Precision timing for all time frames through a 3-dimensional approach to technical
analysis: Cycles - Breadth - P&F and Fibonacci price projections
"By the Law of Periodical Repetition, everything which has happened once must happen again, and again, and again -- and not capriciously, but at regular periods, and each thing in its own period, not another's, and each obeying its own law... The same Nature which delights in periodical repetition in the sky is the Nature which orders the affairs of the earth. Let us not underrate the value of that hint." -- Mark Twain
Current Position of the Market
Very Long-term trend - The very-long-term cycles are down and if they make their lows when expected, the secular bear market which started in October 2007 should continue until about 2014-2015.
Long-term trend - In March 2009, equity markets began a corrective move in the form of a mini bull market. Cycles point to a continuation of this trend into 2011.
SPX: Intermediate trend - After a short-term pause, the SPX has resumed its uptrend.
Analysis of the short-term trend is done on a daily basis with the help of hourly charts. It is an important adjunct to the analysis of daily and weekly charts which discusses the course of longer market trends.
Overview:
The challenge of the stock market analyst is two-fold and it applies to all time frames: is the trend up or down, and how far will it carry before either consolidating or reversing.
If I had to choose one single analytical tool to determine the above, I would choose a Point & Figure chart of the medium being studied. Lately, I have been concentrating more and more on this methodology, and as my degree of proficiency increases, I am amazed at the consistent analytic precision that it affords. Let me give you an example by analyzing the S&P's current short-term trend and where it is probably heading.
I keep by hand a 1X1 (1 point box with 1 point reversal) P&F chart of this index. I cannot reproduce it here, so I have chosen a compacted version of a 5m chart of the index to illustrate the various phases considered, and the P&F counts they produce. P&F charting is only concerned with price and ignores time and volume. The trend ends when the valid count is reached. The market then has an option of reversing the trend, or simply making a consolidation phase before it is extended.
First, a little history. After starting a rally from 1040, the SPX had a very short correction after reaching 1148 (its first base count), then moved on in a slightly altered, less steep channel which is represented on the following chart by the heavy green lines. When the price reached 1196 on 10/25, it soon became apparent that a pattern was developing which could turn out to be a short-term top. Overbought indicators and negative divergence substantiated this possibility, as well as coincident patterns in gold and the dollar index charts. After making a double-top on 11/1, and pulling back sharply, the risk of a top increased. But the bottom of the channel held, and after it was tested and held again on 11/3 -- the date on which the Fed clarified its QE2 policy -- the index started up and broke out to a new rally high which reached 1127.08 last Friday.
With these preliminaries out of the way, let's now analyze the 5m SPX chart as if it were a P&F chart.
Instead of becoming a short-term top, the chart pattern from 10/25 turned out to be a consolidation or reaccumulation phase. There are actually two distinct phases. A smaller one which looks like a H&S pattern, and a larger one which continued until the break-out above 1196 on 11/3. I have identified both of these on the chart with different colored lines. The smaller pattern is marked with dark green lines, and the larger one with light green lines. Both have potential extensions (weak count) shown in blue lines.
The counts are taken for each phase, starting on the right, to the low point or to the next "wall". Starting with re-accumulation phase #1 (dark green), the count is first taken to the next wall just past the low and produces a count to 1227. This is precisely where the rally stopped on Friday, before its first consolidation. When that consolidation is complete, the index should move on to the count taken across the entire H&S pattern, which produces 1239 and, if the blue extension is added, 1245.
Another count which is taken across re-accumulation phase #2 (light green) produces counts to 1237-40, 1246, and eventually 1269. There are rules for producing valid counts, but this is not the place to go into the various subtleties. I merely want to point out the projections for the current trend which have the most merit.
On Thursday, I sent subscribers a chart on which valid measurements taken across 3 different phases produced confirmed counts to 1222 and to about 1245. The index chose to completely ignore the 1222 target, and to move right on to 1227 before starting its interim consolidation.
P&F counts only give potential targets for market trends. These have to be substantiated with other analytical tools, but it's amazing how often the projections are spot on.
Analysis
A good part of our analysis of the current trend is already done (above). Let's continue with the Daily Chart of the SPX.
