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
Last week's newsletter spoke of a potential short-term top. The markets spent most of the past week resisting the down turn, but by Friday they finally gave in. The first correction of the up trend which began at SPX 1090 is underway and it is affecting all market averages.
The cause of the correction is the bottoming action of the short-term trading cycle which, in spite of the underlying strength of the larger cycles which recently turned up, is able to turn prices around temporarily.
Negative divergences in the A/D and NH/NL indicators began to appear early in the week as well as in the hourly momentum indicators. This is always the warning sign that a top is near.
The correction is not expected to be either long or deep, and could be over by the middle of next week. A good reason for the low to take place mid-week is that, seasonally, the first part of the Thanksgiving week is weak, but it finishes strong.
It is remarkable that when cycles make their lows they often seem to coincide with external events which act as catalysts to cause a market reaction. This time it was chairman Greenspan warning about deficits, and oil having a sharp rally from its near term oversold condition. This happens much too frequently to be a mere coincidence and is much more likely to be the way our universe really functions. But we need reasons that satisfy our minds and cycles are far too abstract to do this, so we explain the reaction by saying that it was caused by the events.
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 mid-2005.
SPX: Intermediate Trend - A strong intermediate up trend is in progress.
SPX: Friday's action is not expected to put an end to the short term up trend at this time and new highs are likely to be reached before a longer correction takes place.
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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As stated above, the current pull-back is the first attempt at correcting the short-term overbought condition of the market since the up surge began 3 weeks ago. The number '3' -- whether hours, days or weeks -- often brings about a temporary reversal in a trend. 3 weeks is also 1/4th of a 12-week cyclic rhythm which has been very dominant in the stock market lately, and 6 weeks from the low -- the mid-point of this cycle -- could very well mark the top of this rally. With the short-term cycle due to make its low next week, the odds were high that a top would occur last week. When the short-term cycle causing the current reaction turns up it will add its upward push to the longer cycles which recently made their lows.
If you look at the chart of the Dow Jones Industrials which appears below, you will see that from the February top, each correction and subsequent rally has lasted about six weeks. This regular pattern is a little unusual because it is so well defined (and at some point other cycles will interfere and cause it to be less clear), but everything points to the probable continuation of the pattern at least once more and perhaps two more times. Thus, the preferred scenario for the near term is that the top of the rally will come in early December (approximately) and then our first real correction can cause a market retracement into mid-January. The date of the next 12-week low also coincides with the time that had been foreseen for the bottom of the 9-month cycle, and makes this scenario even more probable.
We don't want to get too far ahead of ourselves, but based on a similar except longer term analysis, it is at least possible, if not probable, that the long term up trend which is currently under way could carry into mid-year. As you will see later on, there are good technical reasons for this to happen.
Oil had a sharp rally on Friday and it was cited as one of the reasons for the market retracement. Oil had come down 10 points from its recent highs without any meaningful counter trend move. It was oversold and entitled to a rally and the odds favor oil selling off once again, afterwards.
More on Cycles
I have mentioned before that the majority of cycles appear to be rooted in the number 360 and its subdivisions. For instance two powerful long-term cycles which are affecting the market presently are the 12-year cycle (1/30th of 360) which made its low in October 2002, and the 10-year cycle (1/36th of 360) which bottomed this Fall. The 12-week cycle, which is unusually dominant currently, is also 1/30th of 360 weeks. And there is a well-defined 30-year cycle as well, which is 1/12th of 360 years, and a very powerful 40-year cycle, 1/9th of 360. The March low was caused by the 120-week cycle (1/3rd of 360) and the 120-year cycle is scheduled to make its low in 2014 in conjunction with the 30-year and 40-year cycles. The few years preceding that date are not likely to be a very good time for the stock market and the economy.
