The market has been moving sideways for the past few weeks. Action in DIA has been confined inside a 1.5% flat channel for the past 17 days, something that has never occurred before. Confinment inside a 2% channel has occured twice in 2005 and once in 2004, during hot summer months. As the charts show, this action was followed by 4 months of sideways and volatile motion. Although the sample is very small and any inferences made from it not statistically significant, nevertheless it may be an indication of a possible scenario for what lies ahead.
Below is a daily DIA chart showing the current flat channel of 17 day duration and 1.5% height:
Below is a chart showing the only 3 past occurrences of the same pattern of price action in DIA during the summers of 2004 and 2005 for a 2% channel height:
The past occurrences of the flat channel are enclosed in shades ellipses as shown. It may be seen that both in 2004 and 2005 when there was the same hesitation and caution in the market, it was followed by 4 months of volatile and sideways action. Of course, the situation may be different this time because causality cannot be established. However, it is good to always know what happened in the past, especially in cases when the event was unusual.
If the market goes into an extended period of volatile and sideways action, the first victims will be trend followers who have made most of their gains this year from trends in stock indices. But systematic trend followers are an easy prey. I warned them back in September of 2011 about similar price action when I wrote:
“Choppiness may continue for several weeks giving more troubles to trend followers. I would turn off any automated trend following system at this point. There is no point in getting caught up in a fight of this kind. This is a good market only for experienced very short-term swing traders, scalpers and option sellers. Trend followers should take a break, in my opinion, until the technical picture is clarified.”
Same observations may be appropriate also this time.
Disclosure: no relevant position at the time of this post and no plans to initiate any positions within the next 72 hours..
Charting program: Amibroker (Charts created with AmiBroker – advanced charting and technical analysis software. http://www.amibroker.com/”)