In my June 25th article “Why June/July Could Be a Smaller Version of October 1987”, I stated that a decisive break below both the Dow Jones Industrial Average (DJIA) and the German DAX (DAX) 200 day simple moving average (SMA) could release selling pressure.
As it turns out, the DAX found support right at the 200 day SMA and the DJIA only had a marginal break. This support triggered a sharp rally in both indices. Evidence suggests the rally maybe short-lived.
DJIA and DAX
Please see the illustrated daily chart of the DJIA in Figure 1. And the illustrated daily chart of the DAX in Figure 2.
The 200 day SMA is very important because many fund managers make trading decisions based on its position. Also within recent trading history breaks below the 200 day SMA have been rare. From late 2011 to June 2015 the DJIA had only five moves below the 200 day SMA and the index didn’t stay below the line for very long.
That both the DJIA and DAX found support at the line in 2015 is further proof that fund managers are paying attention to this important indicator.
After July 7th both the DJIA and DAX had sharp rallies that ran out of steam at chart resistance. This is the first clue of what could be a very sharp and deep decline in the coming weeks.
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My June 25th article also made note of the very weak momentum in the US stock indices.
For several months the number of stocks reaching 52 week highs have not confirmed new highs made in the US stock indices. In July, the momentum situation has deteriorated further with only the Nasdaq composite able to make a new 2015 peak.
The biggest sign of momentum weakness has come from China in the form of a stock market crash. All over the world, less and less individual stocks are participating in up trends. It’s only a matter of time before even the strongest stock indexes buckle- perhaps in a very sharp decline.
The 200 day SMA is the key indicator to watch. So far the DAX, and in the US the S&P 500 (SPX) are holding above their respective 200 day SMA lines. If in the next few weeks both these indices break below the bottoms made on July 7th it could cause fund managers to panic and sell a lot of stocks very quickly. A panic could bring the DJIA, DAX and SPX in just a few days, to major support at the October 2014 bottom.
Be vigilant, on July 28th the DJIA, SPX, and DAX all had rallies over 1%, if this rally can continue for the next few days it maybe the last chance to take defensive action.
The time to get defensive is while the major stock indices are trading above the 200 day SMA. If one day soon, you wake up and hear the DJIA opens down a 1,000 points it will be too late.