With this larger perspective, you can see how the present channel started at a lesser degree of ascent on 9/23. After a few days of consolidation around 11/1, the index shot up to the top of its channel to meet the 1227 projection, and is now in a near-term consolidation. Incidentally, I use "near-term" to define something shorter than short-term. There is a short-term cycle due on Tuesday which could signal the duration and end of the consolidation.
With the resumption of the uptrend, the indicators have found new life. All three were near a sell signal which was never confirmed because the lower one found support on its trend line twice, and could not break through. With a well-defined projection to about the 1245 level (with a possible pause at about 1239-40), I would expect that we will see the index reach that level before finding the next opportunity to reverse.
Next, I want to look at the QQQQ because an interesting development could be taking place there. Let's look at its Daily Chart. I maintain a 0.50X1 P&F chart of that index, and it shows the same H&S pattern that you see on the bar chart. The P&F count taken from the RS to the H has a count to 52.5 with a small extension to 53.5. In P&F charting, only round figures count, and since the price never reached 54, the high of the QQQQ is still within its P&F objective. There are also some Fibonacci measurements to this area.
On Thursday, the index made its high of 53.86, and even though the SPX tacked on another 6 points to its high on Friday, the QQQQ traded below Thursday's number. Also, in reaching it's Thursday high, the index gapped higher on Thursday's opening from 53.01 to 53.50, a move which looks very much like an exhaustion gap at the end of the long uptrend from 42.97 without a significant correction.
Note also that the gap took the index above its Andrews pitchfork channel, making it extremely overbought, as can be seen on the o/b-o/s indicator which has remained at a very high level throughout the entire rally and closed the last two days at its maximum of 100.
Here is what I am getting at: a reversal in the market is very often preceded by relative weakness in the QQQQ vs. the SPX. If -- as is indicated -- the QQQQ is making a high at this level and, after a short-term correction, cannot exceed this high while the SPX makes a higher high, we will have an important signal warning us of a short-term correction. Of course, this is pure speculation at this point, but let's see how it goes.
Cycles
I have spoken of the longer-term cycles driving the market since the March 2009 low. Since there is no weakness showing in the market, we have to assume that they have not crested yet, and will probably carry this uptrend into 2011.
The 9-mo and 17-wk cycles which were supposed to bottom two and three weeks ago did not have much of an effect on the downside, but they are probably currently contributing to the uptrend.
There is a short-term cycle due on Tuesday.
Projections
Short-term projections were discussed in Overview. My preferred long-term projection for the bull market top is currently about 1320.
Breadth
The NYSE Summation index (courtesy of StockCharts.com) is struggling to stay in an uptrend, and the RSI is still overbought and showing increasing negative divergence. These are signs that a short-term top is not too far away .
As you can see on the daily chart, the A/D indicator has received a new lease on life. The next time it turns down, it will probably go through the support line and signal the beginning of a short-term downtrend.
Market Leaders and Sentiment
The SentimenTrader, which had served us well in the past, is no longer available. I do not know if this is temporary or permanent. I am therefore including another sentiment index (courtesy of Market Harmonics). From now on, we'll track the VIX which I also recently started following with a P&F chart.
Since I am still studying it, I do not know how reliable a result this will produce, but the current VIX reading is at 118.26. According to the P&F count, it needs to go to about 16.5-17.00 to produce a market top.
Gold
P&F targets for GLD: Long term -- approximately 235; Short term -- 139.
GLD is traveling in a channel within a channel within a channel. The short-term channel is the green one. After reaching its 134 P&F target, the ETF had a short 6-point correction, consolidated, and then resumed its uptrend toward the next target of 139. After it reaches it, it is expected to correct again. Since gold and the equity markets are still moving in tandem, this may coincide with the SPX reaching (about) 1245 and then correcting.
Considering the current position of the indicators, it is very likely that they will both show negative divergence when GLD reaches 139.
Summary
The recent formation which suggested that the SPX could be making a short-term top turned into a reaccumulation pattern instead from which projections can be derived from the P&F chart.
The index has now broken out to a new high, and on Friday reached an interim projection of 1227. After some consolidation, it should move to its next target of (about) 1245 which is the level at which it should produce a short-term top. There is a potential higher projection to 1269, but reaching it may turn out to be problematic.
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