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 but their influence will be reduced in the weeks ahead as intermediate and long term cycles bear down into year-end.
SPX: Intermediate Trend - A pattern of deceleration is beginning to show in several indices. An intermediate consolidation is expected to begin by the end of February or early March.
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.
This is getting repetitious to the point of becoming boring! "In the last two weeks the major indices made new bull market highs", etc. And misleading, since it might suggest that large gains are being achieved, which is not the case. However, even the Nasdaq 100 which had been a laggard managed to top its previous high by a minuscule margin. But the big event was that the Dow Transportation index made a new bull market high! If you believe in the Dow Theory, you have to pay attention because this reaffirms the fact that the bull market is still in a primary trend.
Nevertheless, there are definite signs of deceleration. Since the 10-week cycle made its low in the second week of January, the advance has resumed, but at a less steep angle. This is particularly noticeable in the NDX and the OEX. It could be interpreted as a warning that the market is getting tired and in need of a rest, if not of an outright reversal of the trend. On the other hand, as we will see later, this behavior is perfectly consistent with the cyclical pattern which lies ahead.
To the cycle analyst, the course of the market is determined by cycles, from the shortest to the longest. Cycles are repetitive patterns which are easily observable and can be classified by the length of their phases. Thus, they provide a loose roadmap for the stock market which must be refined with other analytical tools. Some cycles are more dominant than others and these are the ones which will provide the best guidance.
The long term cycles which made their lows in October 2002, March 2003 and August 2004 are still in their up-phases and continue to fuel the bull market. And if the Dow Theory is as credible today as it was when it was first introduced -- in spite of the major changes which have taken place in our economy -- the bull may be around for a bit longer. However, this is not a one-way street. The deceleration pattern which is beginning to take place suggests that other cycles are beginning to exert pressure in the opposite direction. If this pressure is great enough, it will eventually create a counter-trend in the stock market of an intermediate nature and perhaps even longer. It is a little too early to tell, but this is what we may be facing at this time.
In my last Week-end report, I mapped out the cycles which should have an influence on the trend between now and next Fall. I suggested that a nesting of short term cycles due to occur at the end of the month would create a short-term decline. This decline started when the SPX backed off after reaching 1461.57, a target that I had repeatedly mentioned as an important level, and it is expected to continue for a few more days.
As we will see under "projections", it is unclear at this point whether we have made an important top or if a higher high will take place after the short-term cycles turn up. Countering their upward trend will be two more important cycles which should extend the correction into at least late March, and perhaps mid-April; the 20-wk cycle and the 9-mo cycle are respectively due to bottom in that time frame. After that, it becomes even more interesting because there is a nest of longer-term cycles which are due in the Fall. Will the resumption of the uptrend which should take place after the decline into late March mid-April be powerful enough to make new highs? If it is not, it will send a strong signal that a major top may be in place.
The amplitude of a cycle can vary depending upon a number or extraneous factors, but these can generally be reduced to supply and demand, and there are a couple of ways to measure how far a cycle will carry prices (up or down). Point and Figure analysis measures the amount of accumulation or distribution which has been created at the bottom or at the top of a move, and a "count" is taken across the base or the top. In early January the 10-week cycle bottom created a base composed of multiple phases with counts to 1440, 1459 and 1472. The first count did take the SPX to1440 before a reversal occurred. The next, which was later reinforced by a re-accumulation level with a target of 1461 was reached this past Thursday.
Another way to determine how far prices will carry is with the help of Fibonacci ratios, and since there was a Fib. projection which matched the P & F count to 1461, this, along with other technical factors looks to be a good level for the market to start a consolidation. For instance, there are short-term cycles due to make their lows in the next few days and, as we will see later, short-term negative numbers in the advance/decline ratio (an indication that some selling is taking place), both suggesting that this short term decline has farther to go.
However, we still have to keep in mind that there is one more potential projection built into the base that could take the SPX to 1472. It is not as well defined as the others and may prove irrelevant, but it cannot yet be discounted. It depends on what kind of a rally will be generated after the short-term cycles make their lows. If this level is to be achieved, the best opportunity will be right after March 1st.
