August 31st, 2010

A Fan of Upward -Sloping Trendlines

I must confess that I too am confused, frustrated and starting to lose both my patience and my motivation. I read other blogs, newsletters, financial sites and come away convinced that no one knows with any degree of certainty what’s coming down the road.

If you’re a fundamentalist, then you can make a strong argument based on the economic picture that there’s another leg down, perhaps down 35-30% from current levels back to the 750-800 range (one bear prognosticator predicted on Bloomberg a 5000 target for the Dow by 2012). If you’re a technician than you pick from either the Elliottician’s view of the S&P 500 down to 500 or a more bullish view that index moves to 1250-1300 sometime next year.

One thing you can count on however, is that there’s little value of sloping trendlines as the foundation of any of these predictions. A sloping trendline can pivot at any angle and the angle you probably will select will link to the most recent pivot you see. In other words, sloping trendlines are highly unreliable either as support or as justification for predicting a major decline should they be broken.

For example, take the ascending trendlines we’ve been drawing for about a year coming up from the March 2009 lows. We’re looking for the fifth of these upward sloping trendlines. While each may have indicated an opportunity for a short-term trade (short the index), none marked the beginning of a long-term market decline.

First there was the trendline (1) connecting the 2009 bottom to the January 2010 high. Then a trendline (2) connecting the bottom to the February 2010 low and April 2010 high. And so on and so on. With each of these upward sloping trendline there were calls that a break would lead to the decline back below that history 2009 low or further. [Each of these have been part of a Fibonacci fan pattern but, honestly, I just figure out how that works or what it means.]

But the market didn’t crash. For some inexplicable reason, the market was able to hold its own and stay within the 1025-1150 trading range. That’s why I put much more stock in the relevance and power of horizontal trendlines. There’s something unequivocal about them. You can be more confident that decisions were made at these levels in the past (whether for individual stocks or a market index) which may impact current or future decisions at the same level. Should there be a break of a horizontal trendline it would, therefore, more clearly indicate a directional change of momentum.

I’m concerned but haven’t panicked – yet. There is a head-and-shoulder reversal lurking somewhere in this one-year horizontal congestion but, again, psychology doesn’t sync with this being a top. If it is a top, then a new category will have to be added to the emotions of euphoria, excitement, etc marking tops. …. we’ll have to add exhaustion.

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  • Jesse

    In all seriousness you really should consider changing your blog name to "THE ETERNAL OPTIMIST".

  • Jesse

    also, to keep it on topic and intellectually honest, you can get a free copy of Elliott Wave International's view of the markets here – http://www.elliottwave.com/
    The Elliott Wave shows a market bottom coming in 2016, not by next year. I can't say that I totally agree with Pretcher of EW, but they nailed the last bottom (666). They were early on the last top(1219), missing it by 5.6%. But considering the big picture, not bad at all and should be respected.

  • Joe

    Considered it but the url Eternal Optimist was already taken, as was Eternally Optimistic and EternalOptimist.net.

    By the way, this last one has a nice optimist's reggae tune and the quote "A pessimist sees the difficulty in every opportunity, an optimist sees an opportunity in every difficulty."

    Which way would you rather live your life?

  • Anonymous

    Joe,do tires have to be made from rubber ?

  • Jesse

    how would I rather live life? Awesome question and I could write a book about this topic. But, to sum it up, I live life embracing the truth, allowing it to change me and shape the way I think and live. Everyone wants to live life innocent and with there head buried in the sand pretending things away, but that's a real good way to lose everything, your house, your job, your investments, you relationships, ect. I need to be able to discern truth and then live according to it. The stock markets are going down. The best thing to do when a ship is sinking is not to try to be the last optimistic guy in denial left on the boat. That will get you killed and history will not look at you as a hero, rather a fool. If the ship is sinking, I adjust to survive. But in the world of finances, surviving is not enough. I want to thrive. There were many people who recognized the last great depression and adjusted and went on to become millionaires. Our economy is in deep trouble which we can not continue to buy our way out of. There are so many signs in plain view of what is coming. No one should be caught of guard…I live according to truth and reality, not according to fantasy and hopes of not drowning.

