A 3-dimensional approach to technical analysis
Cycles - Breadth - 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 cycle is still in its up-phase but, as we approach its midpoint, some of its dominant components are topping and could lead to a severe correction in 2008.
SPX: Intermediate Trend - The intermediate trend which started at 1555 on 7/16 should soon come to an end as the 4.5-yr cycle reverses.
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.
Overview
The past two weeks were extremely volatile for the equity markets and was characterized by large price swings. Beginning last Monday, and after dropping 127 points from its 1555 high of three weeks ago, the SPX had a 3-day, 76-point rally only to give most of it back in the next two days. All other indices behaved similarly.
The fundamental reason behind this chaotic condition was that the extent of the sub-prime mortgage woes suddenly became glaring with a number of funds, domestic and European, reporting sharp losses and shutting down, causing concern that the problem and its repercussions may be far more severe than had originally been realized. This caused central banks to inject massive amounts of funds into the system to alleviate fears of a liquidity crisis.
The technical reason is that we are in the time period when the 4.5-yr cycle is due to make its low. Major cycle lows usually coincide with economic disturbances, and this is no exception.
But there are signs that the worst of the price decline may be over. During this last retracement, while the Dow industrials made a new low, the Russell 2000 and the Banking Sector -- both of which had presaged the coming decline by their relative weakness to other indices -- remained comfortably above their previous lows, thereby displaying short-term relative strength. It's also interesting that two sectors that have been the most directly affected by the housing problem -- the Dow Jones Home Construction Index and the Dow Jones Equity REIT index -- also performed relatively well.
Another small positive is the fact that crude oil prices have given up a good deal of their recent gains in the past week. I had stated earlier that the Point & Figure chart formation of oil predicted a move to about $75-78. After reaching that level, it has now retraced to 71. It is too soon to determine whether this is only a correction in a longer-term trend which will eventually take oil to new highs, or the beginning of a more severe decline.
It is normal for the stock market to fluctuate between periods of order and chaos. The beginning and end of chaotic (corrective) conditions, small and large, are predictable with cycle analysis. Some of the indicators which gave warning of an approaching correction are now beginning to predict that this period is coming to an end. We should therefore be looking for the equity markets to stabilize and a resumption of the uptrend. The original estimate was that the correction could extend into September, but some preliminary signals suggest that the low may come sooner.
What's Ahead?
Momentum:
We turn again to the SPX daily chart (courtesy of StockCharts) to show the progress that the correction is making.
You can see the positive signals which are beginning to appear in the RSI (top of the chart) and Money Flow (bottom) indices. They have lost their downside momentum and have flattened out at the bottom of their range. I have also drawn descending trend lines on these indicators. A resumption of the uptrend will be confirmed when these trend lines are broken to the upside.
I have also drawn two channels on the price chart. The SPX has already tried to move out of the smaller channel, but was pushed back. It is important that, in the current retracement, it does not travel all the way back to the lower trend line before it turns back up. This would be an indication of the deceleration in price which precedes a reversal.
Moving decisively out of the smaller channel and overcoming the recent high will be a positive sign that the uptrend has resumed. The index should then move beyond the confines of the larger channel, which would most certainly confirm the fact that the long-term bull market is still intact and that new highs lie ahead.
A positive sign for the longer term is that the 200-DMA is still moving up. Prices are currently fluctuating around it but should eventually move back above it as the uptrend resumes.
The weekly chart gives us a better perspective of the long term action. It shows that, unless it continues for a while longer and goes deeper, the current correction does not seem to be too much different from the previous intermediate downtrends which have taken place over the past 2+ years. What is remarkable here is that the 4-year cycle which bottomed in July-August 2006 and now the 4.5-yr cycle which is currently bottoming have only produced such shallow price declines. This should be an indication that the bull market has longer to go.
If prices had held at a higher level as they retraced after last week's rally, it would have signaled that the correction was already over. But since the index gave back most of its gain, it is likely that the bottoming process is on-going and will take a bit longer.
With last week's price action, the thin blue line of the bottom indicator has become deeply oversold, but has not yet been able to turn up. It will do so when the SPX is ready to resume its uptrend.
Cycles
The long, intermediate and short-term cycles are all playing an important part during this time period.
Longer-term, the 6-year cycle has already topped and the 2 year should do so between now and October. These dominant cycles will not have an immediate effect on the market except to slow down the bull run over the next few months after the 4.5-yr has made its low and takes the indices to new highs, but they should begin to exert downside pressure as we enter 2008.
The 4.5-yr cycle is in the process of making its low. This could take another 1 to 3 weeks of base building action.
The bottoming of the 20-week cycle was probably the cause of last week's substantial rally. I must admit that, because of the strong upside momentum, I initially thought that it might have signaled the low of the larger cycle as well, but the subsequent market action makes this extremely dubious, and it may be at least 2 more weeks before we have strong evidence that it has reversed.
Why 2 weeks? Because the week after next will see a nesting of several short-term cycles which should have some effect on the market. If the 4.5-yr low does occur next week (which it very well may) these short-term cycles will only provide a retracement after the initial lows. Or they may give us the final downward thrust of the larger cycle.
Projections
The 1440 projection given on July 29th did provide a good, temporary rebound for the SPX, but it was followed by a deeper decline to the next projection level of 1426-28 (given to subscribers) which saw an even larger bounce. Since it now looks probable that we will make new lows next week, what would be a reasonable target?
Unless the Point and Figure pattern which was made on Friday changes dramatically on Monday, the next downward projection appears to be between 1410 and 1420. This is supported by Fibonacci ratio targets as well, so it would be the area to look for another reversal and potential low for the larger cycle.
Breadth
There are two aspects of the A/D ratio to which I pay close attention. The hourly figures and the MACD of daily closes, which is a very close simile of the McClellan oscillator.
I find it significant that the low of the hourly figures came on 7/26 when it reached almost -3000, and that this figure has not even been approximated since that date. Subsequent selling waves only brought the ratio down to -2000 on three separate occasions, including last Friday. I believe that this is a sign that we are very close to the cyclic low.
This possible bullish implication is also strongly reflected in the performance of the daily oscillator.
Market Leaders & Sentiment
I have acknowledged NDX and GE as leading indicators. There was no divergence between these and the SPX at the 1555 top, which probably implies that the bull market is still in force. But the RUT and BKX showed plenty of negative readings. Now these two appear to be stabilizing nicely even though the DOW and SPX are still weak. The performance of the Russell was particularly impressive on Friday.
The ISEE Put/Call indicator is also at a level which is normally associated with important lows. Note that it is currently even more bullish today than it was at the March low.
Summary
The intermediate decline which began at 1555 on the SPX and which is caused by the bottoming of the 4.5-year cycle may be just about over. Preliminary positive signs are appearing in momentum, breadth, and sentiment indicators. Also, the recent performance of some leading indexes which pointed to the top are now signaling the opposite.
The 4.5-yr or 54-mo cycle which last bottomed in March 2003 is now in its 53rd month and is on schedule to make its low.
Because of the short-term cyclic configuration, the bottoming process may be extended for another two weeks.
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