A 3-dimensional approach to technical analysis
Cycles - Structure - 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
A Review of the Past Week
With the exception of the Dow Industrials, the major indexes extended their gains this week before pulling back on Thursday and Friday. The Dow Industrials is the weakest of them all and remains in a basing pattern. The advance/decline ratio was slightly positive for the week, but the new highs/new lows surged to 400 net positives on Monday before backing off. The volume remained high except for Friday when it dropped back in conjunction with the correction. It is also worth noting that although Friday saw the bulk of the correction, the A/D remained positive during most of the day and was only slightly negative at the close.
Oil reached an all time high on Friday and this had a negative psychological impact on the averages.
I had mentioned earlier that we were in a three-week period of bottoming cycles which could see a correction. Next week will be the third week. I believe that the current pull-back is the result of the last of these cycles bottoming. Oil, by contrast, appears to be affected by the cycles in precisely the opposite manner, and if this is so it should now be topping out. More about oil later.
Current Position of the Market.
Long Term Trend: The long term trend turned up in October 2002 in conjunction with the 12-year cycle. It is still in a BUY/HOLD mode, and is likely to top out at some point in 2005.
Intermediate Trend: The BUY ALERT was upgraded to a BUY SIGNAL this past week.
The Short Term Trend is undergoing a correction Because of market volatility, the short term trend is better analyzed on a daily basis. This is done in our daily market updates and closing comments.
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The Short Term Trend is being monitored continually through daily Closing Comments.
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In the last newsletter I listed a number of strong positives for the market and displayed several charts which indicated that an up trend was underway. In spite of the correction of the last two days, nothing much has changed. But let's dissect the market to get a better idea of where we stand.
Cycles: One can never know precisely when a long term cycle will make its low, but it does appear that the 10-year cycle is beginning to turn up and has begun to exert upward pressure on the averages. If this is so, then all corrections in the market which are caused by lesser cycles will be well contained, and the nest of smaller cycles bottoming in the current time frame should not cause a permanent reversal in the developing intermediate term market trend.
Also of significance is a study done by Edson Gould, a renown analyst of the 1960's -- and later published by Larry Williams -- of the 10-year pattern in the U.S stock market. According to this study, the best years to invest in the stock market are in the second and third year because they usually mark the bottom of a bear market. The fourth year is a year of consolidation, and the up trend resumes toward the end of that year and extends into the 5th and 6th year. Therefore, according to this pattern, the remainder of this year and all of next year should see prices moving higher. Of course, the decennial pattern -- which is an average of price patterns for the past 200 years -- will be subject to some variations depending on the long term cyclic configuration. For instance, in 1975 the bottoming of the powerful 40-year cycle caused it to be somewhat distorted. This is why cycle analysis is important to fine-tune this larger pattern.
With the above in mind, it would be logical that the up trend would resume when the current nest of short term cycles have made their lows. One of the best longer term indicators is the new highs/new lows index. It had recently become disproportionately bullish to the current market action with a net 400 new highs registered this past Monday and it needed to correct, which it has. The McClellan oscillator is a shorter term index which is causing concern to some of its followers, including McClellan himself, because of its present behavior which is interpreted as bearish. Once again, this can be explained through cycle analysis. It would make sense that during a 3 week period of cycles making their lows, the advance/decline ratio would have a difficult time sustaining bullish readings. This would impact the bullish momentum of the McClellan oscillator.
Is there any cycle on the horizon which could severely affect the current up trend and cause a reversal?
Yes! The 9-month cycle is the intermediate cycle which appears to have more impact on stock prices than any other cycle. Its past two lows have only had a minimal impact on stock prices because its down phase was curtailed by much stronger cycles. But the next one, which I believe is due in late December or early January, could bring a more severe reaction. There appears to be some disagreement as to when that next low will be and some analysts believe that it is imminent.
The 9-month cycle is often confused with the 40-week cycle. In fact, these are two separate cycles which tend to be of the same length and which make their lows 10-12 weeks apart. I place the last low of the 9-month cycle in late March, which would put its next low in late December or early January. The 40-week cycle bottomed last week, and 10-12 weeks from that low also brings us well into December. Could the 9-month cycle be topping at this point? I suppose, but the last top came about 3 weeks prior to its low, and it seems to be a little early in the light of what was discussed above for it to top now, especially if the 10-year cycle has turned up. My guess is that some time in the middle of November would be a better time frame for this cycle to make its high.
