The Dow made a stronger up move than the NASDAQ today. The Emini closed up at 1,346.75 on Tuesday. This is the first sign of weakness we’ve seen in the last 10 days. Keep reading below to understand how larger moves in the Dow can be used to identify market turning points.
Large percentage moves in the Dow can indicate a change in market mood
The Dow is made up of 30 blue-chip stocks, whereas the NASDAQ is made up of 100 high-growth stocks. These indices normally move in sync, and because of the conservative nature of the Dow, it normally makes smaller percentage moves than the NASDAQ. However, occasionally the Dow makes a larger percentage move than the NASDAQ or moves in the opposite direction. Unusual moves like these can forewarn changes in market direction.
At market tops, sophisticated investors shift their focus from high-growth stocks and move their money into more conservative blue-chip stocks. Therefore, market tops can be shown by either the Dow rising and the NASDAQ falling or the Dow making a larger percentage up move than the NASDAQ. Conversely, at market bottoms smart investors shift their focus from blue-chip stocks to high-growth stocks. Therefore, market bottoms can be shown by either the Dow falling and the NASDAQ rising or the Dow making larger down moves.
Measure these changes in the Dow and NASDAQ in 2 ways
On the Emini chart above I've included two indicators that measure this relative Dow and NASDAQ market activity. The first indicator plots white and red dots on the daily bars when the Dow and NASDAQ move in opposite directions. White dots are bearish and red dots are bullish. This indicator does not fire off as frequently but it’s signals can be more accurate.
The second indicator plots below the daily bars and shows the difference in percentage move between the Dow and the NASDAQ, when the Dow moves by a larger percentage than the NASDAQ in the same direction. This indicator fires off more frequently and needs more interpretation. In particular, I take more notice of the larger percentage moves than the smaller ones.
In the chart above, this second indicator labeled DJIA NASDAQ Diverge shows that today the Dow rose by 0.36% more than the NASDAQ. This shows that investors are becoming more conservative and switching out of NASDAQ stocks and into the Dow. This is the first sign of weakness we've seen recently. (note: I use the Dow and NASDAQ futures in my calculations rather than the indices themselves)
This is an easy measure of market sentiment you can track yourself
Remember, don't use this pattern alone; combine it with other non-correlated market indicators to identify high probability market turning points.
Do a Google search for Dow NASDAQ divergence to find more information.