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
The stock market indices continue to perform according to their historical yearly and decennial patterns.
The October period of each year is a period of consolidation which results in a year-end rally after it is completed.
As of 2 weeks ago, things still looked a little "iffy", with wild daily swings which could not establish a clear trend, but the last 7 trading days have clarified the direction in which the markets are heading.
All indices have made a strong showing, leaving their recent lows far behind, and one of the leaders is, once again, the Dow Transportation Index which has already risen to historical highs. The Dow Industrials only needs to move up just a little more than the distance it traveled over the past 4 weeks to give a powerful Dow Theory buy signal and get a lot of long-term investors on board.
Another index which made an all-time high was the Securities Broker Dealer Index (XBD), and since this is one of the most reliable leading indicators, its performance, along with that of the Transportation Index, has profoundly bullish implications.
Crude oil continues to hover around $60, briefly dipping below $59.
Gold is at an important juncture. If it cannot start another significant rally soon, it could be susceptible to another sharp retrenchment.
The US Dollar finally broke above 90 achieving a new recovery high last week.
Current Position of the Market.
SPX: Long-Term Trend - There were some indications in the past two weeks that after a period of consolidation, the long term bull market trend might be resuming.
SPX: Intermediate Trend- The intermediate trend was down in a fairly mild corrective process for about 3 months, but the past two weeks have given a signal that a new up-trend may be underway.
SPX: Short-Term Trend - After bottoming at 1168, the short-term trend underwent a brief period of indecision from which it emerged into a well defined up-trend. However, there are signs that a correction could begin by the middle of next week.
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.
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Last week I mentioned that three conditions are usually required to signal that the final low of an intermediate downtrend is in place. This time, these signals were a little murky! The conditions were:
1) The structure of the correction must be completed. Until last week, I had difficulty determining the structure, and thought that it could be interpreted as a continuation of the corrective pattern. But after reviewing the Russell 2000, I have to conclude that we are currently completing the first up-wave of a new intermediate-term trend.
2) Prices must enter a final, valid projection zone. My minimum projection for the move was 1166 and since the decline stopped at 1168, I felt that there was a reasonable chance that we could go slightly lower. We did not!
3) The advance/decline Index (and other indicators) must show the kind of pattern which indicates that buyers are beginning to overcome sellers. Normally, this takes the form of distinct positive divergence in the McClellan and momentum oscillators. This time it did not, and even the MACD histogram failed to show it!
Nevertheless, it appears that an intermediate low has been made, but it will require confirmation over the near term to make absolutely certain. Let's examine the technical evidence:
Cycles. There is no question that the 12-month cycle -- the cycle which is responsible for the October correction each year -- has made its low. However there are two other cycles which should bottom over the next 2-3 weeks: the 20-week and 9-month cycles. There is enough overall positive action that we can expect them to provide a successful test of the recent lows and not go below SPX 1168.
Structure. My best guess is that we are about to complete wave 1 and that the cycles mentioned above will create wave 2. After that, if this is indeed the beginning of an impulse wave, the up-trend should pick up significant momentum.
Breadth and other oscillators. For the first part of the move, the advance/decline index mirrored the erratic price action, but all that changed in the past 10 days and some strongly positive numbers have emerged. However, the daily oscillator has become overbought and the hourly is showing negative divergence. This is an indication that the initial move from 1168 is coming to an end and that prices should begin to correct in the next couple of days.
The new highs/new lows index is not quite as bullish as the A/D and has barely managed to eke out a predominance of new highs, but this is not unusual for the beginning stage of an advance.
The BSP (buying/selling pressure) index pretty much confirms the action of the A/D. It is more reliable when constructed from hourly figures and from even lesser time frames because it reflects the action of short-term traders which tends to be more correct about future market trends than longer term investors. For this reason, the BSP index usually leads all other market indicators. It is currently signaling that a short-term reversal is imminent.
The daily MSO is overbought, another sign that a retrenchment of prices is due, but the weekly version, as shown in the chart section, has begun to turn up from an oversold condition and this is normally a bullish intermediate signal.
