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
My analysis has been giving me warnings that the market might be coming to an intermediate top. These warnings have increased over the past few weeks, and can no longer be ignored. It is time to ask ourselves if we have already seen the top and if a reversal has already occurred. Too soon to say for sure, but the next week to 10 days should help us decide.
Let's start by repeating some comments which I made in the 12/10 Interim report.
Projections for the final high: Only approximations coming from Fibonacci ratios -- some extending back to the 2002 bottom -- can be made at this time. After the 4th wave is deemed to be complete will we be able to verify these estimates with shorter term Fibonacci targets and a Point & Figure count.
Current longer term projections range from 1426 to 1433 for the SPX. But it is possible to estimate at least one shorter term projection, and it ranges from 1424 to 1432, consistent with the longer term counts. So it appears that as the pattern moves toward completion, only refinements will be needed to determine the exact reversal point.
On 12/18/06, the SPX reached 1431.81, had a brief decline, and tested the high by moving back to 1429.42 on 1/03/07. And declined again until last Friday.
There is no conclusive evidence that a top has been made, especially since another rally is expected from the current level or slightly lower, but the moment of truth is fast approaching because if this rally does not make a new high and is followed by a lower low -- lower than Friday's low of 1405.75 or Monday's low, if it is lower -- it will become the first rally in a downtrend since July '06 when this uptrend started at 1225. This would imply that a pattern of lower highs and lower lows may have started.
What are the odds that this will occur? To find out, let's put the market under a microscope!
Cycles: As mentioned in the last newsletter, I believe that the long-term cycles are still pointing up and that any correction occurring at this time would be limited in scope and only be a consolidation in the long-term uptrend. But we know that the market "fluctuates", and that there are short fluctuations which are caused by shorter cycles.
There are 3 short to intermediate cycles which are coming into play:
- The 6-week cycle, which I take to have made its low on 12/12/06, and which is currently 15 trading days along its normal span of 26-30 days. Since a dip into its half-phase frequently occurs, we can presume that this was the cause of the current short-term decline. We can also presume that this dip will be followed by another rally before the full cycle turns down into its next 6-week low scheduled to occur toward the end of January.
- The 20-week cycle, which is "presumably" 15 weeks along its normal span of 18-20 weeks -- therefore past its mid-point, and on its way to a low about mid February.
- The 9-month cycle, which is presumed to have made its low in July, is currently 24 weeks along its normal 38-week span, and is expected to make its next low in early to mid-April.
Of the three, the 9-month is obviously the more influential because it is the longest, and will exert the most downward pressure on prices. This cycle has its greatest impact in a bear market. When the long-term trend is up, its effect is minimal, but still significant. In the current bull market, it has topped anywhere from 4 to 10 weeks ahead of its low.
The above cycles and the dates of their approximate lows should give us a road map to the coming correction, and their combined action should (after the high has been reached) push the market to lower and lower levels in a series of short-term declines and rallies until about early April. What happens after that date is a subject for another day, but the long-term uptrend should resume.
What evidence is there that these cycles are collectively beginning to turn the uptrend around?
Deceleration in price and breadth: At the bottom of a trend, accumulation takes place. At the top, distribution. Distribution, simply put, means that sellers increasingly outnumber the buyers, and this is noticeable in decelerating price action and an increasingly negative advance/decline ratio. These are two sides of the same coin.
The price action is telling us that some selling is taking place, nothing major yet, but it started at the 1431 top and has continued for 11 trading days until last Friday. This is the longest short-term correction since the 1225 low. If we don't make a new high next week, it is likely that it will extend into the end of the month in conjunction with the 6-week cycle low.
The NYSE McClellan Summation Index, which measures the amount of time that the McClellan oscillator spends in negative vs. positive territory, has been declining since early December, meaning that breadth is becoming increasingly negative.
The new highs/new lows index is probably more indicative of the intermediate term trend than it is of the short-term. In this sense, it tends to go along with the summation index. Mike Burk publishes the "Technical Market Report", and in last week's edition, he said: "New lows begin to increase as the market approaches a significant top."
Thus, price deceleration and increasingly negative breadth appear to confirm what the short and intermediate cycles are suggesting: An intermediate top may be in the making.
Projections: I started this article by saying that an important Fibonacci price projection had been met when the SPX traded at 1431, and the index did what it was supposed to do when a valid projection is met: It reversed! The question is, how significant is that reversal? I believe that it will be answered next week.
Another way to assess how far price will carry is through Point & Figure analysis. Last week I pointed out that the market had met the lower of two valid projections when it reached 1430, but that there is a higher one to 1437 which is still in play. These projections were taken across the recent short-term lows. Since the shorter (1430) target was met in conjunction with the longer-term Fibonacci targets mentioned above, it is possible that this is all we get and that 1431 will turn out to be the top.
Perhaps we can get some additional clues from the current market action. In an update to subscribers on Friday, I made the following comment: After the first selling wave was over and a brief holding period, another selling wave was expected (abc). Since the last wave reached a potential P&F downside target (1407) for the correction, we could start seeing the beginning of base building action in this area.
In fact, the SPX did go one point beyond its projection to 1406 before engaging in what may have been basebuilding in preparation for the next rally. But we won't know until Monday if that was the actual low of the correction, or if we go just a little bit lower. There are some indications that we may! There are unfilled P&F targets to 1404, and perhaps even 1402 which could still be met. Just as with Fibonacci projections, there are at times several P&F valid targets. It's up to the market to decide which it wishes to honor.
Another reason is that the A/D ratio was heavily negative on Friday, and although it lifted a little into the close, it did not reflect aggressive buying, so there could be some residual selling into Monday morning. In fact this would be perfect, because it would give us the positive divergence, indicating that a low is in place. On the other hand, this high negativity may reflect a short-term selling climax.
Let's assume that the market did make its low on Friday, that the base building is over, and that we start up on Monday morning. We have already established a base for a good "count". In fact there are several with the shortest one taking the SPX back up to 1422, and the longest to -- here is that number again --1437! A caveat: if the market does make a new low on Monday, it will invalidate these counts and establish new ones.
You can see why next week promises to be extremely interesting!
Structure: There is one more important aspect of the current market action to consider: structure! When it traded at 1431, the SPX completed a 5-wave pattern from 1378 which fitted very nicely into a larger structure from 1225. But by making a new high to 1437, this would also fit very well within the longer structure.
In conclusion, there is really nothing in the above analysis which would preclude the SPX from making a slightly new high before it finally reverses to begin an intermediate decline in earnest. In fact, we might have a clue that a new high to 1437 might be the preferred scenario. The NDX, an excellent leading indicator, started to look a little toppy in December when it refused to go higher while the SPX did. Then came the correction in both indices which may have ended on Friday for the SPX, but which ended two days earlier for the NDX in a climactic spat and an immediate rebound. If this obvious positive action of the NDX vs. the SPX continues over the next couple of days, it will increase the probability that we could see a new high in the latter.
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