The DJIA Bear Market Continues

05/28/08 09:24:43 AM

by Alan R. Northam

Now that the market rally off the mid-March lows is complete, the DJIA bear market continues.

Security: $DJIA
Position: N/A

The Dow Jones Industrial Average (DJIA) made a major market top in October 2007. Since then, the DJIA has traded in the downward direction in five waves (1, 2, 3, 4, and 5). These five waves obey the Elliott wave rules for an impulsive wave, which state that waves 1 and 4 cannot overlap and wave 3 cannot be the shortest. In his writings, R.N. Elliott, who studied market waves more than 70 years ago, states that an impulse wave then defines the major direction of the market that in the case of the DJIA is down. These five waves also form wave (1) down of a much larger five-wave impulsive wave.

According to Elliott, after a five-wave move the market will undergo a market correction to correct for this move. Since March 2008, the DJIA has been trading in an upward corrective direction. This upward move is known as a bear market rally. This rally now looks to be complete and completes wave (2) of a five-wave impulse wave down. If wave (2) down is complete, then wave (3) down is now under way. Third waves are typically the longest wave and are normally 1.618 times the length of wave 1. This would then put the completion of wave (3) down somewhere around 9500 for the DJIA.

FIGURE 1: DJIA, DAILY. Daily closing price chart of the DJIA showing the Elliott Wave count, 50-day moving average and the 200-day moving average. The MACD is also shown below the price chart.

Graphic provided by: StockCharts.com.

Looking at the trading action since the beginning of May of this year, I have identified two and possibly three subwaves and labeled them as waves (i), (ii), and (iii). Subwave (iii) looks to be complete but a few more trading sessions will confirm it. If wave (iii) is complete, then wave (iv) should be unfolding but should now carry above the horizontal red line as fourth waves cannot overlap first waves. Once wave (iv) is complete, then wave (v) should unfold and once completed all five subwaves will then make up wave 1 down. Waves 1, 2, 3, 4, and 5 should then make up wave (3) down, which should be complete at or around 9500.

The DJIA has also traded up to its 200-day moving average twice now and both times have bounced off it and moved lower. Thus, the 200-day moving average is acting as strong resistance to the market. Since mid-May, the market has continued to trade lower and has broken through to the downside of its 50-day moving average. I would now expect the market to retest the 50-day moving average, as wave (iv) is completed to see if it is offering a strong line of resistance. If our wave count is correct, then the market should respect the 50-day moving average and bounce off it in the downward direction, as wave (iv) cannot overlap wave (I). Once this test of the 50-day moving average as a strong line of resistance has been proven, the market should then turn much lower.

The moving average convergence/divergence (MACD) oscillator has provided a sell signal by moving below its zero line. This sell signal confirms that the DJIA is now starting to sell off. However, the red signal line has not yet confirmed the sell signal. I would expect to see the signal line cross below zero once wave (iv) is complete and the market starts to move lower again.

In conclusion, it looks like the bear market rally, consisting of wave (2), is now complete and the DJIA bear market continues.

Alan R. Northam

Alan Northam lives in the Dallas, Texas area and as an electronic engineer gave him an analytical mind from which he has developed a thorough knowledge of stock market technical analysis. His abilities to analyze the future direction of the stock market has allowed him to successfully trade of his own portfolio over the last 30 years. Mr. Northam is now retired and trading the stock market full time. You can reach him at inquiry@tradersclassroom.com or by visiting his website at http://www.tradersclassroom.com. You can also follow him on Twitter @TradersClassrm.