Gann had a slightly different approach to cycles, but it was also based on a recognition that the number 360 played an important role in determining high and low points in the market. He spoke of it in terms of degrees with the dominant degrees being 360 and 180. In terms of trading days, these degrees translate into 72 and 36 weeks. The 72-week rhythm has been particularly regular in the Dow Jones Industrials since 1998, sometimes being exact, and sometimes being off only by one or two weeks. The time span from the October 2002 lows to the February 2004 highs was 71 weeks, and the correction from that top to the October lows lasted exactly 36 weeks. This is why there is a good probability that the top of the current up trend will be in June 2005 since it will mark 72 weeks from the February top and 36 weeks from last month's low.
I am including a daily chart of the Dow Jones Industrials which we will analyze from several angles.
1 -- Cycles: From the top of the February top to the October lows (dotted line) is exactly 36 weeks. Furthermore, this period divides exactly into 3 12-week sections. Each 12-week cycle consists of 2 nearly equal 6-weeks sections. The short-term trading cycle is not identified on this chart.
2 -- Momentum: The current position of the STOCHASTICS (at the bottom) is overbought. This, in itself, does not necessarily signify that the market is ready for a correction because it can remain overbought a long time in a strong up trend. But if one of the other oscillators shows negative divergence, then it indicates that a correction is near. In this case, a warning was given by the top oscillator which is the A/D and which, as mentioned in the last newsletter, is usually the first one to identify cycle tops and bottoms. The divergence is marked by the dashed vertical line.
The MACD (in the middle) however, shows no such divergence which means that this top is likely to be insignificant. Furthermore, the height achieved by the MACD is indicative of strong market momentum and time is needed to dissipate that momentum as the market moves higher. You can see that this is what happened as we went into the February top.
3 -- Trend and channel lines: The trend lines that are drawn on this chart use a little-known, but fascinating technique called Andrews' Pitchfork which was brought to my attention by a reader in Australia, and which consists of connecting a low point with the mid-point of the next decline. Lines 1, 2, and 3 are drawn in this manner. The other lines are parallels drawn to line 3, using other low points.
The first thing to notice is that lines 1 and 2 and 3, although drawn separately, are almost exact parallels.
When extended, lines 1 and 2 provided resistance to the subsequent rally and caused a reversal on the trend. Line 3, however, was penetrated decisively by the move which began in October indicating that the entire correction was over and a new up trend had started.
Line 2, provided 2 levels of resistance (a and b) before the market reversed.
Line 3-A, which is the upper parallel to line 3, provides several points of support and resistance along the way. Also note, how prices bounced between 3 and 3-A (c and d) before moving lower.
That's all past analysis. What about the future? First, note that the current decline is approaching the extension of 3-A, and this may very well provide at least temporary support for prices. Lately, the stock market has had a very strong surge either up or down in the first hour or hour and a half of trading, and then did very little for the rest of the day. This same pattern happened again on Friday and is very clear on an hourly chart. This could mean that the decline has temporarily exhausted itself, perhaps completing the A-wave of an A-B-C corrective pattern. This would be logical if the extension of 3-A is providing support and generates a small intra-day rally.
Also, by extending wave 2, we now mark the probable upper limit of the current move. If prices can move up to that level in the near future, they will surely find resistance there. Conversely, if we don't make it all the way to that top line, it will be a sign that deceleration is taking place in the trend, and this should be reflected in the oscillators.
Finally, the lower parallel to line 3 and its extension, which is drawn from the October low, is now becoming our long term trend line and will have to be broken before the current trend is considered to be over. As you can plainly see, this is not likely to be anytime soon.
The above analysis illustrates how important it is to combine several proven technical methodologies to arrive at a clear perspective on the current position of the stock market.
The bottoming of the short-term trading cycle is causing the stock market to have its first meaningful pull-back since the trend began at SPX 1090. The consolidation is expected to be fairly shallow and short, perhaps over by the middle of next week. After that, as the cycle turns up once again, the market is expected to make new highs which could continue into early December.
We should also note that the SPX has valid Fibonacci projections which call for higher prices.