January 10th, 2009

Reversal or Consolidation? That’s the Question.

What you’re about to read is unique; you’ve probably never read anything quite like it before. A technical stock chartist who admits that he’s confused by this market, sees many mixed signals and isn’t quite sure what the near term direction will be. I was more certain just a weeks ago than I am today.

There, I confessed. Let me run through several charts, share my thoughts, show you the source of my confusion and perhaps, together, we’ll all be able to figure this out. First, the moving averages. At the risk of repeating myself, I want to stress that a true reversal of trend can’t be counted on until and unless the Index crosses the MA’s and the MA’s themselves start reversing their rank order.

During the volatile period in November, the market made it’s important blow-out when it fell almost exactly to the low of the Tech Bubble Crash six years earlier in October, 2002. Just as the New Year was beginning, the Index cross the 60-day MA and the MA itself had turned the corner and was starting to advance, an important first step but, as I’ve written here often, far from instilling any confidence.

Another positive indication as the Index crossed the 60-day MA was its cross above the upper resistance boundary of a steep downward-sloping channel:

But weak employment data this week – first from ADP and then the Labor Dept. -undermined the excitement from the market’s having increased 24% from the November lows in a short six weeks. In more “normal” times, we’d be cheering had this sort of move been made in a year, let alone a couple of weeks.

Is the market attempting reversal or is it in consolidation with the downtrend still in place?

If you look closely, you begin to see a symmetrical triangle. It’s a weak pattern because it’s sort of stubby and it’s based on only the minimum pivot points (2 on each of the upper resistance and lower support trendlines). Symmetrical triangles are usually consolidation rather than reversal patterns especially when you see them at the bottom of such a gigantic decline. The implications for a symmetrical triangle like this will depend on whether you’re a pessimist and see all the dire economic and geopolitical fundamentals or an optimist and fall back on the fact that the 2002 Tech Bubble Crash bottom wasn’t violated.

As an optimist, I’m going to swallow my pride and say that I jumped the gun labelling the market action as a true, completed pattern. I’ve been writing for weeks that the bottoming out process will stretch out for months so, if anything, what the chart shows is actually the early stages of forming a much larger and still evolving pattern. All we can do now is anticipate what the scale of that pattern (upper and lower boundaries – the range) might be.

While we still might break above the upper boundary of the symmetrical triangle, in all likelihood the market will still have to retest the previous lows. It’s impossible to tell at this point what the final reversal pattern will be (head-and-shoulders, double-bottom, horizontal channel) but whatever it is the past couple of months trading activity represents only the first phase.

Markets go up, they go down or they stay flat. We can make money in each of them if the trends continues in one direction for a while. However, the market’s trend direction over the next several weeks has become unclear – at least to me. We’re merely gambling if we put money to work in a market without a clear direction. Consequently, the best we can do until this gets resolved one way or another is remaining cautious. In other words, stay on the sidelines with a big chunk of your assets in cash and let the bulls (buyers) and bears (sellers) fight it out to establish the next trend.

(This would’ve have been terrific as a video but I’m still learning Camtasia. I’d appreciate help from anyone out there with experience to share.)

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