The following is an excerpt from commentary that originally appeared at Treasure Chests for the benefit of subscribers on Friday, August 29th, 2008.

The term analog is rooted in the word analogy, which for our purposes is being used with reference to an analog signal measuring a variable signal that is continuous (similar) in amplitude and time. In terms of analyzing the financial markets, and how price movements have a tendency to repeat in terms of pattern (amplitude) and time, it is this understanding that was the primary precept in the work of W. D. Gann, which to this day remains THE comprehensive / definitive template to unlocking the mystery of how markets work. The primary understanding then, is that price movements in markets have a tendency to repeat in pattern and time.

In a nutshell, and in terms of elaborating on this understanding, through his work, what Gann essentially defined was that while movements in financial markets have a tendency to repeat in terms of price and time, change does occur due to variable factors, primarily based in human emotion, in turn altering amplitudes of waves. For example, while it might be a war in the Middle East, or hurricane, that is attributed to moving the price of oil higher in coming days, the degree of movement will depend on the intensity of human emotions with respect to such events, which in and of themselves are variable. This is of course the condition that breaks markets out of trading ranges / patterns.

Sound complex? Yes, you are right, this subject matter is complex, and well outside 'the box' in terms of everyday thinking for most. That being said however, if one wishes to become a successful investor / speculator, then it's imperative one comes to the above understanding early in a career if it's to last. This, and a whole lot more, including the understanding that when prices do move outside of previously defined pattern and time related structures, such movements tend to be violent due to emotion resulting from surprise, which in turn is the result of an entire investing population trading on the basis of false information. Fibonacci progressions / retracements tend to quantify such movements, which is a discussion onto itself, so for our purposes here today, we will remain focused on variable signals that are similar in price and time.

There are several examples of 'range bound' markets today that appear to be trading within defined parameters no matter what is happening in the external world, with crude definitely an interesting study in this regard. Here, it's fascinating to note that no matter what the news is these days, which for crude is quite bullish, again, ranging from events unfolding associated with Russia to those of Hurricane Gustav, oil prices remain subdued and unable to break out of a recent price range bounded at the top by $120. And while bullish traders may find this confounding, this lack of emotion capable of breaking crude out its present trading range, we know from previous discussions it's because speculators are afraid to short it anymore since the squeeze to new highs last month, evident in low and falling open interest put / call ratios. (Type in USO [symbol for the crude ETF] and click Submit.)

As an aside, you should realize then that recent strength in crude oil is corrective, and that once Hurricane Gustav blows over next week, prices could penetrate the bottom of the trading range at $110. What's more, at least initially, such an occurrence will affect the precious metals complex. Thus, expect more weakness next week associated with a break lower in crude, which should stir up increasing deflation talk once again. Of course nothing could be further from the truth, but don't tell that to Mish. I will have more to say on this subject matter on Monday in my report.

So you see in today's markets, which are more akin to betting parlors with all the derivatives speculators use to gamble with these days, it's the emotion attached to how the bets are placed that tend to drive prices, often counter to the fundamental backdrop. This is of course where contrairian-investing techniques measuring sentiment conditions are key in gauging probabilities associated with market movements, this, and history. Why history too? Or more specifically, why do we look back in time for similarities in historical trading patterns to help us picture future possibilities? Answer: Whether it is defined in terms of an explosion in derivatives based betting, short selling, etc., it's no matter, what is essentially being measured when prices follow similar trading patterns are the emotions of the investing population.

And it's this understanding that makes the analog chart based study we are about to embark on so profound then, that, and the realization the present topping sequence in the stock market is of Grand Super-Cycle Degree, at a minimum. What's more, you should also know right off the bat that the reason I am performing this study is because it's my opinion history is about to repeat, and that the implications will indeed be profound for investors. You see, whether it be the investing population of today, with the present environment being the largest mass mania in the history of man and financial markets, or that of the last Super-Cycle (one Degree lower) sequence in stocks marked by the dramatic top in 1929 (followed by a 90-percent correction in the broad measures of stocks), again, it's does not matter, people are the same in terms of the emotional response they will elicit, meaning pattern similarities will likely continue to be duplicated.

In moving on to a look at some charts in this respect now, initially in terms of measuring apples to apples we will cover a series comparing the Dow at the '29 top to the post bubble NASDAQ of today given they are both the specialty / technology markets of their respective eras (and for this reason should be most similar in pattern), followed by the S&P 500 (SPX) of today overlaid atop the '29 Dow, with the last comparison being the same put against the Nikki post bubble experience. If you have not seen this study before, get ready to be shocked at the pattern and timing similarities, a phenomenon considered impossible by most in today's markets predicated on the belief that because of our 'control' of the situation, future outcomes can be manipulated / altered on an indefinite basis. Here's a look at the Dow / NASDAQ comparison cited above to kick things off then, this one measured in calendar days. (See Figure 1)

Figure 1

As you can see above, with the exception of a more recent divergence that has allowed the NASDAQ to remain relatively elevated, the pattern is essentially identical, meaning what happened to the Dow moving forward is the path of least resistance, especially if the divergence is closed in negative fashion this Fall. I say 'this Fall' (instead of sooner) because aside from the fact inflation rates are probably more robust today than back in the 30's, purely on a time related basis, the primary reason the present divergence exists is likely a function of trading days (in order to allow the full range of emotions mature), which can be viewed on a chart plotted on this basis. Here, if history is to repeat, stocks could theoretically remain strong into the early part of next year. (See Figure 2)

Figure 2

Why the timing difference between calendar days and trading days? Answer: Because back in the 20's and 30's stock markets were open on Saturdays too, which added one day per week to the number of days traded. So, between this, and fewer holidays as well, in order to get a trading day related apples to apples comparison, adjustments must be made. Of course this does not mean that the trading day analog will prove more accurate, however we should be aware of this condition, and look for clues as to which measure may more accurately reflect present outcomes. How do we do this? Answer: Take a close up. (See Figure 3)

Figure 3

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Good investing all.