Short-term tops are preceded by a weakening of the advance/decline and there was evidence that we were approaching a short-term top by the fact that declines outnumbered advances over the past 5 days. This has affected the NYSE McClellan oscillator and it has now gone negative. The Nasdaq version has had a resurgence of strength lately, but it has also turned down after making a lower high. Since we are looking for longer-term cycles to bottom in the near future, we'll monitor these closely over the next few weeks to determine whether or not the incipient weakness is persisting; and more particularly, as the short-term rally which is expected after the first of March unfolds.
Longer term tops are more apparent in the behavior of the McClellan summation index and in the relationship of new highs to new lows. Signs of weakness are beginning to appear in the summation index since the market made a new high and the index did not, and now, the summation index looks ready to roll-over again. This is definitely a warning sign that some distribution is beginning to take place and that at least an intermediate-term top might be in the making.
The new highs/new lows index is more indicative of important tops than the summation index, for obvious reasons. The number of new highs have begun to decline, but the new lows have not increased. This index will have to become much more negative before we can assume that a major top is in place. Let's re-visit it in a few weeks to see if a significant change has taken place.
GE, presumably one of the best leading indicators, has been acting very poorly lately. Since it made its bull market high in mid-December and established a distribution phase to mid-January, it has been declining steadily. Friday was a new low for the move. The overall chart pattern since January 2005 does not look all that great, and if the decline persists, it could be a harbinger of things to come for the overall market. Bears watching! (pun intended)
Although the NDX has recently played catch-up with the SPX, it is still lagging and this can therefore still be labeled as negative divergence. Another index which is becoming weaker relative to the SPX is the OEX. This also bears watching, because the S&P 100 was the leader in the rally from the July lows. It may now be signaling, as GE seems to be, that an important correction may be ahead.
When the market began to decline into March 2003, Robert Prechter labeled this decline as the resumption of important weakness which validated his super-bearish attitude. Had he taken into consideration that a major cycle had made its low just a few months earlier and that this decline was caused by the bottoming action of another major cycle, he would never have made that call. Obviously, he was not aware of what was taking place cycle-wise.
Since cycles are the cause of most important market fluctuations, Elliott Wave analysis would be greatly enhanced if cycles were taken into consideration by EW analysts. I also understand that simply mastering one of these methodologies is enough of an achievement, never mind both.
The EW analyst would probably counter with, "Yeah? Look at what just happened with the 4-year cycle!" A valid point, which brings up the question of whether or not the 4-year cycle is a "true" cycle. In a recent article, Clif Droke suggested that his friend, Samuel Kress -- a cycle analyst who has spent a considerable amount of time studying long-term cycles -- is of the opinion that the 4-year cycle is not a true cycle, but is the result of the interaction between the 2-year and 6-year cycles (both subdivisions of the 12-year cycle). Most of the time, this interaction produces a low every 4-years, but when these get out of synch, a low does not occur as scheduled. Examples of this can be found in 1986, 1994, and 2006. The reasoning is that true cycles are fixed in time and their lows are consistent. Consequently, the 4-year cycle is not a real cycle and it will occasionally mislead those who depend on its constency.
I believe that this may be true. Edward Dewey was also of the opinion that pseudo cycles, which are formed by the interaction of true cycles, do occasionally appear, disappear, and re-appear again. If the 4-year cycle is one of those, it is certainly one of the more consistent pseudo cycles. As to its cause, I will accept Bud Kress's explanation since he has done considerably more research than I have and since I don't particularly have any interest in spending the time to research whether he is right or wrong.
At the very least, this is proof that cycle analysis, like all other methodologies, can have its occasional difficulties. But I still believe that structural analysis should include cycle analysis in order to arrive at a greater degree of predictability.
The SPX has been warning for some time that it was approaching an intermediate-term correction, but the evidence is now the strongest since the start of the July rally. This is not surprising since two important cycles are due to make their lows in late March and mid-April. However, unless the technical indicators begin to reflect that important selling is taking place, there is a good possibility that this will only result in a fairly shallow correction which will be followed by a deeper one in the Fall.
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