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 Two Weeks
In order to provide continuity from two weeks ago, I will repeat last week's SUMMARY:
With the NYSE composite continuing to scale new historic heights, one has to conclude that the bull market which started in October 2002 is still alive and well.
On an intermediate term basis, the market is probably in the process of making a well-contained corrective pattern with the short term looking vulnerable to a 2/3 week pull-back.
Indeed, this is what happened in the past 2 weeks. There was a sharp retracement in all the indices and they closed near their lows of the decline, although there was a rally in the past two days of trading.
In spite of another strong hurricane once again threatening oil producing and refining facilities in the Gulf of Mexico, the price of oil was actually down for the week after failing to reach new highs.
Gold spiked up on fears of inflation and made a much touted 17-year high, but with a 14-point pull-back, it appeared to have run out of steam, at least temporarily, by week's end.
The dollar had a strong two-week rally with Friday being one of its strongest days.
Current Position of the Market.
SPX: Long-Term Trend - The bull market which started in October 2002 is now nearly three years old and it would seem unreasonable to expect a dynamic new up trend to develop at this time with the 4-year cycle low expected in about 12/13 months. However, the Decennial pattern has an unblemished history for the past 125 years, and if history repeats itself, the Dow Jones industrials and the S&P 500 will be higher on December 31st, 2005, than they were on January 1st.
SPX: Intermediate Trend - The intermediate trend which began in May continues to correct and could be approaching the end of that correction, providing no real weakness develops in the near term.
SPX: Short-Term Trend - The short-term trend is down in what is probably wave "C" of an A-B-C corrective pattern.
Because of market volatility, the short-term trend is better analyzed on a daily basis with the help of hourly charts. This is done in our daily market updates and Closing Comments.
Daily Market Analysis: If you would like to receive an explanation of how I arrive at buy and sell signals and sign up for a free 6-week trial period of daily comments, please let me know at ajg@cybertrails.com
What's Next?
The current short-term decline started when the Federal Reserve decided to raise the rate of Fed funds again. And then, along came Rita on the heels of Katrina, causing rampant speculation that gasoline was going to spike to $5.00 a gallon.
As interesting as it is for the human mind to find concrete reasons for market fluctuations large and small, I have mentioned on several occasion that there is a regular -- like clock-work -- 12-month cycle low due around October 1st.
I have also maintained that, for the past few weeks, the market was correcting the previous intermediate up trend. Both of these "technical" perceptions are more likely to be the true causes for the current market behavior which was forecast long before the Fed took action, and when the hurricanes were merely a gleam in Neptune's eye. We are therefore forced to consider the possibility, once again, that "events" are not the cause of market fluctuations, but are merely physical manifestations of abstract, repetitive universal forces.
In my opinion, the market action of the past few weeks is cycle-related and the structure is a corrective pattern. Is there technical evidence to support this view?
Since a picture is worth a thousand words, let me start by showing you a composite of 4 charts which can be found below in the chart section. It includes daily charts of the SPX, Dow Jones Industrials, Nasdaq Composite, and Russell 2000.
First of all, note the uniformity of patterns. An intermediate up-trend which began in mid-April/early May ended in early August. The indices obviously vary in individual strength, since during this time period the Dow Jones performed rather poorly while the Russell 2000 made a historic high.
The structure is a little different from one index to the other -- which points out the difficulty in applying strict Elliott Wave principles that conform to all indices, or even to determine exactly which wave pattern is being described by each index. As an example, the mid-course correction -- which was occasioned by the bottoming of the 120-week cycle -- is far more pronounced in the SPX and Dow than it is in the Russel 2000. Yet, there is undoubtedly a single trend for all indices from beginning to end.
The price action since early August is also remarkably uniform for all four indices and, so far at least, can only be interpreted as a correction of the previous up trend. The wave pattern is definitely A-B-C, and we are well along in the "C" wave. I have drawn a channel which encompasses the upper and lower boundaries of the correction. The Nasdaq is the only index which has touched the bottom of that channel by breaking slightly below the "A" wave low.
The next graph in the chart section is an expanded daily chart of the SPX, to which has been added an advance/decline oscillator that, although it is constructed a little differently, is almost identical to the McClellan oscillator. We'll focus this phase of our analysis on the three indicators and their relationship to the SPX price action.
Note that at the beginning of the intermediate term trend in April there was a glaring positive divergence showing in both the A/D and MSO oscillators. It was just a little less apparent in the RSI, but there nevertheless. This type of pattern on the daily chart -- especially when there is clear divergence in both the A/D and MSO -- usually precedes a trend line break in the price chart, a reversal of the down trend, and the beginning of a significant up trend.
The same signs, but in reverse, preceded the early August top, especially in the A/D oscillator. The MSO had already started a downtrend when the SPX made its high, and the RSI had been unable to make a new high for the previous two weeks.
At "A", the A/D oscillator once again showed positive divergence while the MSO was deeply oversold and the RSI showed only minor divergence.
At "B", the A/D index only showed minor divergence, but the MSO was clearly overbought while the RSI merely mimicked the price action.
In the current position of the oscillators vis-à-vis the price index, neither the A/D nor the RSI show divergence and the MSO is not yet deeply oversold. More importantly, the MSO needs to begin to round over to signify that a reversal is near. The combined action of the 3 indicators suggest that the "C" wave is not yet complete.
The third and final chart is that of the hourly SPX. It is provided to show that the exact same analysis can be made for the short term on an hourly chart that is done on a daily chart for the longer term. The RSI is no longer shown here, but it is replaced by the BSP index (middle oscillator). The asterisks indicate when patterns of positive and negative divergence to price occur.
An analysis of the hourly oscillators indicates that the VST up trend probably has a little farther to go but I cannot come up with a clear, valid projection. Projections for the lows of wave "C" of both the SPX and the QQQQ have already been given to subscribers.
I have labeled the smaller waves to the best of my ability.
Since technical analysis is a study in probabilities, we can conclude from the above analysis that the indices are probably making a corrective pattern which, after it is completed, should be followed by new market highs, but this will have to be confirmed by future price action.
If the price of crude oil has a direct impact on stock prices, then the current action of oil futures can only enhance the above analysis. Friday's drop of $2.31 in the November crude futures -- which occurred just as another major hurricane was about to score a direct hit on the highest concentration of oil facilities in the Gulf of Mexico -- is bearish for oil, at least for the short to intermediate term, and bullish for the stock market. For those who are fond of such patterns, the past six or seven weeks of trading have created what appears to be a Head and Shoulder top in the daily oil chart. The neck line is at about 62, and if that is penetrated to the down side, it will confirm the pattern. According to the Point and Figure chart, this break would trigger a drop to about 52 or lower.
Gold made a 17-year high last week, but since the commercial traders sharply increased their short positions, it suggests that gold has made some sort of a high. However, it is too soon to tell for how long, because the short term up trend does not yet look complete structurally. Also, it normally takes a sustained level of substantial shorting by the commercials to indicate that an important top has been made, as was the case during November and December of '04. This pattern may be repeating itself, but it would need to extend for several more weeks.
The US dollar may also be "bugging" the gold bugs with its recent strength, and the indication is that it may be ready to make a short term higher high in its recovery attempt from 81. Long term, it is probable that the dollar is making an important low, but it is only in the beginning stages of this process and does not yet pose an important threat to the long-term gold trend.
Charts
The charts that are included in this section were thoroughly analyzed above.
SUMMARY:
The market action of the past few weeks is interpreted to be a corrective pattern which, if it brought to fruition, should be followed by new market highs into the end of the year or early next.
