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The markets are moving upward once again with the Dow Jones Industrial Average ($INDU) in record territory, along with both the Dow Jones Transportation Average ($DTX) and Utilities Average ($DUX). This traditional Dow Theory confirmation coincides with an S&P 500 Index approaching new highs. The S&P 500 cash contract (SPX) closed just below 1510 on Monday, within striking distance of the previous high of 1517.68 in August 2000. Given the current uptrend for SPX it seems likely it will reach the milestone, but what next?

Traders need to assess market conditions so they can establish positions that are consistent with the existing environment and continually manage their risk. This analysis provides one current view of the markets using major equity indices and considers what may be next based upon trends that are in place. It identifies what one would expect if conditions remain intact and is not predictive.

Assessment Approach

A review of indicators and cycles similar to those reviewed in February will be completed for INDU, SPX and the Nasdaq 100 (NDX) since these tools worked well monitoring conditions in March and April. When conditions change, other tools may be required. A review of equity sector strength will be completed next week.

The monthly and weekly charts for the major indices include linear regression channels, a standard and modified trend indicator, cycle analysis, a leading Stochastic oscillator and a Moving Average Convergence Divergence [MACD] indicator, which has both lagging and leading characteristics. Although each combination of chart settings reviewed for the assessment is not displayed here, they can be found at the end of the article.

The S&P 500

Figure 1 shows a monthly line chart for SPX dated 5/7/07 using standard arithmetic scaling, a 46-month (3/31/2003 – 12/31/2006) linear regression channel extended to the right; 24-month, 9-month and 40 week time cycles; a modified ADX line and an S&P 100 Index (OEX) overlay. The initial analysis in February was performed right after the peak highlighted by the yellow circle. This is mentioned because although the late February decline was severe, the index used the middle regression line as a support area for the pullout. The longer-term upward trend remained intact.  

The SPX is once again moving toward the upper regression line; the modified, shorter term ADX indicator suggests the trend will remain in place. Using the standard ADX setting, the indicator is just moving above 25, also suggesting a trending phase. MACD remains bullish with both lines moving upward and the histogram in positive territory.  

The SPX is moderately outperforming the OEX [use a Relative Strength Comparison line for a better view, when needed]. No cycle lows are due to occur until Oct 2007. This doesn’t mean a new low can’t be put in place before that time [see April 2005] or that a low will occur in Oct 2007; it’s simply a comment on the timing of the next cycle period.  

Figure 1:  Monthly SPX Chart with OEX Overlay, ADX (9) and MACD (6, 13, 4) Indicators  

Given the bullish environment for the index and the fact that record territory remains within the upper channel line, it seems likely the index will continue towards this line in the short-term. A move above the upward channel line that is confirmed by continued strong movement in ADX and MACD would be very bullish for the index. Weakness in the indicators would favor a move back towards the middle regression line.  

Figure 2 displays a weekly arithmetic line chart for SPX with the same 40-week cycle and regression channel. The MACD [6, 13, and 4 periods] is accompanied by a Stochastic oscillator that also displays bullish and bearish regions. Although the regression channel uses the same beginning and end date, it is drawn slightly differently than the monthly view because intra-month closing values differ from monthly closing values.

The weekly chart confirms the short-term bullish view for the SPX, with the index currently above the upper channel line with strong MACD and Stochastic readings. It’s interesting to note that during the Feb-Mar decline the index used the middle regression line as support while the Stochastic indicator remained in a bullish zone. Shortly after the index proceeded upward, the MACD histogram turned positive.  


Figure 2: Weekly SPX Chart with OEX Overlay, MACD (6, 13, 4) and Stochastics (12, 5, 5)

The strong MACD and ADX movement, along with index movement in the upper region of the regression channel all support continued upward movement for the SPX on a long-term basis. Since the index level is flattening as it nears the upper channel line, a move back to the central line is likely in the next couple of months. MACD and ADX movement should be monitored with any potential retracement with continued strength in each suggesting a move back to the upper channel.

The ADX is currently at 36.4. Continued strength of the indicator with movement above 40, combined with MACD strength could occur with a renewed move in the index toward the upper channel line (in place of a retracement). Such a breakout would be extremely bullish for the long-term.

The Dow Jones Industrial Average

Figure 3 is a monthly line chart for SPX dated 5/7/07 using standard arithmetic scaling, 12.5 year (6/30/1994 – 12/31/2006) and 3.5 year (9/30/2003 – 3/31/2007) linear regression channels extended to the right; 4 year and 9-month time cycles; a modified ADX line and an S&P 100 Index (OEX) overlay.  


Figure 3 Monthly INDU Chart with OEX Overlay, ADX (9) and MACD (6, 13, 4) Indicators

The Feb 2007 pullback was short of both middle regression lines, with May 2007 levels pushing above the shorter-term channel. This was accomplished with the ADX indicating an intact trend [the default setting of 14 moved above 25 in May] and MACD strength. On a longer term basis, it is expected INDU will continued towards the longer-term upper regression channel. Since a straight move towards this line is unlikely, the shorter-term weekly chart may provide more insight at this time.

