Canny investors sell out as big gains come before a fall
It's a nice feeling for investors who seem confident of enjoying a little worry-free levity after the trauma of the past five years. But while not wanting to appear churlish, our first column for 2013 may just sprinkle a little rain on the investment parade.
This week's analyst, Alan Clement, a member of the Australian Technical Analysts Association, has produced a chart comparing the Dow Jones Industrial Average against what is known as the Bullish Percent Index (BPI). The BPI is a breadth indicator that measures how many stocks that make up an index (in this case the Dow) are giving off buy or sell signals. So if the general market is rising along with the BPI then the rally is broad-based and vice versa. It's a useful tool for investors in many markets.
However, Cambodia, where your correspondent was ensconced writing this story, is probably the exception as the market is made up of one local company, the Phnom Penh water authority.
There are a couple of phenomena to note about the Dow chart at the moment. While it has been in an uptrend since October 2011 it is now in a rising wedge formation, which is a sign of loss of momentum. It emerges when each upswing has less thrust than its predecessor, leading to a narrowing of the difference between highs and lows.
Technical analysts watch such formations closely and will generally interpret any fall through the lower of the red support lines making up the current wedge as a sell signal. An added depressant is that as the Dow approaches its 2007 high of 14,100, significant market resistance is likely to further impede its progress.
Now back to the BPI. It is giving us a reading of 73, which means that 73 per cent of the stocks that make up the index are giving buy signals.
That might sound reasonably positive but back in March last year the figure was 96 per cent and that difference has formed a downward trend line on the BPI. This in turn has created a divergence between the Dow and the BPI. And, says Clement, that is an indicator that some of the market's more canny investors are selling out to lock in profits from the run up.
When the wider investing public cottons on to that there is likely to be a sell-down in the Dow. For those who would like a little evidence for this hypothesis, look back to the early months of 2011 when there was a similar divergence. Then the BPI proved prescient with the Dow falling out of bed in July.
History tells us that November to January are traditionally strong months for the market so any fall may begin as early as this week.
Frequently Asked Questions about this Article…
The Bullish Percent Index (BPI) is a breadth indicator that shows the percentage of stocks in an index—like the Dow Jones—that are giving buy signals. It helps everyday investors see whether a market rally is broad-based or driven by a smaller group of stocks, which can signal strength or fragility in the market.
A drop from 96% to 73% means fewer stocks in the index are issuing buy signals, even though the Dow has been rising. That declining BPI can indicate some savvy investors have started selling to lock in profits and may signal weakening market breadth beneath the headline gains.
A rising wedge is a technical pattern where each upswing has less thrust than the previous one, narrowing the range between highs and lows. It’s seen as a loss of momentum; technical analysts watch for a break below the lower support line in the wedge as a potential sell signal.
A divergence—where the Dow keeps climbing while the BPI trends down—suggests the rally is becoming narrower. According to the article, that pattern has preceded sell-offs in the past because it can mean experienced investors are exiting positions before a wider pullback.
The article notes technical analysts typically treat any fall through the lower red support line of the current rising wedge as a sell signal. In plain terms, a decisive break below that wedge’s lower trendline would be a warning of weakening market momentum.
Approaching the Dow’s 2007 high of 14,100 creates likely market resistance, meaning the index may struggle to move past that level. Resistance can slow or reverse rallies as traders take profits or hesitate, increasing the chance of a pullback near that price zone.
Yes. The article points out a similar divergence between the Dow and the BPI in early 2011, when the BPI proved prescient and the Dow experienced a notable fall a few months later (July 2011). That example is used to illustrate how breadth indicators can warn of future weakness.
Based on the article’s observations, everyday investors might keep an eye on breadth indicators like the BPI, watch for a break of the rising wedge’s lower support line on the Dow, and be aware that historical seasonality (November to January) is traditionally strong. These are monitoring actions rather than specific financial advice—they help you spot weakening market breadth and potential sell-downs before the wider public catches on.
Call 1300 880 160
Start a chat
Schedule a call
