The Dow Jones Industrial Average Chart That’s Keeping Wall Street Up At Night

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February 12, 2014 1:17pm NYSE:DDM NYSE:DIA

wall-street-etfDavid Zeiler: For months, Wall Street insiders have passed this chart around amongst themselves and nervously discussed whether it foretells a major stock market sell-off.

The chart compares the path of the current Dow Jones Industrial Average (INDEXDJX:.DJI) over the past year and a half to the Dow’s moves over the 1928-1929 period.

While the Dow is trading at a much higher level now than in the 1928-1929 period, the pattern is eerily similar to the path that led to the worst stock market crash in Wall Street history, right up to the recent stock market sell-off and recovery.

Tom DeMark, the founder and chief executive officer of DeMark Analytics, was the first to see the pattern last fall and create the chart – which was laughed off by many market veterans. He told Marketwatch that at first it was “for entertainment purposes only,” but that “now it’s evolved into something more serious.”

What has people worried now is what the pattern shows will happen next.

stock market selloff

After the brief recovery from a similar stock market sell-off in 1929, the Dow Jones nosedived 33% in a hellish two-week span. That stock market crash eventually took the Dow 89% below its peak.

“While investment history doesn’t necessarily repeat itself, it does rhyme,” hedge-fund manager Doug Kass of Seabreeze Partners said of the chart in an email to Marketwatch.

Every day the pattern persists, fewer traders on Wall Street are amused.

But investors don’t have to lose sleep at night if they take these steps to prepare…

What to Do If There Is a Stock Market Sell-Off

It’s important to point out that the radically different scales each line represents means that even if the pattern does persist, we’re not likely to see a full-blown stock market crash.

If the Dow Jones drops in concert with the 1929 line, it would only fall to about 13,600 or so. That’s about 15% lower than where the Dow is now, and right in the neighborhood of the healthy stock market correction that so many market watchers have been expecting for months.

Remember, the Dow had an unusually strong 28% increase in 2013 and is due for some kind of pullback regardless of what any chart says.

“The markets have had 19 corrections of 5% or more since March 2009, so the turmoil we’ve seen in recent weeks is not unusual,” said Money Morning Chief Investment Strategist Keith Fitz-Gerald. “If anything, it’s actually par for the course because it proves that there is some semblance of real price discovery remaining. I’m actually glad to see it because bull markets have distinct phases – a beginning, a middle, and an end. Rather than signaling an end, corrections actually are more symptomatic of the middle.”

The real question isn’t if we’re going to get a stock market correction, but when, Fitz-Gerald said. So investors need to be prepared at all times for whatever the markets might do.

“Nobody knows if and when a correction will hit – not even me,” Fitz-Gerald said. “To get around that, I encourage the use of trailing stops as a decision maker. That accomplishes three things: 1) you can ride the bull still higher if the markets want to run, 2) you keep risk to razor thin levels, and 3) you take emotions out of the equation.”

Money MorningWritten By David Zeiler From Money Morning

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