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 another substantial correction of the bull market which started in October 2002 is probably very near.
SPX: Intermediate Trend - The uptrend from June '06 is rapidly 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.
The stock market is at a critical juncture. Some indices may already have made an intermediate-term top, but a definitive answer to this may not be known for another four to six weeks. Furthermore, in retrospect, this intermediate top could also turn out to be a long-term top which will put an end to the bull market that started in October 2002.
For the past several weeks, I have warned that we were rapidly approaching the end of the upward trend that began in July at 1225 on the SPX. I gave projections of 1400/1405 for the end of the move, and I felt that it could come by the end of December, after the Christmas rally. There is little doubt that the stock market is in the process of mapping out an important top. The only question is whether or not 1407.89 will be the final high for the SPX, or a higher high will be made by the end of December/early January. We should get some good clues in the next couple of weeks.
In the last newsletter, I surmised that the 4-year cycle made its low this past summer and that it was the cause of the powerful rally which started at that time. This premise was based on the fact that no other cycle could have generated such a move. Whether it did or not is a moot point that can never be proven conclusively, no matter what the market does from this point on, but the strong rally had the effect of almost obliterating smaller cycles during a 5-month period. Fortunately, they are now beginning to re-surface and this will make our analysis much easier. Let's begin by looking at a chart of the 6-week cycle which I consider to be an excellent forecasting tool.
On the following hourly chart of the SPX, the 6-week cycle lows are marked with blue asterisks. You can see that the one which occurred in late September was ill-defined, and since this cycle is occasionally shortened to 5 weeks, it was not possible to determine for certain exactly where it had bottomed. But the next low, which came on 11/3 could not have been clearer. We can now forecast that the next low should come -- ideally -- during the week that begins with 12/10, and our first clue as to whether a final top was made on 11/21 will be the amount of weakness that is created by the cycle's bottoming process.
There is another cycle which comes into play during this time period. The 10-week cycle appears to have bottomed on 11/27, causing a quick 30 point decline and an immediate rebound of nearly the same magnitude. The 20 and 10-week cycles also disappeared during the strong uptrend. They had been scheduled to make their lows in mid-October, but there was no visible decline which could attest to the fact that they did. Nevertheless, measuring from that time period, the low which was made last Monday looks very much as if it was caused by the 10-week cycle. The point I want to make is that if this is so, the 10-week, still being early in its up-phase, should counteract the weakness of the bottoming 6-week cycle. Even more important, after the shorter cycle has made its low, the combined strength of the two cycles should produce a strong rally which, combined with the positive influence of the Christmas season, could easily give us a new market high. At the very least, they should generate a test of the highs and forestall severe weakness from occurring for a few more weeks.
The next clue will come from the structural pattern that is completed over the next two weeks. If it is a corrective pattern, it will greatly enhance the chances for a new high. If its nature is impulsive, then the top is most likely already in, and the decline has already begun.
Can we get an idea of how much weakness will develop over the next two weeks? Yes! The distribution pattern which formed going into the high can be translated into a point & figure count. Actually, there are two possibilities. The first is that the current correction could take the SPX down to 1361/1365. The other projects to a maximum of 1354. Since this count is supported by Fibonacci projections which produce the same numbers, this makes them even more valid and worth watching closely to determine if this is where the correction ends.
Note that on the chart above, I have drawn a red horizontal line at 1361. This is the low of the last 6-week cycle. It is also a very important long-term support/resistance level that has been discussed before. Since the Point & Figure and Fibonacci projections center around that level, it is logical to assume that 1360 will, once again, act as support and serve as a platform for the next rally.
I am also including an hourly chart of the NDX so that it can be compared to the SPX. The main purpose of this chart is to show that, as of now, there is no significant divergence between the NDX and SPX. Underperformance of the NDX is a signal that an important top is in place. So far, there is only very short term stuff which indicates that the correction is not over.
The horizontal red line on this index is equivalent to the 1360 level of the SPX. We cannot say with certainty that the uptrend is over until both indices trade decisively below that line. The first sign that a trend change is taking place will come when they break their uptrend line. However, this is not the same as a reversal. The current rally has been powerful and more will be required than the breaking of steep uptrend lines. It will require the penetration of previous support levels as well. During the correction, both trends should be broken before a final rally which may take both indices to new highs. A confirmation that a top is in place would come if the SPX made a new high and the NDX did not.
Our search for clues would not be complete without considering breadth. In fact, both the A/D and the new highs/new lows are showing a deceleration pattern, but it is not one that would suggest and immediate and serious downtrend. Look at the NYSE summation index which appears below. Compare its present formation with the one which preceded the May top. Big difference! Could this mean that the coming decline will be milder than many forecast? Only time will tell; but if this index is used as a gauge of distribution, there is precious little of it at this time.
NYSE McClellan Oscillator and Summation Index
Chart courtesy of DecisionPoint.com
The NH/NL indexes of the NYSE and NQ look pretty much like the summation index: they show little, if any, weakness. There is a little deceleration showing in the NASDAQ, but none in the NYSE. This is not surprising since the NYSE composite made an all-time high last week.
We should also take a look at the long-term trend. And for this, what is better than our weekly forks chart of the SPX. Viewing things from this perspective, there has been little change in the last two weeks. Obviously the two intersecting forks are providing the anticipated resistance, but the price has barely begun to retrace inside the two channels, and the two momentum indicators below have hardly budged. This is not to say they won't when the market is ready, but until they do, how can we call a top?
On the other hand, the long-term trend of the Dow Jones Composite Index is a little more advanced, and the momentum indicators are showing some very definite negative divergence. This is at least a caution signal telling us that this index may be close to an intermediate top.
While there are signs that a significant top may be in the process of developing, the 6-week cycle which is scheduled to make its low around 12/13 is likely to bring about only a short-term correction, after which there is at least the possibility that a new high will be made by some indices, including the SPX.