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Summary: A look at two historic Dow Jones Industrial Average charts may help us differentiate between a minor correction or the start of a more profound sell-off in equities.
The ongoing sell-off in equities has seen the benchmark US indices lose hold of key long-term support levels even as some investors continue to insist that it's just another buying opportunity. Is this time really so different, one wonders, or is history preparing to repeat itself?
Let's take a look at two near-identical chart patterns representing the same instrument at two different points in time.
Zooming in on Chart 1, we see a double top formation with an 11% correction between tops and a bounce off the 55-week moving average. We massive Relative Strength Index divergence with the second top slightly higher than the first; this top is followed by a selloff to the 55-week MA.
Now let's look at Chart 2. Here, we another double top with a 12% correction betweemn the tops close to the 55-day MA; RSI shows massive divergence. Again, the second top is slightly higher than the first and this top is followed by a selloff to the 55-week MA.
The biggest difference between Charts 1 and 2 is the time between tops.
Look at Chart 1 again – this time, we will zoom out a little.
This is a weekly chart of the Dow Jones Industrial Average index, the oldest stock index in the world.
Here we see that the second top was slightly higher than the first, and in fact marked the index's all-time high in early October 2007. Thereafter, the index dropped to test the 55-week MA before recovering into December (a short Santa Claus rally).
Bears regained control around year-end, taking the DJI Index below the 55-week MA. In Q1'08, it was close to the 200-week MA. The rest, as they say, is history – the history of the Great Financial Crisis, that is.
Memory is a funny thing. You might say, “yeah, but that was the Financial Crisis – things are different now”. But the fact is that the double top shown above occurred before the crisis. In 2007, no one expected a bear market to unfold as it did in 2008. 'Crisis' wasn’t even a term in discussion at the end of 2007!
The chart below is Chart 2, zoomed out. It's the same index as above, the Dow Jones Industrial Average Index, and this also a weekly chart: it's just a different period in time.
This chart is for the 2016-now period.
The second top is currently the all-time high recorded in early October, just slightly above the previous top. The index, meanwhile, is currently trading around the 55-week MA.
What will happen next?
If history repeats itself, we should see a couple more weeks' worth of choppy markets and a short uptrend going into December before next sell-off hits, taking the market down close to the 200-week MA in Q1'19.
Maybe it really is different this time... but it usually isn't. This is, at least, something worth considering before dismissing the current sell-off as a mere buying opportunity.
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