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September 21, 2005

Nasdaq At The Brink: "Ws of Doom" Update
by Dan Basch

Introduction

This is a follow up to a previous essay entitled ANN, The Nasdaq and the "Ws of Doom" in which I had written on the similarities between ANN Taylor's 1999 post-Rising Wedge scenario and today's Nasdaq stock market. The correlations between the two have evolved to a point where a severe decline is potentially in the cards for the Nasdaq.

Because their evolution has continued as anticipated, this essay will serves as a follow-up and provides one possibility of what to expect as this potential storm of market capital destruction evolves. If you have not already read the first essay, I encourage you to do so before continuing as it may make the following concepts clearer.

In the first essay on this topic, I drew a correlation between today's Nasdaq and ANN, however it is here that I turn my attention from the Nasdaq composite to the Nasdaq 100 (NDX) as a closer approximation to ANN's 1999 formation. The indication offered by this similarity is that the Ws of Doom on ANN served as a complex distribution pattern which has been emulated by both the Nasdaq and NDX over the past several months. This closely correlative evolution of the formation on the NDX has thus far lead me to handsome profits, and today has reached a strategic inflection point where it may imminently engage in a steep decline.

Nasdaq Teetering on ANN's Precipice

As one can see in the following two charts, the NDX has developed a more proportional chart to that of ANN. On the NDX, the last W of Doom developed through July and then declined in August as anticipated when it had a reaction rally upon touching the pink support line as delineated by three pink arrows. The correlation lead me to expect the early September rally would turn south with a vengeance in a classic bull trap and furthermore, if the development breaks the pink support line to the downside, it will continue in a rapid descent as did ANN.

The NDX is about to tell us whether September 13 was the pivotal point synched up with ANN's last red arrow and if today it's at the same point as ANN's last stand at the pink support line. The defining moment of this market drama is upon us: To crash or not to crash, that is the question that the Nasdaq will answer in the coming days and weeks.

Today's NDX:

Post-Rising Wedge ANN from 1999:

Today's Setup From a Contrarian's Perspective

As a contrarian, I find it amusing that many pundits and newsletter writers tend to be bullish at times when my interpretation is the opposite (and vice-versa), so I will remain bearish until the Nasdaq's fate is definitively resolved. Not recognizing, or recognizing and not believing ANN's emulation on the NDX has caused consternation to many a trader over much of this year and that may be amplified by an order of magnitude if ANN's past is the NDX's prologue.

We live in interesting times and the world continues to evolve in strange and improbable ways. The head of the army corps of engineers placed the probability of Hurricane Katrina's occurrence at 0.5%, or a 99.5% probability it wouldn't happen, and said the levees surrounding New Orleans were not designed to withstand a "two- to three-hundred year event". But with Mother Nature, we must expect the "unexpected" which was in fact anticipated for years. A similar argument can be made for technical analysis when formations arrive at strategic inflection points in the stock market.

With the completion of the Ws of Doom and the Nasdaq now poised at the support line representing possibly its last stand, the stock market now has a perfect excuse to justify a severe decline. But this is not the first time the market appeared to telegraph its intentions before an historically significant disaster.

The Nasdaq Forecasted The Market Decline Which Included 9/11 Terrorist Attacks

One of the most amazing phenomena I've witnessed in the stock market which cemented my belief that technical analysis has real merit was the market setup before the 9/11/2001 terrorist attacks. When that horrific day occurred, it happened to be during a decline to target of a Descending Triangle on the Nasdaq which had broken and retested just days before. This might sound like something some loon in the woods would say, but let me demonstrate using historical record just how the decline of September 2001 was anticipated by the stock market (not the acts of terrorism, just the market decline).

Note that in the weeks preceding 9/11, the Nasdaq had formed and perfectly retested its Descending Triangle with its target calculated as 2328-1934 = 394 points and then subtracting this from 1934 which gives a target of 1540. This is how the Nasdaq appeared on August 27, 2001.

A mere two weeks later, a period which included the 9/11 terrorist attacks, the market arrived at target. By using technical analysis, we can see that the market had telegraphed to those who heeded its message that not only was a severe decline coming, but it also foretold of its magnitude!

History shows the Nasdaq's 2001 Descending Triangle accurately forecasted, developed, broke support, retested support as resistance and then resolved to its mathematical target. An economist friend of mine dismissed this as impossible to discern, but I witnessed it myself. There are certainly times when technical analysis flops, but there are also times when it can be an effective market guide even in the darkest hour.

For my comparison between today's NDX and ANN's Ws of Doom, I am going to consider the high probability of a decline on the Nasdaq, but not calculate any target just yet. The reason for this is that it is an unusual formation and because of this, its target parameters may vary depending on which method of technical analysis is applied. More on this in time should the formation continue as anticipated.

Conclusion

The above demonstration of how technical analysis can telegraph stock market behavior gives one pause for what the Nasdaq's future holds in store. Now that it has traced ANN's post-Rising Wedge formation, will the Nasdaq and NDX take a similar fateful plunge?

Extrapolating further, the recent Hurricane Katrina disaster is an ideal justification for a market decline. It provides all the spin that the talking heads and pundits will need to make the anticipated decline acceptable to the public. This occurring within the context of the NDX's evolution tracing ANN closely, almost rally-for-rally and drop-for-drop, indicates that a decline of commensurate intensity could be imminent.

Since I am not a professional investment advisor, and am merely a garden variety retail speculator and I'm absolutely not qualified to give investment advice of any kind, my non-advice would be to consider the market's setup within the context of historically significant large-scale disasters, for the incredibly close approximation of the NDX to the formation of post-Rising Wedge ANN indicates a severe decline may be in the cards for the Nasdaq. Of course, this is merely elaboration on a theory so the possibility exists that it could go move up instead, and if so, such are the hazards of being a contrarian.

As when a man asked the undertaker, "Don't you ever get depressed in this business?" He replied, "Sometimes, but then someone dies and I snap out of it."

Best regards to you and I hope you are having a pleasant day.

Dan Basch

Copyright © 2005-2009 Dan Basch

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