There are a few tried and true leading indicators in the market that many analysts rely on for confirmation of a trend or potential reversal.
There are times however, when those same indicators tell a very different story. This is one of those times.
Today I’m looking at the Dow Jones Transportation average. Since stocks hit their most recent bottom in November, the Transportation average is up almost 20%. Whats more, is that the same index is up 10% in the first three weeks of January.
Can you say “unsustainable move?”
Normally this index is a very good indicator of where the broader indexes are headed in the short and long term. In theory and simplified, if transportation stocks such as shipping companies, airlines and railways are doing well, it would make sense that the demand for goods is rising and profits are to follow.
That’s all well and good.
There are other times when the reason for a strong move in a sector is more due to speculation and the anticipation of expansion rather than hard facts. Again, this appears to be one of the those times. Unfortunately for many investors, this type of move usually ends with a let down followed by a deer in the headlights look.
Let’s take a look at some logic and good old fashion probability analysis.
First up, the daily chart of the Dow Jones Transportation Average.
Below you see a one year chart with two sets of blue lines. These lines are the first reason we started watching the chart and are on guard for a reversal to take place.
What you see here is a pair of “rising wedge” patterns. You know the phrase “what goes up must come down.” This would be a good example, and if pictures are worth a thousand words, then how much is this chart worth?
On the left side, the smaller set of two blue lines go up uncontrollably for several trading days. Then what seems like out of the blue, as soon as the price drops below the lower line, it proceeds to retrace the entire up move, and them some.
Now take a look at the larger set of blue lines on the right side of the chart. Do you see anything similar? The index has been up 14 out of the last 16 trading days with no end in sight.
This is precisely the type of move that ends without notice and catches everyone by surprise. These wedges are normally broken and retraced around the time everyone is close the maximum bullish sentiment. That would be right about now, give or take a few days.
To confirm our findings, we like to dig a little deeper. Let’s take a look at a longer term chart and see what we find.
Same index on a weekly basis looks like this:
What we have here is a different picture that tells a similar story.
You may have heard me mention before that markets are symmetrical.
Markets tend to move in waves, or similar patterns over time. Beginning in the third quarter of 2011, the transportation average moved up for about five months, then decided to trend sideways to down for the following eight or nine months. You can see that unsustainable move upward I spoke about earlier over the last three months.
If symmetry holds true again, we should be getting closer to the end, rather than a new bull market.
The longer term charts are not used for trading purposes, but more to validate our findings that lead to a nice juicy trade set up.
Our subscribers should soon expect some trade alerts based on stocks within the transportation average that have the best risk reward ratio and a highest percentage chance of success.