a swing of more than 382 points during the day."

The strong opening gap Wednesday, followed by a near 400 point reversal, only to close marginally higher is, in my opinion, simply awful technical action.

I'll spare you the rest of the details of the discussion, and rather, show you this one single chart:

Monthly Dow, 25 Year Chart

Chart courtesy of Richard Russell,

Note that the RSI peak and reversal (top pane) is hardly a flawless tool, nor is it a precise timing mechanism (note the 1997-98 signal).

However, it is a serious warning that weaker returns are likely in the ensuing years. Call it a high probability mean reversion measure.

Dow's 382-Point Swing From High to Low Speaks Volumes on Sentiment
WSJ, December 13, 2007; Page C1