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 could continue to influence the long-term trend, but a correction is probably very near.
SPX: Intermediate Trend - The uptrend from June '06 is coming to an end and could already have ended for some market indices.
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.
In this issue:
- It's all about cycles
- Market Fundamentals
- From theory to practice
- Breadth update
- The long term
It's all about cycles
It is evident that no weakness has yet developed in the stock market. Last week, several indices made new all-time highs before having a mild pull-back into the last day of trading for 2006. This continuing strength is the function of the long-term cycles which are still pointing up. But it is also evident that price deceleration is taking place -- more so in some indices than others. That is primarily the function of 2 cycles which are topping out and are beginning to slow the advance: the 20-wk cycle and the 9-mo cycle. All they have been able to do, so far, is to put on the brakes and reduce the speed of the advance, but they have not yet been able to stop it and put it in reverse. The tipping point for this reversal could come in the middle of January and, when the decline starts, it should continue until these two cycles have made their lows.
The 20-wk cycle seems to range from 18 to 22 weeks in length, so its next low should come in early to mid- February. The 9-month cycle spans about 38 weeks. Here we have a little problem, because the last low was not clear. It could have caused the June bottom, 35 weeks from its previous low, or the July one, which would have made it 40 weeks long. Therefore, the next low could come as late as the end of March.
Another smaller cycle, the 6-week cycle, should be the key player in deciding when this reversal takes place. This cycle has a span which ranges from about 25 to 33 trading days in length and, like all cycles, normally subdivides in 2 or 3 phases. The current cycle made its low 12 days ago and has been instrumental in keeping prices up. Last Friday's market action was probably caused by the half-phase dip of that cycle. If that was the reason, when the market resumes trading on Wednesday it should put an end to this minidecline and continue its uptrend for a few more days before turning down more decisively into the next 6- week cycle low which is probably due about January 18-19.
"Fundamentals", in this sense, has nothing to do with economic statistics. It has to do with the basic forces behind the stock market fluctuations which are anything but random. They are a well-orchestrated scenario of individual components which behave as one. The two principal ones are cycles and structure. When it makes a low, the cycle -- or cycles, if a nesting of several cycles occur -- makes a base which is measured from the end of the previous pattern and the beginning of the new one. By converting this base into a Point and Figure chart, we can establish a "count" which determines how far the next move is likely to carry. The same thing happens at tops, but in reverse. It is amazing how accurate these counts turn out to be most of the time. The difficulty lies in determining the valid count. One has to decide where to start and where to end it, and some base or top formations are more clear than others. Making the right guesstimate comes from experience.
While the base determines how far the move will carry, the structure determines the form that it will take to reach its target. Another amazing thing about the stock market is that the structure becomes complete at the same time that the count is reached. Following the structure from its inception to its completion is the task of Elliott Wave analysts. They use a different tool to measure the extent of a move: Fibonacci ratios, which measurements often coincide precisely with the Point & Figure count. Go figure!
There are a number of other factors which affect market fluctuations that analysts can focus on, all combining to produce the fractal composite which constitutes what we know as "the stock market". I have only described the two which I consider to be the most basic.
From theory to practice
Let's now try to put some of these theories into practice by looking at charts. Starting with cycles, I have already given you the dates when I think the lows will be made. Since the highs and lows of cycles can be elusive, there are many technical tools that we can use to confirm that they have peaked or bottomed. Besides projecting the price move, we can look for structural completion and patterns of deceleration, followed by the breaking of trend and channel lines.
Since the 6-week cycle plays a big role in our short-term analysis, It is important to identify its phases correctly. I have discovered, quite by accident, that GE does an excellent job of that. The following chart which compares GE to the SPX will show you why. Note that there was some ambiguity in the SPX on where the last 6-week cycle low occurred, but not in GE! Clear as can be! The two vertical red lines gives you an approximation of where the next low should occur.
By the way, this represents a new bull market high for GE, and since it is considered to be a leading indicator, where is the stock market weakness, current or future???
Now, we'll switch to a chart of the SPX by itself and look at other things. First. projections: If I take a count (on the P&F chart) at the base of the 10-week cycle (pink lines), I come up with a short and long version. The short one projected to 1430 and has already been reached. The long one which is measured two different (valid) ways give me a target of 1436. This is reinforced by a count taken across the 6-week low (blue asterisks) which measures 1437. Since there are Fibonacci projections which correspond to this level, it has to be considered as a potential target for the final high of this move before the intermediate cycles take over. However, we have to keep in mind that the short count to 1430 may prevail.
Next, structure. Earlier, I had discussed a potential ending diagonal pattern. Based on what I have labeled here, a final short wave which makes a new high (to 1436, for instance) would be perfect to complete the final wave 5 and bring about a reversal. If the 6-week cycle can give us a little more on the upside after Friday's correction, it may just push prices right up there to satisfy both projection and structure.
The stock market is like a puzzle; the more pieces we can fit together, the higher the probability of getting the picture right!
Whether or not all that was discussed above comes to pass, we should decide what market action will confirm an important reversal. Looking again at the SPX chart and doing a little mundane technical work, we come up with 5 trend and channel lines which converge on the area between 1411 and 1415. These should provide important short-term support for price. If penetrated, it would be an indication of market weakness and, to me, mean that the cycles have now turned down. Also, just below that area lies 1410, the last retracement level of the SPX (horizontal red line). If it should fall below that, it would be the first time since 1225 that the index has made a lower short-term low, and THAT would have to be considered significant, technically.
In the last newsletter, we discussed several warning signs, one of which was the under-performance of the NDX to the SPX. Nothing has changed in the past two weeks, and the warning of an intermediate-term top is still there.
This warning is also becoming more pronounced in the breadth indices, as the following charts make clear.
Note that the underperformance of the Nasdaq to the NYSE also shows in the breadth charts.
The long term
Finally, to show that what is about to take place is probably nothing more than a correction in the long-term trend, here again is a chart of the weekly SPX. Major trends very seldom end without signs of serious distribution. So far, we have none.
Slowly waning strength is the message that is being sent by the stock market. With GE making a new bull market high recently, there is very little indication of long-term weakness on the horizon, but intermediate cycles are beginning to slow down the advance and should soon reverse it, bringing about the first important correction since the June/July lows.
I want to wish everyone a new year filled with peace, joy, health and prosperity.