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Issue No. 59 – January 2, 2006 Prescott, Arizona Systems@WiserTrader.com
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1.0 Trading
Statistics on success and failure rates for chart patterns tell you how much weight should be given to their interpretation.
1.1 Crossroad
If your time horizon is a few years or so, we are in a bull market. Since spring of 2003, the S&P500 has risen about 50%, the DOW about 35% and the NASDAQ about 65%. A 2 year chart for the S&P 500 Index in Figure 1 shows the index at the top of a rising wedge formation. Charts for the NASDAQ Composite Index, the NYSE Composite and the Dow Jones Industrial
FIGURE 1
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Average are similar with very slight differences in shape details. Furthermore, Williams %R indicators for all of the indices are in an oversold condition. Is the market headed up or down?
In late November and mid December the S&P attempted to rise out of the channel but bounced off resistance in the 1270 range on lower than average volume. According to the Encyclopedia of Chart Patterns, by Thomas N. Bulkowski, 2nd Ed., Wiley, New Jersey, 2005, volume is typically reduced for this type of overall chart pattern. If the S&P remains in the rising wedge pattern, the index can be expected to decline from its current level of 1248 and reach support in the 1200 to 1225 range within a few months.
The index bounced off resistance at the top of the channel in January 2005 in a similar manner. The short term decline was significant (2.5% indicated by the two red lines) and was accompanied with a drop in volume. In anticipation of a similar decline this January, traders have been reluctant to buy and volume began to decrease earlier in December. The fact that the four indices mentioned are all oversold indicates a near term, but short term, rise before heading lower.
A more bearish case would occur if the index broke out of the pattern below support on higher than average volume. Bulkowski’s historical stock data indicates that the average decline after a downward breakout in a bull market was 14%. For stocks that broke out of the formation downward in a bear market the average decline was 20%. After the decline, the average change after the trend ended was 53% in a bull market and 36% in a bear market. Within 30 days after a downward breakout, 63% of stocks pulled back to the level of the downward breakout.
Before a more bullish expectation is justified, the indices need to break out of their wedge shaped channels, moving upward with confirming higher volume. The fact that they are oversold implies they will make another run towards resistance very soon. Bulkowski’s historical data indicates that the average rise after an upward breakout in a bull market was 28%. For stocks that broke out upward in a bear market the average rise was 17%. After the rise, the change after the trend ended was -30% to -35%. Within 30 days after an upward breakout, 73% of stocks in a bull market and 66% of stocks in a bear market retraced to the level of the upward breakout.
All we can say with absolute certainty is that the market indices will not move in a straight line. They are oversold, indicating a short term rise. They are at the top of a rising wedge channel with lower than average volume, indicating a longer term decline. Notice that the narrowing of the channel requires an eventual breakout of some kind. A sideways breakout is not out of the question. As indices move toward support and resistance lines that form the channel boundaries, it would be prudent to watch the daily volume and be ready to trade accordingly.
2.0 Market Analysis
Major indices continued their sideways movement for yet another week. This consolidation still appears to be concern about the sell off with reduced volume that occurred a year ago last January. The inverted yield curve (2 year treasury interest rate higher than the 10 year) has many investors spooked, expecting an economic slow down at the least, if not a recession. Most will take a wait and see position for the first few trading days of the year. The absence of a sell off will be moderately bullish.
Key industry ETF’s in Table 2A are Biotech and Semiconductors which confirm the NASDAQ. Transportation confirms the Dow Jones Industrial Average according to Dow Theory. Banking and Financials are confirming indicators for the S&P 500. Gold and Real Estate are respective indicators for the inverse health of the currency (inflation) and the capacity for consumer spending.
Table 2A
Indices, Key Industry ETF’s and Sector SPDR’s
|
|
1 month |
1 wk ago |
2 wks ago |
3 wks ago |
4 wks ago |
|
Dow Jones Industrials |
-1.5% |
-1.5% |
0.1% |
0.9% |
-0.9% |
|
NASDAQ |
-3.0% |
-2.0% |
-0.1% |
-0.2% |
-0.7% |
|
S & P 500 |
-1.3% |
-1.6% |
0.1% |
0.6% |
-0.5% |
|
Russell 2000 |
-2.5% |
-1.9% |
0.5% |
-0.8% |
-0.3% |
|
GLD, GOLD |
2.5% |
2.9% |
0.1% |
-4.4% |
4.1% |
|
RKH, Banking |
-1.1% |
-2.1% |
0.0% |
1.5% |
-0.5% |
|
IYT, Transportation |
1.4% |
-1.3% |
2.7% |
1.0% |
-0.9% |
|
SMH, Semiconductors |
-5.4% |
-2.6% |
-0.6% |
0.3% |
-2.5% |
|
BBH, Biotechnology |
-3.4% |
-1.9% |
2.3% |
-1.5% |
-2.3% |
|
IYR, Real Estate |
-2.5% |
-1.3% |
-1.1% |
0.6% |
-0.7% |
|
OIH, Oil |
0.4% |
-1.8% |
1.4% |
-2.3% |
3.3% |
|
XLE, Energy |
-1.2% |
-1.3% |
0.4% |
-1.4% |
1.3% |
|
XLU, Utilities |
-0.3% |
-1.1% |
-1.5% |
1.0% |
1.4% |
|
XLB, Materials |
0.8% |
-0.6% |
2.4% |
-1.4% |
0.3% |
|
XLI, Industrial |
-0.6% |
-1.1% |
0.5% |
0.7% |
-0.8% |
|
XLK, Technology |
-4.8% |
-2.0% |
-0.8% |
-1.1% |
-0.9% |
|
XLV, Healthcare |
1.9% |
-1.6% |
1.9% |
1.6% |
0.1% |
|
XLF, Financials |
-1.1% |
-1.4% |
0.7% |
0.3% |
-0.7% |
|
XLP, Consumer Staples |
-0.7% |
-1.4% |
-0.5% |
1.9% |
-0.7% |
|
XLY, Consumer Discretionary |
-2.6% |
-1.1% |
-1.0% |
0.1% |
-0.7% |
