The DJIA Index

The Smart Profits Report: Issue #415
Wednesday, April 25, 2007

The DJIA Index: As The Dow Goes 14 For 16, Beware The Momentum Indicator Warning Signs
By D. R. Barton, Jr.
Quantitative Analyst, Mt. Vernon Research

On Monday, the Dow Jones Industrial Average or DJIA Index dropped 42 points. It was just the second time in 16 trading sessions that the index finished down.

With the DJIA Index making new all-time highs and the other major indexes (S&P 500, Nasdaq and Russell 2000) all peaking above their February highs, the market is on a real tear.

So what’s not to like?

Actually, there are several momentum indicators and chart patterns that are throwing up warning signs here. And while these aren’t strong enough to imply that you should jump off the bullish bandwagon completely, they do call for a few days of caution. Let’s see why…

The DJIA Index: A Trio Of Warnings

The "Tick Index" Just Raced Higher: The Tick Index is a very short-term indicator that is based on an easy measurement: The number of stocks trading on an uptick minus the number trading on a downtick.
The Tick index tells us whether traders are taking the offer or hitting the bid - and the magnitude of buying or selling strength. High numbers mean investors are buying many individual stocks at the offer at any given moment. Conversely, large negative numbers mean sellers are willing to sell at the bid price. And last Friday, we saw the highest closing tick since mid-March (>1300) and another big intraday tick reading. Both point to a market that has reached the "frothy" level.

Markets Are Overbought On Most Momentum Indicators: When a market moves upward this strong and this fast, it’s not unusual that it will show up as overbought on the momentum indicators. That’s exactly what we’re seeing now in the Relative Strength Index, stochastics, plus others. I’ve illustrated this for you on the Dow Industrials chart in the Chart of the Week section below.

The Russell 2000 And Nasdaq Are Not As Strong As The DJIA Index: While the DJIA Index has powered to new all-time highs, the Russell 2000 (the proxy for small-cap stocks) and the Nasdaq have just barely exceeded their February highs. This tepid response to the recent three-week rally is important. Ever since the stock market’s strong run, beginning in July 2006, these two indexes have performed the best. But to have them both make a muted response to the Dow’s recent big surge is a clear warning sign.

What Goes Up Must Come Down

There’s no doubt that the stock market has proven to be exceptionally resilient over the past four-and-a-half years. But even strongest markets like the DJIA Index need to take a breather sometimes.

As my good friend and business partner Christopher Castroviejo says, "A high jumper needs to flex his or her knees in order to jump higher. And the current signs point to the need for at least a short-term flex down for this high jumper of a market."

Great trading,

D. R. Barton, Jr.

Today’s Smart Profits Cribsheet

The Dow Jones Industrials quickly shook off Monday’s decline and resumed their torrid pace yesterday, with the index rising 34.5 points to 12,953.94 at the close. Good news from both Dupont (NYSE: DD) helped propel the index forward after the company reported a 16% jump in first-quarter profits. IBM (NYSE: IBM) also cheered investors by saying it will boost its quarterly dividend payment by one-third ($0.10) and will kick its buyback plan into high gear by buying $15 billion worth more shares. This sent IBM shares up $3.28 (3.4%) and accounted for 26 points of the Dow’s 34-point up move.

Elsewhere, a 15-year water rights dispute in Montana is finally over. The Montana Reserved Water Rights Compact Commission and USDA Forest Service were haggling over the ownership of federal water rights on national forest land. But while this proves that federal and state authorities can resolve water rights disputes, many other states aren’t so lucky. In fact, in New Mexico alone, over half the state is locked in legal battles over water rights. The story is the same across the entire southwestern U.S. To read more about how this opens up some explosive investment opportunities - and the company perfected poised to take advantage by closing a deal worth $408 million, and a 102,000% return on its capital, follow this link.

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The Chart Of The Week

This six-month chart of the Dow Jones Industrial Average (.DJI) shows two interesting items.

First, we see what could be shaping up as a classic "prairie dog top." This is where the market makes a new high and then drops quickly lower, just like a prairie dog sticking its head out of its hole and then jumping back down.

Secondly, we can see that the stochastics are clearly showing overbought conditions that is ripe for a correction.