November 20th, 2005

Markets on the verge of a break out?

It may be during this shortened week or in the weeks after Thanksgiving but, excluding the intrusion of unpredictable outside events, there’s a clear possibility that the internal market momentum will push the NASDAQ, followed by the S&P500 through their upper boundary resistance trend lines to levels not seen for over 4 years. The SP500, for example, at 1248 is just above its current resistance level:

Most technical stock market analysts look at the NASDAQ chart and see a classic pattern (perhaps and “ascending triangle”) signifying a consolidation after a steep decline; this is often a precursor to a strong recovery. Moreover, the length of the consolidation is often directly proportional to the extent and rate of recovery that follows. (Caution: a breakthrough above the upper resistance level is usually followed by a testing of the strength of that trendline, now as a support level.)

(Compare these longer-term charts with the 18-month charts in the November 7 posting.)

Since mentioned here on November 7, the most important change in the rankings of Industry Groups has been the rise of stocks in the Metals Ores, Gold/Silver and Steel Groups. While stocks in the various Oil & Gas Industry Groups have declined in ranking, significant improvement should be noted in the various transportation and transportation services groups.

A reader asked “Why do you put so much confidence in trendlines? Are they fixed or do you ever change them?” A good way of answering that question is by following a real case study-Tellabs (TLB). Note the chart scale changes for better chart fit.

There was a clearly discernible resistance trendline visible on the TLAB intermediate-view chart (3 years) at the beginning of 2004 at approximately 10. Additionally, an ascending trendline had formed the bottom support levels. The move to 10 over the previous two weeks was accompanied with significant volume; a move through 10 with comparable volume would represent a breakout.

However, almost immediately after the above breakout, the market turned bearish and all the major indices started a long drop and didn’t start moving up again until August, 2004 (see the SP-500 chart above). There’s truth in a basic trading rule, “Don’t fight the tape (market)”. As I’ve written here before, the market explains about 50% of a stocks movement and TLAB at the beginning of 2004 was no exception:

It retraced the breakout but failed the support level test (previously, the previous resistance level); by July, it had dropped 0ver 30%.

Moving ahead a full year to July 15, 2005 we would have found that TLAB had bottom on April 19, ahead of the rest of the market, and gapped up. As it approaches the old resistance trend line, TLAB reinstated on the breakthrough watchlist.

And now, fully three years after beginning to build a base, TLAB again failed to break through the resistance trend line at 10 and retraced to 9.84 as of last Friday. But is the situation different now? Will the market as a whole be successful in scaling to new high levels? Are the various Telecom Industry Groups more in favor today and have their rankings improved? That’s what makes the stock market so intriguing and challenging. Only time will tell if the length of TLAB’s 3 1/2-year consolidation base portends a sustained move up after is successful breaches the resistance level at 10.

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