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
I would assume that with another very bullish week, even the die-hards are beginning to be convinced that the market action is not simply short-covering. Every major index extended its gains smartly with the Dow closing up another 151 points, the SPX 28 points and the NASDAQ 46 points. The first thing one notices, however, is that although these were good gains, they were measurably less than last week, and this represents deceleration. So a correction might not be too far off, perhaps even next week.
The star of the week was the Russel 2000, which traded at an ALL-TIME HIGH, kinda smashing the bearish refrain that we are in a "secular" bear market. The other star continues to be the Dow Jones Transportation average which is quickly approaching its all-time high and is putting a new spin on the Dow Theory. Could it possibly be less relevant than it used to be in today's era of globalization?
Current Position of the Market.
SPX: Long Term Trend - The long term trend turned up in October 2002 in conjunction with the 12-year cycle. It is now reinforced by the 10-year cycle. A top is likely in 2005.
SPX: Intermediate Trend - A strong intermediate up trend is in progress.
SPX: The Short Term Trend continues to be up, but could find a top as early as next week.
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.
Note: If you would like to receive an explanation of how I arrive at these signals and be notified on the day that they occur, please let me know at firstname.lastname@example.org.
The Short Term Trend is being monitored continually through daily Closing Comments.
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Before we get carried away with too much bullish glee, let's take a few things into consideration in order to determine how long this up trend is likely to continue.
1 - We need to remember that the current move probably represents wave 5 of the move which started in March 2003, so we should not expect the same kind of action which prevailed last year. Unless, wave 5 turns out to be the extended wave!!!
2 - The move which started at 1090, as mentioned last week, looks very much like a wave 3 of the move which started at 1060, and it is currently in its fifth and final wave (5 of 3), unless it decides to subdivide. So the biggest wave may be nearly complete and could be followed by a pretty decent correction which would most likely be wave 4, and could last into the lows of the 9-month cycle. Wave 2 lasted about 5 weeks, so, according to the "law of alternation" wave 4 will either be shorter or longer. If it is shorter, we could complete wave 5 before correcting into the 9-month cycle, which would be preferable for the long term outlook.
3 - What happens after the completion of wave 5 will have to be watched very closely, because it this is the end of the move which started in October 2002, we are in for a long ride down to the 4-year cycle low in 2006.
One strong factor in favor of the bulls, is that the 5th year of a decennial pattern is one of the strongest years of the entire decade. Undoubtedly, this is caused by the bottoming of the 10-year cycle at the end of the 4th year, and when this occurs in conjunction with a 12-year cycle which is still in a strong up phase, it makes for an unusually bullish long-term combination.
There was an excellent article published on Safe Haven this past week about the decennial pattern, and you owe it to yourself to read it: http://www.safehaven.com/showarticle.cfm?id=2187, but as you do, just remember where you heard this discussed first! (Turning Points, Oct.10, 2004)
I am going to post some charts of the SPX which will show you the status of the indicators that I follow. As mentioned in the "Explanation of how I arrive at market signals" which has been sent to all those who have requested it, the great majority of market turns are marked by divergences in the indicators, so the first thing to look for is an oscillator which is beginning to diverge from the price trend. This, of itself, is not a buy or a sell signal because divergences can last a long time depending on the current structure and cycle configuration, but it is an indication that the trend is weakening. The next thing to look for is for the trend line to be broken. This is a confirmation that the trend has turned.
Right now, some divergence is just beginning to appear in the "early warning" indicators, but the trend lines are still intact. I will analyze all this in detail in the chart section below.
I am including a daily and a weekly chart of the SPX in order to show the current structure and the position of the indicators relative to the index. An analysis of the charts follows.
Structure: The longer term structure shown on the weekly chart is clearly a 5-wave pattern and we have entered the 5th wave. But where do we start the count? I we start at the October 2002 low, the completion of the current 5th wave will be the end of the bull move. But if we count from March 2003, the current up trend only represents a wave 3 of the up trend with much more to come! Because this is still unclear -- and not really relevant at this time -- we'll come back to it later.
Turning to the daily chart, the structure is much more clear. After completing an A-B-C intermediate corrective pattern, the trend started up again. The current move is clearly either a wave 3 pattern of the move that began in August 2004, or a segment of that wave, if it wave is undergoing a subdivision. Only time will tell which it is. The buying euphoria which is taking place is also a characteristic of a wave 3 pattern. In either case, we can still expect a wave 4 and 5 before the up trend which started in August comes to an end.
Indicators: Indicators are absolutely essential in determining the correct structure. They pinpoint the end of each wave and facilitate proper labeling.
On the weekly chart, notice how at point A, the strong positive divergence which occurred in the MACD -- at the same time that the STOCHASTICS was oversold -- indicated that the long-term downtrend was about to reverse. At point A', both the MACD and STOCHASTICS were overbought, but there was no divergence and this meant that after a consolidation/correction, the up trend would most likely resume. This is now happening. Both of the oscillators and the price are back in an up trend.
Note also that when the MACD becomes severely overbought it normally comes back to the "0" line - as it did at point B - before the correction is over. The same happens in reverse when the market is severely oversold, as you can plainly see at point X where the MACD returned to the "0" line before the next down trend took effect. At point B the STOCHASTICS had become oversold again and the market was ready for a turn.
Now go to the daily chart. Here we display 3 oscillators, the top one being an almost identical replica of the McClellan oscillator. This is the most sensitive of the three in pinpointing the end of trends, because it is the first to diverge from the price. This is very apparent at points A and C, and both divergences occurred at the time that the STO was near its lows.
At point B, the negative divergence was screaming at us and it showed up in the MACD as well, while the STO was near its highs. This was followed by a decline which is considered to be wave 2.
This brings us to the present. At point D the STO is very overbought, the MACD is still moving up with no top in sight, BUT the top oscillator is beginning to show negative divergence. This is a pattern which is very similar to what took place at A, whereby the top oscillator stopped going up while the MACD was still in a strong up trend. The result was that we had a small decline followed by a new high. A similar market performance is likely in the near future.
The current market action is the result of the one year, 10-year, and 12-year cycles combined up trend.
Structurally, the move which started at 1090 is either a wave 3 which is just about to complete, or a segment of wave 3, if that wave is subdividing. In either case, a wave 4 and 5 will have to take place before we can arrive at a top of the move which started at 1060.
With the Russel 2000 making an all-time high this week, the notion that we are in a "secular" bear market has been completely invalidated.