The Dow Jones Index is trapped between two key support and resistance areas, and it will be interesting to see which force breaks first – a break of the upper level will have profound implications for the future.

Notice I have drawn the proverbial “Line in the Sand,” which is an area just beneath 12,800 which has served as both key support and resistance (going back further even than this chart shows).

A clean break of this level would be significant because the area would likely revert to support and the market would be set to retest highs (or at least other congestion zones) near 13,600. Can anyone foresee a 1,000 point run-up in the Dow under these conditions? The charts may be hinting that scenario could be in the cards.

Also, notice we have a technical ‘ascending triangle’ which is struggling to complete itself (two black converging trendlines). Generally, ascending triangles are bullish, but there is no guarantee of any outcome from a consolidation pattern.

There is a slight momentum divergence forming, but that is unsurprising considering that momentum narrows as price forms (and completes) any consolidation pattern.

Notice how many ‘long upper shadows’ have formed as price has failed to rally above the “Line in the Sand” around 12,700.

Also, I wanted to highlight the potential crossing of the 20 period moving average above the 50 period average. Should this cross complete (if price stays above these levels), this would be another significant sign of market strength and support.

As it stands, we would say the odds may favor pullbacks to this area serving as support.

But wait! The market is trapped! There is support just above 12,400 and resistance beneath 12,750. What is the market to do? Can it stay in this 350 point zone forever?!

Of course not! The market is bound to break one of these levels in the near future, and there is potential for a momentum burst in the direction that the market breaks. It’s really difficult to predict the direction of the break, but easy to predict that the odds are high for some sort of continuation move once a clear direction is established out of this recent consolidation zone.

Be ready for anything and try to have fun when it happens!

With Microsoft (MSFT) and Yahoo! (YHOO) in the news lately regarding take-over bids and deadlines, let’s allow cooler heads to prevail by looking at the charts of these two stocks.

It’s clear that Yahoo has been the beneficiary of the latest news, which is the cast most often for potential take-over stocks.

From a low of beneath $19 to a high of $30, Yahoo shareholders certainly welcomed the price behavior following the announcement. On February 1^st, Yahoo received a $31 per share acquisition offer, sending the stock just shy of this value on the announcement. Yahoo rejected this deal, and as of yesterday, said it was open to a better arrangement.

According to the above Reuters article, “”Yahoo management’s position is still that Microsoft’s bid is too low and undervalues the company,” said Bernstein analyst Charles Di Bona in a note to clients. “Investors are becoming increasingly skeptical and there appears to be growing concern that this view is both unrealistic and self-interested on the part of Yahoo’s management.”

Yahoo rebuffed Microsoft’s 3-week deadline by declaring “”As a result of the decrease in your own stock price, the value of your proposal today is significantly lower than it was when you made your initial proposal,” Yahoo’s letter said.”

What has happened to Microsoft’s stock since the initial offer?

MSFT closed near $32.50 the day before the proposal was made public. The stock then trended downward and hit a low of $27 before recovering some of the losses.

This is a standard and expected pattern that occurs frequently in take-over negotiations. The stock of the company that is making the offer usually declines (possibly due to concerns of over-spending, etc) and the stock of the company that is being acquired usually rises, sometimes dramatically.

As traders, we have very little information at all regarding possible take-over announcements, and so I suggest that it’s generally a bad idea for new traders to try to anticipate these moves. Consequently, traders should not be discouraged when they miss one of these overnight large price increase moves – remind yourself that there was nothing feasible you could have done to buy the day before and sell the day after the announcement.

If anything, there may be a slightly profitable edge to playing the reaction against these moves, but still due to the large volatility moves that are possible, I would suggest newer traders stand aside and let the more experienced traders take part in such volatile plays.

While some people may hate overnight gaps, others love them for their simplicity and potential profitability. Today, almost like clock-work, the US Stock Market opened with a down-gap and filled it by Noon EST.

Keep in mind that yesterday’s trading opened with a gap-up that was filled also.

