By: Steve Smith
Technical analyst extraordinaire Chris Kimble has been tracking a megaphone pattern that has been developing in the Dow Jones Industrial Average since November. From a market watch standpoint, his insights are invaluable.
He now says we’ve reached a critical juncture which presents a major test for the stock market. Let’s review where we stand.
Back in November, he looked at the long-term historical chart of the Dow Jones Industrial Average and pointed out a megaphone pattern breakout that looked bullish for stocks.
After that post, the Dow Industrials rose over 3000 points into January, before embarking on a long overdue correction.
So what does our market watch indicate now? Let’s take a look at an updated chart below.
The Dow has spent the majority of the past 70 years inside parallel channels (points A, B, and C). And as you can see below, the Dow’s latest breakout above a megaphone pattern (point 3) has lead to a test of the upper channel (point 4). This is acting as resistance right now.
Look familiar? It should. This same pattern took shape during the last megaphone breakout (point 1). That breakout lead to a test of the overhead parallel channel (point 2) in 1987. That channel acted as (rising) price resistance until 1995, when it broke out once more and went on to test the upper channel boundary.
If this is any indication, its understandable why stocks are stumbling a bit here (at first pass). BUT, if they follow the same pattern, they may continue to test this rising channel resistance… and clearly bulls would LOVE to see the Dow breakout above point 4!
For my money I think the market moves lower, back to the trendline labeled (3) or even into the light blue shaded region.
This has me looking to buy put spreads on the DIA.
The trade I’m targeting is the March 250/245 Put spread for a $1.50 net debit. This gives me a chance to make $$3.50 or 230% if the Dow retreats a mere 2% over the next few weeks.
Here is the risk graph for the trade.
Related: Is High Volatility the New Normal?