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Market Indicator for the Week Ahead
October 24, 2011
The Dow and the Trading Range



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The Dow Breaks Both Ends of Its Trading Range



dowjones

Blue-chip Dow Jones index is on a tear - Armageddon looks as if it will be postponed again — or so Wall Street must think.

The blue-chip index rose for a fourth straight week, boosted by a strong rally Friday as money poured in despite uncertainty over Europe's plan to contain its government-debt crisis.

The Index jumped 267.01 points, or 2.3%, to 11,808.79, the index's highest closing level since Aug. 3. It gained 1.4% for the week.

Although many investors feared that October would bring another market bust, the opposite has happened: After diving to one-year lows Oct. 3, stocks have mostly moved higher since, although trading has remained volatile.

The DJIA is up 8.2% this month, and is up 1,153 points, or 10.8%, from the Oct. 3 low.

Range-bound

From late July into the early weeks of August, the Dow Jones Industrial Average (DJIA) fell more than 15%. Since that collapse, we've been trading in a pretty tight range. You can see in the chart below that the Index broke the lower end of that range in the first few days of October, and then quickly rebounded and broke the top end of the range. With the index making new medium-term lows before swiftly rebounding to new medium-term highs, it seems that this might signal an imminent breakout to higher levels -- or perhaps it just indicates a more volatile range!

Dow 1



Previous Instances of Range-bound Fluctuation

By looking at previous occasions where the Index touched a two-month low, and then, within two weeks, made a two-month high, the most recent signal actually happened just about a week ago, on Oct. 21. The chart below shows all occurrences since 1995, as indicated by the red dots. From a longer-term perspective, it looks to be a pretty bullish development after those past few instances. At least, there weren't any sustained downtrends after those signals.

Dow 2



This is the 18th such signal since 1950. Below are some tables showing Dow returns after one of these signals, as well as typical returns for comparison. It's encouraging to see that these occurrences generate relatively bullish returns. Across all time frames, the average returns are better after a signal, with a higher positive percentage. One concern is that the big moves to the bottom and top of the range might be indicating some upcoming volatility. However, when you look at the standard deviation of returns, they fall right in line with typical standard deviations.

Dow 3



The Dow Jones Performance in Oct–Dec Over the Past 5 Years

From the below graph, it may be observed that the Index Industrials have performed relatively well during the fourth quarter of the previous 5 years, returning an average of 7.13%. 2007 and 2008 were an exception though, with the index falling quite sharply during the latter year (2008) largely due to

panic selling across the markets as the global financial crisis started to gather momentum during this period.

Dow 4



However, judging by the movement since the previous two Q4’s coupled with expectations that US economy is showing signs of improvement and EU leaders are stepping up their rhetoric to curb debt crisis, the Dow could recoup its Q3 slide and end on a stronger note this quarter.

Conclusion

The ongoing pattern of abrupt market moves suggested that activity remains dominated by short-term players.

On Monday, the Dow had tumbled 247 points, or 2.1% which spells trading money that is zooming into the market now.

But those buyers could continue to pour in if the October advance holds up: Momentum feeds on itself, and even if traders think the rally is good for just another 10%, that's 10% they don't want to miss.

Also, portfolio managers who are lagging key market indexes will face pressure to hop into stocks if the rally persists, hoping to improve their performance for 2011.

What's more, Wall Street knows that November and December historically have been strong months for the market, as investors look ahead to the New Year.

Since 1950, November and December have been the best two-month period of the year for the S&P 500 index, according to the Stock Trader's Almanac. The index's average gain has been 1.5% in November and 1.7% in December.

Year to date the Dow is up 2%.

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