Here is today’s Gap-Fade trade, with two potential entries and two potential exits (depending on your level of risk aversion):

The gap-down was approximately 60 Dow Points ($0.60 DIA points) and had some initial play to the downside. I like to wait about 10 to 15 minutes to see what the reaction will be just to guard my risk a little bit and make sure some of the excess is shaken out.

You could have entered at any point, but the safest entry probably came at the second “enter” arrow, which represented a pullback in price to the Daily S1 Pivot level. I placed a stop beneath the intraday low with a target of yesterday’s close (just under $126).

Price then trended higher as expected, and found initial resistance just shy of the target, which would have allowed a conservative exit (meaning not playing for the full target) but aggressive traders who stomached the pullback reaped a larger reward when the target was achieved and exceeded.

The typical play now is to play the market back down in the direction of the original impulse. After all, gaps do occur for a reason and they are inherently a momentum impulse.

The Gap-Fade trade is one of the simplest trades you can take, but it can be one of your most profitable trade set-ups, depending on your strategy.

Let’s take a quick annotation of today’s DIA action on the 5-minute chart, scanning for ideal trades of the day.

First, the market gapped near over 60 Dow Points, setting up the classic “Fade the Gap” trade. Today’s gap fell about 10 cents (points) short of a full gap fade, but the initial action is to play against the opening gap for a retracement.

Gaps serve as momentum impulses, and reactions often follow impulses, while impulse moves often lead to higher prices. My classic “impulse buy” trade set-ups seeks to capitalize on the concept that “impulse follows impulse” but that there is not an infinite loop.

Nevertheless, the impulse buy trade set up just as price cleared the hurdles of the flattening 20 and 50 period moving averages which failed to serve as resistance. I highlighted the positive pull-back that signaled a ‘buy’ trade just after 11:00am which led to higher prices.

A divergence set-up as price peaked for the day going into 1:00pm and I commented to clients that I felt this zone could be the intraday high due to the following developments:

Price reached the upper Bollinger Band
Price formed a key negative momentum divergence
Price formed long upper (candle) shadows (signs of weakness by the bulls)

You never know which price will be the intraday high or low, but you can look to a confluence of indicators to help raise probabilities in your favor.

Nevertheless, a true trend change came around 1:30 (marked on chart) and price made a lower high and lower low and then broke down through the 50 period moving average.

A short term momentum move down occurred, and we never really got any sort of reaction against this downward trend move until a neat bear-flag (one of my favorite patterns) formed which carried price just above yesterday’s close and beneath key resistance from the 20 period moving average. This bear flag trade reached its target, which happened to coincide with the intraday low before recovering (also notice the positive momentum divergence which occurred at the lowest price of the “measured move” portion).

As always, I recommend annotating your charts with the ideal trades based on your understanding of indicators, price behavior, and market structure. Through time, you will improve your pattern recognition skills which should lead to more profitable trading.

Apple Inc (AAPL) continued its remarkable, almost vertical steady rise today, gaining almost 4% intraday before noon!

Since the middle of March, Apple has been traveling upwards at neck-breaking speeds, ascending in a near 70 degree angle.

The angular momentum of the stock is changing, meaning the rapid ascension may be unsustainable in the short term, but nevertheless one cannot deny the strength Apple has shown as of late.

This zoomed in graphic shows the three angular momentum changes as the stock has accelerated to recover 50% of its recent downswing:

Also, please note that volume is trending lower as Apple surges higher. This serves as a non-confirmation of higher prices and is a warning sign that things may not be as rosy (short-term) as the impressive price action might otherwise indicate.

Although you might be encouraged by the recent strength of Apple, note that the higher probability trade (or investment) at the moment now with these new technical developments would be to anticipate and wait for a retracement against the current price strength (perhaps down to the $140 level) before joining at these levels.

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Price generally can go down with minimal retracements, but it usually stair-steps up with retracements as price travels higher.

Don’t get too caught up in the hype and always seek to manage your risk in every position.