Battle of Two Patterns

For the past few months, Dow Jones Industrial Average is not giving clear signals which direction it will go. This confusion is due to the uncertainty created by many current and future events around the world. European financial crisis is going strong and the policy makers are not able to devise a cohesive strategy to deal with it. The upcoming presidential election in the US has generally paralyzed American politicians and the gridlock in the US Congress is preventing to meaningfully address the upcoming fiscal cliff by the end of the year – when expiring tax cuts and sequestered spending cuts will cripple the US economy. Chinese economy is faltering and it is not clear if her leaders will come out with a stimulus or if they can do anything to jump start the economy. All of this has created an ambiguity that is reflected in DJIA’s chart.

From early March to mid-May, DJIA traded within a horizontal channel bounded by an upper limit of 13340 and a lower limit of 12710. The eventual break out was on the downside with a targeted move near 12100, which it reached in early June.

Since then the index is trading in an upward sloping flag. This is a bearish pattern. The beginning of the pattern was roughly at the 50% retracement of the move up from last October to May. The flag is shown by the blue lines in the chart.

For this pattern to complete, DJIA has to break below the lower trend line convincingly. If that happens then it may go down 1300 points – the fall from May high of 13338 to June low of 12035 – from the previous high point.

However, the DJIA is not so simple. Since middle of June it is in a horizontal trading channel (see red lines in the chart). The upper limit is around 12960 and the lower limit is around 12450. Within this pattern it is making higher lows and higher highs but not by much. Currently DJIA is knocking at the upper limit with a breach by today’s price action. If this breakout sustains then the targeted move may take the index to 13400.

So Doc, what is it going to be? Will the bearish downward sloping flag prevail and Dow will sink below 12000 or will the upward breakout of the horizontal channel prevail and Dow will fly towards 13400?

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