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 year-end rally continued to forge ahead during the past two weeks and the Russell 2000 finally joined the other equity indices in making a new bull market high. The only laggard is the Dow Jones Industrials which has yet to exceed its March 2005 high.
The first profit-taking/consolidation of the rally took place this past week, with the SPX giving up about 20 points, most of which were quickly recaptured in a single day, this past Thursday. But there was no meaningful follow through on Friday by this index or any of the others.
The A/D is still generally supportive, but the NYSE New Highs/New Lows index continues to lag the Nasdaq and has not even come close to matching its performance of the last intermediate uptrend.
Oil is beginning to show signs of having ended its correction from 70 and may be making a short term base in preparation for a rally.
The US Dollar continues to be held in check by the 92 level, while gold made a new long-term high to $508.
Current Position of the Market.
SPX: Long-Term Trend - With all indices making new bull market highs except for the Dow Industrials, this trend could continue a bit longer.
SPX: Intermediate Trend - the intermediate trend which began in October is about to be challenged as prices appear to be reaching what is at least a temporary peak.
SPX: Short-Term Trend - The first meaningful correction of the short-term uptrend has now taken place. Since projection targets have been basically met, very little upward progress is expected before the next reversal takes place.
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 firstname.lastname@example.org.
The stock market is at an important crossroad. The short-term trend is topping out and its reversal should bring some clarity about the status of the intermediate and long term trends. The key player over the next few weeks will be the 9-month cycle. It will be responsible for the decline as well as for the ensuing rally. Both will be closely evaluated to determine whether or not we have reached the bull market top, or if it will required another 3-4 months to form.
The base that was established prior to the year-end rally was discussed in the last newsletter. By one Fibonacci measurement, the SPX carried a minimum projection of 1251 and a maximum of 1273. Others suggested 1263 to 1293. This was reinforced by Point and Figure counts from the smallest phase of 1257 to a maximum of 1314. The 1314 count is probably not reachable at this time, but there are valid targets to 1278/1280 which could satisfy both intermediate and long term counts.
As you can see, although there is a fairly wide range of projections, if you take an average of the two extremes, it gives you 1272. This is interesting, because the SPX went up without any pull back to 1270.64 and had its first correction of 20 points after it reached that level Although the correction ended on Thursday with a powerful rally which re-couped most of what was lost, Friday's action may have been significant in the fact that there was no follow-through, with all indices ending the day basically unchanged, except for the Dow which was down 35 points. Also significant, in spite of the fact that the A/D soared to its best level in weeks on Thursday, it spent most of Friday in negative territory, barely eking out a small positive number by the close.
The behavior exhibited during the last two days by both the indices and the A/D suggests that prices are encountering some important resistance at about 1270, and you will see one of the reasons why on the chart below. By resistance, I mean that this is where a significant amount of investors have decided that it is a good place to take profits, and now a battle has begun which will determine who will have the last word: the buyers or the sellers! While this is being decided, prices trade in a narrow range which forms a congestion area. The extent of that congestion area will determine how far the next move will carry.
Quoting from Andrews (P/F) Technical Studies: How far a movement will carry is determined by "THE COUNT" -- which means that we simply count the number of squares across a congestion area to determine the approximate number of points the stock will move. A study of many thousands of congestion areas reveals that there is a direct relationship between the width of a congestion area and the distance the movement which follows will travel (up or down).
As I mentioned in the last newsletter, getting the right Point and Figure "count" is tricky because bases and tops take various forms, each of which has to be evaluated individually. This becomes even more difficult with stock indices, because the patterns they form are not as tight as those of stocks. Nevertheless, with a little practice, and by confirming the count with Fibonacci ratio projections, we have an important means of determining how far a move is likely to carry.
Considering that all the various P&F counts and Fibonacci projections point to the current level of the SPX, it is logical to be prepared for a reversal of the trend, and whether we have already seen the high point of the rally, or it extends by a few more ticks, is probably not important.
While having a valid projection in mind is an essential aspect of market analysis, the next step should be to confirm this projection with analytical tools to see if they also signal a top. In fact, they do!
1. The daily MSO (modified stochastic oscillator) has been in an overbought condition for several days. Recently, it has turned and begun a downtrend. This indicator has a double function: not only does it signal overbought and oversold conditions, but it also works as a momentum indicator, and right now it is showing a loss of price momentum as well as definite signs of negative divergence.
2. The behavior of the A/D provides the best confirmation to price. Currently, the daily A/D indicator is giving us the same topping indication. Although it is still positive, it is obviously losing upside momentum, and it would not take much weakness in the A/D to cause it to break below its uptrend line.
3. Finally, my daily BSP (buying and sell pressure) turned negative a few days ago, and remains negative.
Technical tools which measure momentum, breadth, and buying and selling pressure appear to be confirming that the projection target has essentially been reached and that we should expect a reversal at any time. But the ultimate confirmation will come when the trend line which best represents the current uptrend is penetrated to the downside, and, that this is fully supported by significant weakness in the A/D. What kind of a downtrend can we expect to take place? How far will it go, and how long will it last?
How long will be measured by the time it takes for the 9-month cycle to make its low. Ideally, this is scheduled to be about mid-January. If it goes to term, this is about 6 weeks away.
We don't have to guess at the extent of the decline, because this will be determined by how much congestion develops at the current top, and since this pattern is not yet complete, we have to wait until it is.
In my last Week-end Report to subscribers, I reasoned that it was logical to conclude that we might be reaching the top of the bull market. This would be confirmed if enough weakness developed over the next 6 weeks to break below the October lows. However, there might not be enough distribution in this topping pattern to bring this about. But, if the up-phase of the 9-month cycle fails to make a new high, this could also signal a bull market top.
It is too soon to tell if crude oil has completed its correction, but after an uninterrupted decline of 14 point over a three month period, it has filled the minimum expectations and is now resting on support. It should be entitled to at least a partial retrenchment.
The US Dollar continues to find resistance at about 92 and could move to 94 when it breaks through, but faces increasing resistance which could take months to overcome. Only the building of a long-term base, a process which could take 2 or 3 more years, would allow it to move significantly higher.
Gold has entered a substantial area of resistance which extends from 500 to 550. It would be surprising if it were able to move through this congestion level without further extensive preparation.
Only two charts are included. This will be sufficient to fully illustrate the comments that have been made about the current market position.
The first chart is that of the weekly SPX. It is designed to show the shape of the 4-year cycle. You can see that although the long term trend of prices is decelerating, they have not yet reversed. For the bull market top to have taken place, the next downtrend would have to break below the October lows or, as an alternative, the following uptrend would have to stop short of the current top before turning down again.
The reason why the aging 4-year cycle has yet to turn prices down is that the last low also represented a 12-year cycle low. This does not mean that the market will continue to go up for another 3 years. There are far more powerful cycles which will exert more and more downward pressure with every passing month. These will be discussed in a future issue of this newsletter.
Another reason, is that the projection for the bull market top has not quite been reached. So far, prices have stopped a little short of the minimum target. If the current uptrend could expand by another 10 points, it would give us a better chance of making a 4-year cycle top.
The second chart, a daily chart of the SPX, is provided to focus attention on the current year-end rally. As stated above, we have basically fulfilled the projections and there is enough evidence given by the various indicators that we are in the general area of a short-term top.
On this chart, you can clearly see why the SPX is encountering resistance at this level. It represents the convergence of several trend lines: trend lines that mark the top of price channels, and the extension of a former uptrend line.
The fact that we are at or very near a short-term top is a given. What still needs to be decided is whether or not we are currently at a bull market top. We may not know for sure for another couple of months.