  • Joe

    You have to be kidding! That's the strangest comment or question I've ever read on a stock market oriented blog.

    If it's intended to be satirical, it went way over my head.

  • Jesse

    btw the opportunity is not to be long stocks and lose half your money or more. the opportunity is to protect yourself and avoid that or take advantage of it through shorts…So I'm always looking for opportunity to capitalize on the current reality. And I've said it before, I'd love to be bullish but that's not what the markets are telling us. No one makes money by being on the wrong side of the trade. We've all learned that through experience.

  • Anonymous

    High dividend yielders along with inverse etf's to protect on the downside are the best combo for this market and have been working well for myself.

  • Anthony

    In an answer to your question Joe-neither-a realist is what I choose…and I think you would agree based on what I have read over the last couple of months. I think the optimist/pessimist debate deviates from how I perceive you to approach investing. It's not about how you FEEL about the stock market and whether you are an optimist or pessimist but what is the reality of the data. For me that is what has been reinforced for me in reading your blog over the last couple of months but it *appears* you are deviating from that now.

    The reality of the data right now it's full of ambiguity and a higher level of uncertainty (both to the upside and downside). Given that we all have to decide our risk tolerance and thus exposure to the market given this information.

    Do you disagree?

    Personally, I like the high yielder/shorts approach as well.

    PS-I will concede that it may be important to gauge the general "feeling" of the market but in essence that's another piece of data, right?

  • Joe

    Anthony, you're absolutely correct. I am deviating from the charts themselves, moving into the realm of "feelings" – I like to think of it as market psychology – because when the market moves laterally, charts become less meaningful.

    As I've written here, that lateral movement can be either a reversal or a consolidation. Yes, today's economic data points to a reversal but "tomorrow's" data still is conjecture. The market discounts the future and in that case your feel is good as mine as good as anyone's.

    Let's put this into proper perspective. I'm not a diehard optimist; I don't expect the S&P to cross above its previous high until late 2014 or 2015. But I'm also not pessimistic enough to say it will drop much below 950-1000, either.

    When it comes to managing my money, I'm leaning more to a thinking the moves going to be to 1250 rather than to 900 (or 600 as the Bears claim).

  • Jesse

    Joe, by saying you dont think it will drop below 1000-950, you are being extremely optimistic. 1000 is only a drop of 4% from current levels. If this is really true, then you should be advising everyone to start scaling into long positions because the bottom is very close. That's extreme optimism because you're essentially saying that the November elections won't effect our spending binge which has artificially propped this market up. You're also saying that you don't believe that the largest tax increase in American history will effect the consumer or the market. Or that the shrinking GDP numbers will effect the markets. You're ignoring the dma cross that's imminent. Those who don't learn from history are doomed to repeat it. Where you this optimistic in 08 when the 20 (1week) crossed under the 50 (1week)? I know you follow moving averages, yet still no comments about this very bearish sign. Why have you stopped talking about moving averages?

  • Jesse

    well bulls came in just in time today, keeping your hope alive. can the bulls keep the ball after this straight up shot today? either way, I'll let you have you day. everything is great, the economy in great shape, 1300 here we come 😀

  • Joe

    Jesse, no reason to sulk. I'm not a buyer today and am still at 50% cash. If it crosses 1081 I'll add another 10-15% and another 10-15% if it crosses 1125. I'll be in with both feet if and when it crosses 1165.

    You may be absolutely convinced in your bear prediction. I'm more cautions and need more evidence for my bull prediction before I commit more money.

  • Jesse

    that was me cheer leading for your bull rally. but hey looks like you're talking about moving averages again. will the 50dma contain today's rally? We started august the same way we're starting September, with mutual funds putting there money to work. I wish I could post charts here…but I believe this move can go to 1100 before meeting the resistance line, if it gets through the 50 & 20dma's and that won't change my long term bearish view at all. It's right in line with the chart I've followed for months now.

  • Bala

    recently nasdaq has formed a temp bottom, so went up 63points. soon it will resume DT

  • Jesse

    really good call joe! have a great weekend

  • Joe

    Thank you, Jesse, your congratulation and support is important to me.

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