The Technical Argument for a Bigger Bull Rally

The Technical Argument for a Bigger Bull Rally
The Technical Argument for a Bigger Bull Rally

Back on June 30, when the Dow Jones Industrial Average was sinking fast toward 9,600, I made the case for a stock market rally to 10,700 on the Dow and 1,150 on the S&P 500. Then on July 19, just after the market dropped precipitously, I reiterated the bullish case based on technical analysis.

In the weeks that followed, the market rose, with the S&P 500 going to 1,120 and the Dow hitting 10,600, then fell back modestly.

Is this the end of the summer rally, or just a standard retrace in an uptrend? Technically, a strong case can be made that it is the latter -- just a typical retrace in a longer bullish trend.

This chart following the daily movement of the Dow may look cluttered, but follow along and it will become clearer: Let's take each bit of technical evidence one at a time.

  • The MACD (moving average convergence-divergence) is rising, and has climbed above the neutral line. This is an unabashedly bullish signal.

  • The stochastic is overbought. It's currently declining, but an overbought market still suggests continued strength in buying.

  • From the early July lows, the market has entered a strong uptrend, carving out higher lows and higher highs.

  • The downtrend from May 1 has been decisively broken by this new uptrend.

  • The 20-day moving average (MA) has crossed bullishly up through the 50-day MA, providing strong evidence that the uptrend is not a flash-in-the-pan.

  • The sharp July16 downdraft held at the key support level of the 20-day moving average.

  • The market broke decisively above the 50-day moving average which had offered strong resistance in May and June.

  • The market has risen above the key technical level of the 200-day moving average. Despite several dips that took it close to falling below this key support, the market rallied every time to close above it. That suggests significant buying is still taking place.

  • A bullish A-B-C-D pattern is being traced.

Technical analysts have long noted that stocks tend to move both up and down in zig-zag patterns which often repeat over time. In a classic A-B-C-D pattern, the first leg (A), whether up or down, is followed by a retrace leg in the opposite direction: the B move. The third (C) leg is another move in the primary trend direction, but it is longer than the A leg. The final step (D) is another retrace in the primary trend.

We see a clear A-B-C-D pattern in the trend down from May 1, and now we can discern a clear A-B-C-D pattern in the move up from the July 2 lows.

If the trend up is strong, then we can expect another A-B-C-D pattern to develop. From this point of view, these four or five days of weakness are a weak countermove or retrace against the primary uptrend, and are to be expected.

To look for evidence of whether the trend is long-term or not, let's refer to the weekly chart of the Dow Jones Industrials.

Here we see that the Dow has regained the key 50-day moving average, a level of support which it penetrated in the May-June weakness. That the Dow has closed decisively above the 10,257 50-day MA is a bullish sign.

The MACD appears to be about to make a bullish cross, and the histogram has been rising for several weeks, adding to the bullish case. The stochastic has been rising strongly off deeply oversold levels.

The targets I mentioned back on June 30 now beckon: 1,150 on the S&P 500 and around 10,700 on the Dow. If the market can surpass those lines of resistance, the path ahead will be clear for it to challenge the April highs around 11,250 on the Dow and 1,220 on the S&P 500.

Originally published