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 Bull Market Top? Maybe!
A Review of the Past Two Weeks.
A week ago, the stock market was still acting as it has done for the past few months with the NYSE composite and Russell 2000 making new historic highs, while the Nasdaq composite was playing catch-up. But a significant change may have taken place last Friday when, at the opening, an attempt at resuming the uptrend failed immediately and all the indices closed near their lows of the day with the worst daily advance/decline figure in nearly six months.
What marks Friday as a day on which something significantly different took place, is that there was cohesive negative behavior among all the indices.
Oil has been on the rise throughout the whole month of March and, last week closed above 67.
Gold was also on the rise and is challenging 600, its highest level in 25 years.
The US Dollar is still in a trendless consolidation pattern.
Current Position of the Market.
SPX: Long-Term Trend - Equity indices are in the process of ending the bull phase which began in October 2002 and are about to begin a retracement into the 4-year cycle low which is due in October 2006. This past Friday's market behavior is, at the very least, a sign the market is having difficulty moving higher, and this could soon lead to a trend reversal.
SPX: Intermediate Trend - The intermediate-term trend which began in October just made a new bull market high but will be coming to a critical point, next week. This statement made in the last newsletter was premature by one week. Last Friday's action carries strong technical implications that the SPX is beginning a correction.
Analysis of the short-term trend is done on a daily basis with the help of hourly charts. It is an important adjunct to the analysis of daily and weekly charts which determines the course of longer market trends. Daily market analysis of the short term trend is reserved for subscribers. If you would like to sign up for a FREE 6-week trial period of daily comments, please let me know at firstname.lastname@example.org.
In the last newsletter I showed that most indices were up against the top of their Phase III long term channel which began in October 2004 where they were likely to meet very strong resistance, and that this would be a good area from which to start a reversal. The market action this past Friday suggests that a reversal may have begun, but one day does not make a trend and this will have to be confirmed by additional weakness in the next few days. Let's begin with an analysis of the daily SPX chart.
Note that the projection area (pink bracket) had been reached three weeks ago and that repeated attempts a pushing beyond it had failed. The heavy red lines are the extension of trend lines which provided resistance to prices. Two of these were converging on Friday and the SPX, after a brief attempt at moving through them, quickly gave up and continued to sell off into the close, thereby making one of the most bearish technical patterns known: an outside day where prices closed on their lows accompanied by the worst daily advance/decline figure since last October. The oscillators at the bottom of the chart fully support the negative scenario, and we have to conclude that a reversal is probably at hand.
Let's assume that we are beginning a decline, what does that imply? Have we seen the top of the bull market?
Only MAYBE! It all depends on the follow through from here. The fact that the indices were up against the top of their long term channel is a sign of long term strength, and it is very rare that long term strength suddenly turns into long term weakness. At the very least, a top is followed by a decline and then a test of the highs takes place. When that fails, it is followed by much more weakness. The 2000 top was tested 5 months later and only then did significant weakness begin.
All important tops require a period of distribution whereby stock changes from strong hands to weak hands. This is another way of saying that, when they deem that the time is right, the professionals take advantage of the amateurs who have become bolder and bolder in their purchase of stocks as the market advances. After many months of uptrend, they are finally convinced that the advance is here to stay, and this is where the distribution begins. You can see this process taking place better on a point and figure chart than on a bar chart, but the sideways trading within a limited range since the middle of March very much looks like distribution which should eventually lead to a decline!
Friday's action suggests that we may have made a short term top, which COULD turn into a larger top if that high is not exceeded in the next rally. But all we can say for certain at this point is that it would represent the end of the market phase which began in October of last year. Having reached its projection zone, it should be complete and ready to reverse. Last Friday, when the SPX rose to 1314 at the opening, immediately reversed, and continued to sell off into the close, it implied that the three-week old sideways pattern that marked the top of that phase had come to an end and that a reversal was probably under way.
Because of its fractal nature, the market moves in phases. Each phase has a pre-determined price projection based on the amount of accumulation or distribution that takes place at the high or low point. As stated earlier, the degree of accumulation or distribution is best observed on a Point & Figure chart from which a "count" can be taken and which is normally confirmed by a Fibonacci projection. When an up-phase is complete, then a down-phase begins and continues until it has exhausted its distribution potential.
On numerous occasion in past newsletters, I mentioned that the amount of accumulation that took place at the October low in the SPX called for a move to about 1320. Later, as a result of confirming projections along the way, I established a projection zone from 1304 to 1320. For three weeks, the SPX tried to move beyond this level and was forced back every time. Last Friday this happened again, but this time, the failure was accompanied by the worse A/D ratio since last October. I believe that this signals an important change in market psychology which could lead to an important reversal of trend.
Forecasting a major top, however, would be premature. First, we have to see a trend develop. Also, because cycles help to determine how long the down-phase is likely to last, we can estimate that if a decline begins now, it will only continue until about April 18, at which time, another up-phase is likely to begin, Only if this subsequent rally fails to make a new high can we say for sure that 1314 was the top of the bull market.
I think that it would help us to put the market phase which began in October in the proper perspective by seeing where it fits within the longer trend. In order to do this, let's expand the above chart and take it back to August 2004. When placed in that context, you can see that the move which started in October is only a segment of a much larger complex which began to form nearly 2 years ago. You also notice that the larger channel can easily be divided into two portions and that since November last, trading took place exclusively in the upper portion of that channel. This is a sign of strength but, no matter how much it tried, the SPX could not reach the top of the channel, and THAT is a sign of beginning weakness.
Another sign of weakness was the fact that in the move from the October low, prices have remained in the lower part of that channel since February. So, considering that there is recent observable weakness and that we do see an apparent phase of distribution, it is not unconceivable that the high made last Friday might be the Bull market top.
That, however, is only speculation at this point and we should, instead focus on the coming decline--if it materializes. I have already mentioned that it would be expected to last until April 18, but how far can it go? Looking at the above chart, there is an internal support line which is a parallel to the lower trend line and which currently runs at about 1260. Just below that, the red horizontal line is drawn where there is good support. Since this area would also represent a .382 retracement of the entire October phase, it looks like a logical place for the alleged decline to end. There is also a phase of the distribution which took place in the topping area which projects to 1260. If we should go lower, a 50% retracement would take the index to just above 1240.
There is good evidence that a decline has already started in the Dow Jones Industrials. You may remember that in the last newsletter I had pointed out that it had come up against a resistance line in a 5-wave pattern, and that made it vulnerable to a pull-back. One could also make a case that the S&P 500 just completed a 5-wave move, but the last wave turned out to be a "terminal pattern". On the chart of the Dow below, it looks as if a shortterm downtrend is already under way and a drop of only another 25 points would take the index below the last support level and confirm the downtrend. The decline in the momentum indicator at the bottom of the chart is already well established.
An argument that this may only be a short term decline is that the divergence between the Nasdaq 100 and the SPX no longer exists. In the past two weeks, the NDX has had a good rally and is now on an even par with the SPX. By rallying it also pulled away from the trend line and support level which it threatened to break less than a month ago. This resurgence of strength may only be temporary, but it is another reason to think that we are not quite ready for an immediate and sustained decline.
SUMMARY: The long term trend is still intact, but last Friday's market action implies that a change of trend may be starting.