September 17th, 2008

Where are Strongest Supporting Trendlines

The market is acting as we anticipated (it would be politically incorrect to say “as we hoped”). As of 11:20, nearly two hours into today’s trading, the S&P 500 is down 2.93% to 1178.01 and on its way to the target I set back in February.

But it’s about to connect with the bottom boundary trendline of a downward sloping wedge that goes back to the October highs:

Will it bounce on the support of the bottom boundary trendline of the descending channel or will it break through that trendline and seek support elsewhere? There are other potential support areas but none based on recent action (there’s little standing in the way of more free-falling.

All the other possible support areas eminate from congestion (high volume and tipping points) back in the bottom and ensuing reversal back in 2003-04. They are:

Some people scoff at looking all the way back to 2003, 2004 and 2005 to find explanations for things happening in 2008 and 2009. But, unfortunately, that’s the way market psychology and stock charting works. Some will take this chart and draw other lines and ask “what about my lines, why aren’t they supports?” To that I have no other answer than say that there are an infinite number of possible trendlines and we won’t know for sure until the market actually bounces; for now I’ll rely on my experience and intuition.

I most recently commented on trendlines in “The Difference between Trendlines and Moving Averages” on August 7 when I wrote that a trendline is:

“the extrapolation of a vector between hypothetical past and future potential pivot points. A trendline connects a minimum of two and preferably more actual prices over any historical time period and projects it to where likely future pivot points might be. More correctly, if future pivot points do, in fact, materialize someplace where a trendline extrapolated out it might then be assumed that the factors generating the prior pivot points remain in force and therefore the trend remains in force.

The selection of the specific historical prices used to generate the vector of future pivot points (the trendline) is critical since, theoretically, an infinite number of trendlines can be extrapolated into the future. In my experience, horizontal trendlines (for example, an extrapolation from a pivot point representing a previous high or low) is significantly more reliable than trendlines (extrapolations) that are either downward or upward sloping. By extension, the steeper the slope of the trendline, the less reliable.”

That’s not to say, for example, that the reasons the market peaked in March 2004 and drifted down for 7 months until it surged in October 2004 will be the same reasons the market uses those pivot points hinges for a trendline on which the market finds support in the near future when touches 1120.

Whether that line becomes the long awaited bottom depends on fundamentals then. If they remain weak, the bounce will be short lived and called a “consolidation”. The next move will be down to the next potential support trendline at 1035. If conditions improve by then, the bounce will extend for a period and a bottom will form. We won’t know for sure until then,

You can draw your own supporting trendlines but I’m going to base my game plan on the S&P 500 hitting the trendlines on the above chart.

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