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STOCHASTIC OSCILL


Dow Jones Basic Materials Hits Support

07/30/07 10:07:00 AM
by Arthur Hill

The Dow Jones Basic Materials Index led the market lower last week, but traders should be on guard for a bounce as the index is now oversold and at support.

Security:   $DJUSBM
Position:   N/A

On the daily chart (Figure 1), the Dow Jones Basic Materials Index ($DJUSBM) declined around 6% in the last six days and has become oversold for the first time since March. My oversold assessment is based on the stochastic oscillator, which moved below 20 for the first time since March. The index also suffered a sharp decline in late February and bottomed in the first half of March. The indicator should be considered both oversold and bearish as long as it remains below its signal line (magenta line). The signal line is called %D and it represents a three-period exponential moving average (EMA) of the stochastic oscillator, which is called %K. A break above %D would signal the first upturn in the indicator.

FIGURE 1: DJ BASIC MATERIALS, DAILY. The index declined around 6% the last six days and has become oversold for the first time since March.
Graphic provided by: Telechart 2007.
 
In addition to being oversold, the index is trading near a support zone that extends back to early May. DJUSBM bounced off support at 270 at least four times in the last three months and the index is once again testing this support level. A break below this support zone would forge a lower low and reverse the medium-term uptrend. For now, the support zone is holding and traders should prepare for an oversold bounce.

While an oversold bounce is possible at support, I am turning to the 60-minute chart for some evidence of strength and a short-term breakout (Figure 2). The index is clearly trending lower on this chart and remains below the trendline extending down from July 24. In addition, the stochastic oscillator is fluctuating between zero and 20, which is oversold territory. I am looking for a breakout in both the stochastic oscillator and the price. A move above 277 would break the trendline, forge a higher high, and reverse the downtrend on the price chart. I would also confirm this with a momentum breakout in the stochastic oscillator. The indicator hit resistance at 45 last week and a move back above 50 would turn short-term momentum bullish.

FIGURE 2: DJ BASIC MATERIALS, 60-MINUTE. Some evidence of strength and a short-term breakout can be seen.
Graphic provided by: Telechart 2007.
 
The initial upside target would be broken support around 285. On the 60-minute chart, the index broke support at 285 last week (red circle). This area now turns into resistance and an upside target zone. On the daily chart, this target area also corresponds with resistance from the June highs. The index was turned back at this level in early and mid-June.



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.

Title: Editor
Company: TDTrader.com
Address: Willem Geetsstraat 17
Mechelen, B2800
Phone # for sales: 3215345465
Website: www.tdtrader.com
E-mail address: arthurh@tdtrader.com

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