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
Current Position of the Market.
SPX: Long-Term Trend - The 12-year and 10-year cycles are still in their up-phases and should continue to influence the long-term trend, but a substantial correction of the bull market which started in October 2002 is probably very near.
SPX: Intermediate Trend - 1356/1360 is an important level of resistance which could mark the top of the uptrend which began in July.
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.
The 10 and 12-year cycle should be a positive influence on prices until 2009. But that does not mean that the bull market will continue without interruption until that date! There will be corrections along the way -- some quite severe -- and one is probably right around the corner. Expectations that the 4-year cycle would bring about a substantial decline into October 2006 have been dashed. Some say that an "inversion" is taking place, even though this has never happened to this cycle before. Others believe that it is simply late and that its low is still ahead of us. Based on an analysis of current market patterns, I suspect that both sides will end up thinking that they were right. Whether caused by the 4-year cycle or some other factors, the stock market is about to enter a substantial corrective phase. Let's discuss why, going from the general to the specific.
First of all, proof that history repeats itself can be found in the 10-year pattern of the U.S. stock market which is illustrated below. This represents an average of price patterns for the past hundred years and it is known as the decennial pattern. There is no known rational explanation for it. It simply happens! As you can see, based on this evidence alone, an investor would be wise to become cautious at this time.
The next set of charts compares the price behavior of the SPX with three other indices which have had an excellent record as leading indicators. All are in an uptrend, but the new high recently registered by the SPX remains unconfirmed by the other three. This is a red flag, and another reason to be cautious.
Since deceleration in price normally precedes a top, let's look at a weekly chart of one of the broadest stock averages, the NYSE Composite. Plenty of deceleration, here! You can see it plainly in the price, but the momentum indicators below show it even more graphically. Also note that it did not make a new bull market high last week along with some of the stronger indices.
The picture that we have, so far. is that we are approaching a time period which, historically, has proven to coincide with a major stock market top. Evidence that history is about to repeat itself is ample as more and more indices are reluctant to extend their gains. In fact, the Dow Jones industrials and the S&P 100, both of which are made up of large cap stocks, are the only ones still showing real strength, and since they have a strong influence on the SPX, that index is also making new bull market highs. When it reverses, it will probably signal a reversal for the entire market. Can we predict when that will be and from what price level? There is no way to know for sure, but an analyst can make some assumptions that are based on proven methods.
Since our previous credible Point & Figure projection of 1332 taken at the July base was surpassed, we should consider the next one which counts to 1352/56. If we go beyond it, the final one which can be considered valid using that base is at 1383. Using Fibonacci ratios, we also project that 1355-1360 is an important level which should arrest the uptrend of the SPX at least temporarily, and you can see on the next chart that resistance at that level is also provided by an extension of a previous support line and the convergence of upper channel lines. The index reached a new bull market high of 1353.79 on Thursday and backed off early on Friday: but by the end of the day it was trying to get back in an uptrend. The potential for this to be a high point is enhanced by the expectation that short-term cycles should make their lows in the next week or two. If they bring about a fair amount of weakness, it may signal that a top has been reached.
Of the two indicators below the price chart, the breadth indicator appeared to be on the verge of giving a sell signal two weeks ago. Since then, it has steadied itself and is oscillating in a small range on both sides of the zero line. If it should experience a sharp break in conjunction with price weakness, it could mark the start of a decline. The same can be said of the momentum indicator, above, which has been overbought for several weeks. A break of its uptrend line would also correspond to the beginning of a downtrend. But final confirmation that a significant reversal has taken place can only come from the price action itself.
On the chart, I have drawn two horizontal red lines near the top. If prices reverse below the first line which is at 1328, it will be the first indication that an important reversal may be taking place. If they go through the heavier line at about 1310, we can be almost certain that a bull-market top has been made. By dropping that far, prices would also have to penetrate their uptrend line as well as the moving average, and this would be a major negative sign.
Finally, I want to show you an hourly chart of the SPX and of the advance/decline ratio because it too seems to be telling us that a reversal could take place at any time. The deterioration which has been taking place in the A/D is very visible on this chart, and after a one day surge which occurred on Wednesday, there was no follow through and a short-term sell signal was given on Friday. Since the daily price indicators also gave a preliminary sell signal that day, I believe that a decline could start as early as Monday. The price structure probably needs one more small wave up to a new high to be complete, and this would put it in the Fibonacci/resistance zone. The market action following this completion will determine whether or not a major top has been made.
Fewer and fewer stock indices appear capable of making new highs as we enter a time frame which has historically proven to bring about a market top, followed by a significant decline. The short-term indicators also signal that a reversal is imminent. Whether this turns out to be the actual top of the bull market or it means that we are just starting a period of distribution that will take a few more weeks to complete will be decided in the near future, but the risk to investors has become very high.