As for the short term cycles that are currently affecting the market, I believe that next Tuesday would be the ideal time for the low to occur.
Structure: A problem faced by Elliott Wave analysts is that cycles affect various averages differently and cause different structural patterns. This could not be more evident than now when you compare the Dow Industrials to the NYSE. But since our focus is primarily on the SPX, what does it tell us?
The pattern of the move which began at 1060 should be construed as one single wave. However, I believe that that wave is subdividing, with the first wave ending at 1131, and the next one beginning at 1 102.Therefore, the current correction is not the top of the entire move, but more likely the corrective action of the first phase of the new wave. I believe that the above cycle analysis supports this conclusion, as does the behavior of the volume and advance/declines on Friday.
Oil: There is another significant factor currently impacting the market negatively: the price of crude oil! If it could be shown that oil is topping out and ready to retrace from current levels, this would go a long way to justify the above analysis. In fact, structural analysis, time analysis and Point and Figure count analysis currently place oil at, or near, an intermediate term top from which it could reverse to the down side any day!
When I first analyzed oil a few weeks ago, I displayed a Point and Figure chart which showed that it had a potential to reverse at 49, which it did, followed by a 7 point retracement. I also mentioned at the time that there was a potential to go to 54. The re-accumulation pattern which has been formed between 43 and 45 gives me a count to 42. This was exceeded by one point on Friday and, so far, there have been two reversals between 42 and 43. There is enough momentum in the move that there could be some more topping action in this area with a few more reversals at the current level before the move is completed. Since the ideal time for the top is Tuesday, and this coincides with the short term market cycle lows, it will be interesting to watch what happens over the next couple of days of trading.
Does the behavior of the XOI (oil stocks average) give us a clue about the future behavior of crude oil? Very definitely! The Fibonacci projection for the move on the XOI taken from the 406 low of 3/12/03 was 735. This price target is determined by a very reliable Fibonacci count methodology and it would indicate that the top of the move for the XOI should take place at or near this price level. On Thursday, the XOI reached 730.21 and has since then traded in a 15 point range. With both the XOI and crude oil appearing to have reached valid price projection levels, they reinforce the probability that a reversal of prices is imminent.
Projections: The SPX has projections to slightly lower levels for the current retracement. Because these projections may have to be revised during the week as a result of market action, specific short term price projections will only be given the readers who receive daily emails.
What do we need to confirm the intermediate term trend break out?
These criteria were given last week for a confirmation of an intermediate term break out of the SPX:
Price action: The SPX must move immediately to 1150 or higher with only very minor corrections along the way.
Volume: This move must be accompanied by continuing good volume
Advance/declines: The ratio must continue to be strongly positive
New highs/new lows: This ratio must continue to expand.
Only two of the criteria were actually met this past week: continued good volume and a continued expansion of the new highs/new lows index. I did feel that an intermediate BUY SIGNAL was justified because the SPX overcame its former high at the same time that it traded outside of its intermediate term down trend line going back to the March highs. However, until it trades above the 1150 the break-out will remain unconfirmed and the price action will have to be re-evaluated if this fails to occur over the next two weeks.
Charts: I am including a chart of the SPX which shows its attempt at breaking out. Please note how prices have penetrated the upper down trend lines of the down channel, but have not yet risen above the 1150 level.
For those who follow moving averages, you will notice that the 200-day moving average (blue line) is still moving up. The 30-day moving average (red line) has continued to move up in spite of the last correction, and it is currently crossing the 200-day moving average on the upside. Furthermore, prices have risen above both averages and have pulled back to their levels on Friday.
This past week, the intermediate term attempted to resume its up trend progress, but it was impeded by bottoming short term cycles and surging oil prices. Both of these negatives are expected to be resolved by next week and if they are, the intermediate up trend should extend prices to higher levels. If the 1150 level is not exceeded over the next two weeks and negative technical indicator readings appear, it would become probable that the first leg of the intermediate up trend has concluded and that a move down into the December/January 9-month cycle lows is likely.