3 big reasons why the Dow Jones Industrial Average is bracing for a pullback

3 big reasons why the Dow Jones Industrial Average is bracing for a pullback

Dow Jones Industrial (DIA) stocks have barely budged this year, even with so many stocks plummeting in the stock market carnage of 2022. Expect the mighty Dow to eventually fall rapidly in early 2023 .



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Stocks have certainly rebounded strongly from their recent lows. The NASDAQ 100 (QQQ) is now up just over 12% from October lows. The S&P 500 (SPY) rose nearly 15% over the same period. The Dow Jones Industrials (DIA) was the star, gaining almost 18% over the past two months.

Lower interest rates and not-so-awful earnings have certainly fueled the recent hot rally. Now that earnings season is winding down and rates are bottoming out, look for stocks that are struggling to gain traction from here. This is especially true for Dow 30 stocks which have gotten too far ahead of themselves on a comparative and real-world basis. Additionally, the Dow is poised to enter a seasonal downturn in early 2023. Traders and investors looking to short sell stocks might be advised to consider doing so with DIA for all three reasons just mentioned.

Comparative

The Dow Jones Industrials (DIA) has arguably been the best performer of the three major indices so far in 2022. The DIA is down just under 4% year-to-date while the S&P 500 (SPY) has lost more than 14% and the NASDAQ 100 (QQQ) has fallen almost 29% this year. Factor in the higher dividend yield of the DIA versus the SPY or QQQ and that overall performance gap widens a bit more.

Normally, these three indices tend to move in unison – or be much more strongly correlated to use a more sophisticated term. Look for both the SPY and QQQ as relative outperformers, and the weakest DIA of the three, at 23 to bridge that performance gap to a more traditional relationship.

The Dow Jones has become a bit cheaper from a P/E valuation perspective. The current P/E stands at just under 21 today versus just over 22 a year ago, a decline of around 5%.

Compare this relative decline to similar metrics on the S&P 500 and NASDAQ 100. Both indices have seen their current valuations fall by well over 30% on a P/E basis. In fact, SPY now trades at a significantly lower P/E multiple than DIA. 12 months ago, SPY was trading at a premium of nearly 7 points to DIA.

Techniques

DIA again hit overbought readings on the chart that matched past highs. Stocks are hovering around 70 on a 9-day RSI basis. Bollinger Percent B crossed the 100 mark but has since softened. The MACD has reached an extreme but is about to turn negative and generate a sell signal. DIA is trading at a steep premium to the 20-day moving average and has again stalled at a resistance of $340. A pullback towards the $328 area to test the 20-day moving average seems the most likely path.

Seasonality

The calendar suggests the Dow Jones will begin to slow as New Year approaches. January was the worst performing month in 20 years with gains less than half the time and an average loss of -0.70%. November, on the other hand, was one of the best months, while December is just above average.

Stock traders looking to position themselves for a weak start to 2023 might consider shorting DIA towards the end of 2022.

Options traders might choose to set up a bearish calendar spread by buying January puts and hedging by selling December puts to position themselves for a potential pullback in January, but can to be further consolidation in December. This is especially true given that implied volatility (IV) has fallen to relatively cheap levels at just 31%, especially compared to historical volatility of twice that of 62%.

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All my wishes!

Tim Biggam

Editor, POWR Options Newsletter


Shares closed at $396.03 on Friday, up $1.79 (+0.45%). Year-to-date, it’s down -15.65%, versus a % rise in the benchmark S&P 500 over the same period.


About the Author: Tim Biggam

Tim spent 13 years as Chief Options Strategist at Man Securities in Chicago, 4 years as Chief Options Strategist at ThinkorSwim and 3 years as a Market Maker for First Options in Chicago. He makes regular appearances on Bloomberg TV and is a weekly contributor to the TD Ameritrade “Morning Trade Live” network. His primary passion is to make the complex world of options more understandable and therefore more useful to the everyday trader. Tim is the editor of the POWR Options newsletter. Learn more about Tim’s journey, as well as links to his most recent articles.

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