The daily MACD has rallied from deeply oversold to neutral. After such a move it usually pulls back a little before turning positive. The RSI is non-committal.
Leading indicators. These range from bullish to very bullish. In the last newsletter I mentioned that I was keeping a close eye on the Nasdaq 100 because it tends to lead the SPX and because signs were beginning to appear that it was outperforming it. This is even more visible now, with the NDX already challenging its early August high. Its performance is all the more impressive considering that it should have suffered a set-back when the Semiconductor index made new lows a week ago.
The Banking Index (BKX) is acting well, but the Securities Broker Dealer Index (XBD) is acting even better and has extended its move into record-high territory where it was joined last week by the Dow Jones Transportation Index.
Projections. For the SPX, the end of the short-term trend is likely to come in the next couple of days. Longer term, if 1168 holds and a wave 2 is confirmed, it should be followed by a wave 3 and easily surpass the former high of 1245. This would trigger projections for this move to 1277/1292.
Oil has held at $60. Short-term, it is very oversold and looks ready to attempt a rally which will probably fail before it gets to 70. After this, it could easily retrace to the low 50's but it does not seem quite ready to reverse its long term up-trend just yet.
Last week, the US Dollar made a recovery high of 91+, but it may not be able to move above 92 without further consolidation. It appears to be making a long term base in the form of a Head and Shoulder pattern with the neck line at 92. If -- I should say "when" -- it moves above its neck line, it should easily continue above 100.
Such a move by the dollar would be bearish for Gold. However, gold's short-term technical pattern suggests that it is ready to test its recent highs, and this is confirmed by the COTs which have covered a little more of their short positions. From a longer term perspective, however, the fact that the XAU has not confirmed the recent move of bullion to new highs is bearish. The Point & Figure chart pattern of the XAU is beginning to show a significant accumulation or distribution area which will shortly result either in a very strong up-trend or down-trend. We should know in a matter of weeks which it will turn out to be.
In the first chart, that of the daily SPX, the corrective pattern is outlined with dashed lines. The up-trend which started on 10/13 paused briefly on the top line of the channel and then broke through and penetrated the down-trend line (solid) line as well. However, it is not a decisive move through the trend line and prices will have to close above 1233 (dotted line) for an absolute confirmation that the trend has reversed. On the hourly chart, you will note that the NDX has in fact accomplished this and it is a positive signal.
Back to the daily SPX, the RSI is not telling us much, simply rebounding from an oversold condition and going along with prices. However, the MSO is not only overbought, but is beginning to round over. This indicates that a short-term top is forming and that we should expect a pull-back.
The A/D oscillator has become overbought and needs to correct as well, confirming the signal given by the MSO.
The second chart displays the weekly SPX on top and the NDX on the bottom. I have included it to demonstrate how the NDX is outperforming the SPX, and also to show how close the NDX is to making a new bull market high. Another aspect of this chart is that the weekly MSO is turning up from near-oversold on both charts, strongly indicating that an incipient intermediate up-trend is taking place.
The next chart, an hourly chart, shows the positive divergence of the NDX (second from top) even more clearly. The horizontal dashed lines are drawn across the early August highs from which the intermediate correction began.
Another very important feature of this hourly chart is that both lower oscillators are diverging negatively from the price and this is another clear sign that a short-term correction is imminent.
Finally, the last chart compares the Dow Industrials to the Dow Transports. It speaks for itself! The transportation index, on top, is forging ahead. Will it lead the Industrials to new highs? That's what the future will determine.
The MSO on both charts is also overbought and needs to pull back. If the Industrials do not suffer too much of a set-back on this retrenchment, it will enhance its chances to follow the lead of the Transports.
There is technical evidence that the October correction is over and that a new intermediate term up-trend has begun which could result in new bull market highs by the end of the year. In fact, the leaders are already there! But a lack of uniformity is apparent, and much will depend on how all the indices behave in the coming short-term retrenchment.