After an epic rally, the Dow Jones now sits on the precipice of cracking the 27,000 level. While fundamental traders are desperately tracking trade war developments, technical analysts have their eyes set on a pocket of juicy resistance. This obvious pocket of resistance has all the makings of a death trap for retail investors who may try to short the stock market when it opens next week.
The thing that makes this Dow Jones chart formation so dangerous is how obvious it is. It is a well-known fact that small retail day traders typically try and sell market highs based on basic fundamental analysis. Larger, longer-term money prefers to buy high and sell higher. One thing that attracts novice traders like flies to honey is a pronounced resistance level close to a record high, and that is precisely what the Dow has done in this case.
Where you have lots of retail traders shorting the market, you often have a buildup of market orders or “stops” placed tightly behind the target level. Greedy predator algorithms love to feast on these weak hands. These bots will buy the market higher, clear out the stops, only to run out of steam, and dump the stock market short again with the path of least resistance once more to the downside.
As technical analysis demonstrates a high risk of a whipsaw, the pain for short-sellers could be even worse as they may yet be proven correct. The steepness of the Dow Jones’ rally has it looking vulnerable to even a small piece of bad news after Trump announced his “Phase One” Trade Deal with China. Morgan Stanley recently came out with a “sell the news” call for the stock market, as they believe that fundamentally, the US is in a cyclical decline, with the trade war only a small part of the stock market’s inability to rally over the last year.
When you place the market fundamentals over the technical positioning for the Dow, it becomes apparent that there is only one story line here that matters. If the trade war fades from the headlines, and Trump declares victory before 2020, does this stock market keep heading for 30,000 or does it finally cave and leave a double top and the real bear market begins? No one knows the answer to this question, and that is what has been driving all the volatility over the last few months.
The rally on Friday stopped precisely at 27,000 as Wall Street’s bots bait the hook. It’s prudent to consider that even the most ardent technical analysts only believe it helps with the probability of the success of the trade, and never have absolute trust in the formation. When it comes to trading Dow resistance levels in 2019, it pays to remember that there is no spoon.
This article was edited by Samburaj Das.