Futures Trading Charts: Dow 14460 Is Gone-What's Next

Extracted from Oct 03, 2006, Market Update

Futures Trading Charts: Why Dow 14460 Was Hit Years Ago

This was a simple exercise that took a lot of time and effort to accomplish. We adjusted the price of the Dow from Oct 1999 on a quarterly basis to reflect dollar strength or weakness. In other words, the Dow was re-priced by where the dollar was trading in each of those quarterly periods. As the saying goes, “a picture is worth a thousand words”, so that’s precisely where we will begin this analysis.

As the dollar index is currently trading around the 85 mark, we will use this figure to base all our calculations. We have also plotted a chart of the Dollar on a quarterly basis starting from Oct 1999. Each point on the Dow and Dollar charts represents the highest reading for that quarter.

Look closely at the charts.

If one looks closely at both charts, there is one colossal pattern that emerges; the Dollar and the Dow tend to trend in the same direction, and usually, the Dollar leads. Several other factors come rushing out also. First of all, is that the Jan 2000 high was not the real high. The Dow put in 3 higher highs before it started to correct (we expand on this soon). The current high of 11865 plus is not a new 52-week high; in fact, we have traded way past this mark in each of the last three quarters. On Jan 06, the high was 12081; in the 2^nd quarter, beginning on April 06, the high was 12318; and in the next quarter (July 06) the high was 12010. Hence in each of these three last periods, the Dow traded much higher than this so-called new 52-week and an all-time illusory new high. This year’s actual 52-week high occurred in the 2^nd quarter.

Futures Trading Charts: Currency charts Yield valuable data

All this can be explained with four words “Currency Strength or Weakness”. For example, when the Dow put its so-called high back on Jan 00, the dollar index was trading at 105. Since we are using 85 as the starting point for all our calculations, the dollar in Jan 2000 was trading almost 20% higher than it is today. Hence the true value of the Dow in Jan 2000 priced in 2006 dollars is 14100. This same calculation was performed on each piece of quarterly data.

We are not going to go into details about the currency workings (this is something that is reserved for our subscribers). However, those who can fathom the inner workings of the currency markets have a huge trading advantage over those who do not (the majority falls under the latter category). Note that in reality, the True high did not occur in Jan 2000; the Dow went on to put on several new highs, one in April 2000 (14167), another in July 2000(14524), and the all-time high occurred 15 months later in April of 2001. In April 2001, the Dow traded at 14660 when priced in today’s dollars. You ask how this is possible. Well, that’s where currencies come into play.

USD Futures Trading Charts Provide Valuable Clues

Take a look at the second graph of the US dollar. In Jan 2000, the index was at 105, and while the market started to correct, the dollar continued to rally. So the dollar was appreciating faster than the market was declining. The two graphs clearly illustrate this relationship. Hence on April 01, the dollar was trading in the 120 range or roughly 15% higher than it was trading in Jan 2000 (105).

One can see that, in reality, most bears were right when they were screaming out in the past that the Dow was mounting what appeared to be a bear rally. However, being right does not mean that one can always make money. One has to be right and also rightly positioned to make money. The bulls were and are still actually wrong, but for the time being, they are the ones making money.

When it comes to the market only one select group of individuals wins all the time. These individuals are neither bears nor bulls; they are wise traders who understand that sometimes one has to be bullish, sometimes one has to be bearish, and sometimes one has just to shut up and sit on the sidelines, waiting for an opportunity to present itself. It’s not what you don’t know that causes the most pain it’s what you think you know that usually causes the most damage.

Conclusion

One notices immediately that there appears to be a pattern between the Dollar and the Dow in that they tend to trade in the same direction generally. One also notices that the Dollar has corrected considerably in the last seven years and it has hardly mounted a strong rally in that period. One also notices that the high the Dow set on April 06 is higher than that set today. Even though the Dow is still in a bear market, all bear markets mount solid rallies in between, and these rallies can be so strong that they can fool even the strongest of bears. The problem is that a plunging dollar has cleverly disguised this bear market.

Since the Dow appears to be mounting a solid rally in what seems to be taking place in the context of a long-term bear market, one could conclude that the Dow technically could trade much higher and still be in a bear market. The currency markets will be the key to determining the length of this rally. One has to understand how these markets work and also be in a position to somewhat predict their direction for the next 6-12 months. In this instance, it’s the direction of the U.S dollar that will be key in possibly determining what the Dow will or will not do. As stated before, this is something that we usually reserve for our subscribers. Also, it would take too much time to go over it here; a separate essay would be needed.

A declining dollar bodes well for the markets

Thus a declining dollar does not bode well for the markets in the long run; in the short-term time frames, the negative impact might not be huge, but the long-term pattern can be seen in the above charts. Every serious bear market has always experienced some sort of relatively strong relief rally, and this has not yet taken place with the dollar. Hence it’s possible that this could still occur. If this were to take place, then it means that the markets could go on to put in a series of illusory new highs. We will examine the possible reasons, if any, for a dollar rally next week and new support and resistance points for the Dow based on the adjusted value of the Dow and not its current new value.

Bottom line

The next few months will be packed with extreme volatility; expect the volatility to increase by a factor of 2 to 3, so if you think the last nine months have been volatile, wait till you see what the next nine months could bring in. These markets are great for playing the indices via options or futures, which is what we have been doing via the issuance of higher-risk plays.

Two other positive factors from the Dow chart. Note that it has broken its long-term downtrend line, and it’s still trading above the primary uptrend line. Under perfect conditions, it would not be inconceivable for the Dow to trade close to its all-time high before resuming its downward trend. Conditions are perfect, but 900-1200 points would not be out of the question if the dollar had to stabilize.

Final note

We see no reason to celebrate this so-called new high that the Dow put in this week. We were expecting this and warned our subscribers that the coming highs would be nothing but illusory highs. While the penguins on Wall Street are flapping their flippers and expanding their lungs to scream about this all-time new high, get some popcorn to find a comfortable seat and watch this new reality comic show unfold. There is an old saying once an idiot, always an idiot.

It takes 50000 nuts to put a car together, but only one to scatter them all over the road.
Darryl Somers