A long term technical indicator I use which compares the returns of the Dow Jones Industrial average (NYSEARCA:DIA) and the Dow Jones Transportation average (NYSEARCA:IYT) has flashed a SELL signal as of yesterday. The indicator consists of the following:
1. Comparison of the percent change in the Dow to the Transports.
2. Multiple comparisons of the trend of the Simple moving average, and exponential moving average for the Dow.
3. Lack of Positive volume.
4. Lack of meaningful money flow.
5. Use of Price channels.
Overall using those 5 indicators, I get twelve criteria that make up my indicator. I created this indicator two years ago and it has proved extremely reliable. The indicator is only triggered when all 12 criteria are met. This has only occurred 3 times before yesterday since January of 2004, which is when data starts for IYT. So a total of 4 occurrences during a 9 year span. After each of the previous signals stocks had meaningful correction, with one of the three being extremely severe. In the charts below I will show what happened after each signal was triggered.
The first Sell signal was triggered on 9/19/2007, extremely close to the previous all-time high. What makes this different from other the two other occurrences, besides the current one, is that the whole candle is above the upper price band [red line], and subsequently that was near the top and stocks fell substantially afterwards.
The second sell signal was triggered on 4/19/2010 and had a correction of about 12% over the two months following the sell signal. Also, notice from the chart below that the candle is below the upper price band [red line].
The third sell signal was triggered on 4/26/2012, and has a correction of around 8.4% over the following month and a half. Again the candle was below the upper price band.
The fourth signal that occurred yesterday, had its candle ABOVE the upper price band, which has only occurred the last time the market was near an all-time high and fell substantially afterwards. Only time will tell how big the coming correction will be. But using history as a guide, I would be very wary of the Dow, Dow Transports and stocks (NYSEARCA:SPY) in general.
For those that have the thinkorswim platform here is the code for my custom indicator, that you can copy and paste into a new study:
input price = close;
input length = 200;
input displace = 0;
input malength = 9;
input exlength = 50;
input mflength = 21;
input movingAvgLength = 1;
input displace2 = -1;
input blength = 20;
def UpperBand = Highest(high[-displace2 + 1], blength);
def MFI = Average(moneyflow(high, close, low, volume, length), movingAvgLength);
def SMA = Average(price[-displace], malength);
def AvgExp = ExpAverage(price[-displace], length);
def AvgExp2 = ExpAverage(price[-displace], exlength);
def Dow= close("DIA");
def transports= close("IYT");
def ind= (chng1-chng2)*100;
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.