Market Gaps Through Support Trendline

Aug 19, 2008: 10:44 AM CST

With the inflation numbers (double what was expected) and weak housing data, the market took the opportunity to gap downwards through the prevailing rising support trend channel on the daily chart (evident on the Dow and S&P 500).  We’ll need a close beneath the trendline to validate it, but as of noon, it looks like we’ll finally get that close.

Dow Jones DIA ETF Daily Chart:

I’m showing two interpretations of the daily bottom channel trendline (the top channel is not drawn) which is likely seen by all – on one trendline I use intraday closes and on the other, I use closing prices – the recent difference being yesterday’s action broke the trendline using intraday prices (candle wicks) and today’s action broke them both.  It’s possible that price could support, or could be stealing stop-loss (or triggering short-selling) orders and that we’ll need to re-draw the trendline, but for the moment – with a close beneath $114, we will need to classify these two valid trendlines as officially broken.

I’m sort of jumping the gun prematurely and posting intraday, rather than waiting for a close, but we must do our analysis in real time and be ready to chage if market conditions dictate so.   It will be frustrating if this turns out to be a whipsaw, but again, analysis and trading decisions are made in real time.

I mentioned yesterday that a test of the trendline offered an attractive place to ‘get long’ and play for the upper channel, but luckily before we could put on a position at that level, the market gapped lower, invalidating that play (opening and moving into the area where a tight stop-loss would be placed).  It is a great example of how we should do evening analysis, develop a strategy/game plan, and then wait for the market to confirm or disconfirm our analysis.  In this case, the market disconfirmed it, and a trade was not taken.

Let’s take a peek at the intraday action so far to see how this happened and what might be in store.

Dow Jones DIA ETF 5-min Chart:

Yesterday’s ‘trend style’ day action gave way to a late and pronounced positive momentum divergence and end-of-day rally, which seemed to indicate that price – being at support from the daily trend channel – would trade higher into Tuesday’s action and could travel as high as $117 to $118.  The economic news invalidated this pattern/analysis and the trend is strongly confirmed as “down” on the 5-minute timeframe (notice the most bearish orientation possible of the moving averages).

Also, notice the daily trend channel is – as of this writing – just over $1.50 away.  Odds are quite high that we’ll get that close definitively beneath this line, which would make the bullish case much more difficult.

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