Dow Forms Potential ABC Correction

05/24/04 08:22:54 AM

by Arthur Hill

Technically, the medium-term trend is down for the Dow, but a potential ABC pattern could make this a big correction within a larger uptrend.

Security: $INDU
Position: Hold

After the summer consolidation just above 9000 (green oval), the Dow advanced from 8997 in August to 10754 in February. This was a sizable advance and a correction or consolidation was certainly in order. Over the last few months, the Dow declined to 9852 and retraced around 50% of this advance (blue line). This is within the norms for a correction and the Dow is now firming around 9900.

Graphic provided by: MetaStock.

In addition to a normal retracement, the Elliott Wave count shows a corrective ABC pattern as the decline consists of three waves. Wave A extended from 10754 to 10007 (-6.9%), Wave B from 10571 to 9852 and Wave C from 10571 to 9852 (-6.8%). Wave A is often equal to Wave C and both declined around 6.85%.

The relative strength index (RSI) also argues for the correction theory as it sports a large bullish divergence. While the Dow moved below its March low, the RSI held above its March low and above the oversold level (30). This shows that downside momentum on the current decline (10571 to 9852) was less than downside momentum on the prior decline (10754 to 10007). Less downside momentum translates into less selling pressure and traders should be on guard for a bullish reversal.

The lower high (10571) and lower low (9852) make the trend technically bearish. However, the ABC pattern, the 50% retracement, and bullish divergence in the RSI suggest that this is just a correction. This pattern could even be viewed as a sharp advance and large falling flag. A move above the upper trendline and prior high (10571) would signal a continuation higher and project further strength above 11000.

Arthur Hill

Arthur Hill is currently editor of TDTrader.com, a website specializing in trading strategies, sector/industry specific breadth stats and overall technical analysis. He passed the Society of Technical Analysts (STA London) diploma exam with distinction is a Certified Financial Technician (CFTe). Prior to TD Trader, he was the Chief Technical Analyst for Stockcharts.com and the main contributor to the ChartSchool.

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