The weekly chart for INDU displays a double bottom touch of the middle regression channel [longer-term channel] with the Feb decline. The index moved above the shorter-term upper channel in late April, accompanied by an upward turning ADX [standard setting], and strength in both the MACD and Stochastic indicators. Although the index is short-term bullish, a straight shot to 15,000+ [the upper regression channel line] is unlikely.


Figure 4 Weekly INDU Chart with OEX Overlay, MACD (6, 13, 4) and Stochastics (12, 5, 5)

Index and indicator action should be monitored as the INDU moves towards the upper regression line. Renewed strength in the indicators as it approaches the channel line suggests a successful push through the upper channel is possible. Weakness in the indicators prior to, or at this point, suggest a move back toward the middle regression channel.

The Nasdaq 100 Index

Figure 5 is a monthly line chart for NDX dated 5/9/07 using standard arithmetic scaling, a 49-month (3/31/2003 – 3/31/2007) linear regression channel extended to the right; 21-month, 9-month and 48-week time cycles; a modified ADX line and an S&P 100 Index (OEX) overlay. The rise in the NDX has been more modest when considering its position relative to the long-term upper channel or when viewing a Relative Strength Comparison versus the OEX. Regardless, the NDX also continues its upward move, using the middle regression channel as support in the Feb-Mar decline.


Figure 5 Monthly NDX Chart with OEX Overlay, ADX (14) and MACD (6, 13, 4) Indicators

The standard ADX line for the monthly chart has been rising since late 2006, but remains below 20 [approximately 17], so the index is not considered to be in a strong, long-term trending period. The modified, faster setting suggests a trending period was initiated in late 2006, with readings above 20. Both settings will be monitored. The Stochastic indicator is bullish with the oscillator remaining in bullish territory in Sep 2006. The index is expected to continue its rise towards the upper regression channel line.


Figure 6: Weekly NDX Chart with OEX Overlay, ADX (14) and MACD (6, 13, 4)

The weekly chart confirms the short-term bullish view for the NDX. Figure 6 displays the weekly view for the NDX chart using all of the same settings. Both the standard and modified ADX settings indicate the start of a new trending period in early April. This coincides with the movement of the Stochastic oscillator back into a bullish region. The indicator remains bullish and the NDX is also expected to continue its movement toward the upper regression channel line.

Next week, we’ll explore the lagging nature of strength in this heavily technology-laden index.

Clare White, CMT
Contributing Writer and Options Strategist
Optionetics.com ~ Your Options Education Site
To see the other articles by this author, please click here.

SPX Chart Settings:

1. Logarithmic and standard arithmetic settings,
2. A linear regression channel of approximately 4 years,
3. The Average Directional Indicator standard setting of 14 periods and a modified, faster setting of 9 periods for trend review,
4. 24 month, 9 month and 40 week cycle review,
5. Momentum assessment using a fast Stochastic with settings at 12, 5 and 5,
6. Additional horizontal lines incorporated into the Stochastics oscillator to reflect potential bullish zones (40 & 80) and bearish zones (25 & 65) [see “Stochastic Ranges” Technical Toolbox Articles from June 2005 for Connie Brown technique],
7. A fast Moving Average Convergence Divergence (MACD) with settings at 6, 13 and 4, and
8. An S&P 100 (OEX) overlay chart.

INDU Chart Settings:

1. Logarithmic and non-logarithmic settings,
2. Linear regression channels of approximately 12.5 years and 3.5 years,
3. The Average Directional Indicator standard setting of 14 periods and a modified, faster setting of 9 periods for trend review,
4. 4 year and 9 month cycle review,
5. Momentum assessment using a fast Stochastic with settings at 12, 5 and 5,
6. Additional horizontal lines incorporated into the Stochastics oscillator to reflect potential bullish zones (40 & 80) and bearish zones (25 & 65) [see “Stochastic Ranges” Technical Toolbox Articles from June 2005 for Connie Brown technique],
7. A fast Moving Average Convergence Divergence (MACD) with settings at 6, 13 and 4, and
8. An S&P 100 (OEX) overlay chart.

NDX Chart Settings:

1. Logarithmic and non-logarithmic settings,
2. A linear regression channel of approximately 4 years (revised),
3. The Average Directional Indicator standard setting of 14 periods and a modified, faster setting of 9 periods for trend review,
4. 21 month, 9 month and 48-week cycle review,
5. Momentum assessment using a fast Stochastic with settings at 12, 5 and 5,
6. Additional horizontal lines incorporated into the Stochastics oscillator to reflect potential bullish zones (40 & 80) and bearish zones (25 & 65) [see “Stochastic Ranges” Technical Toolbox Articles from June 2005 for Connie Brown technique],
7. A fast Moving Average Convergence Divergence (MACD) with settings at 6, 13 and 4, and
8. An S&P 100 (OEX) overlay chart.

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