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Trader's Corner

It Works Again

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On October 11, an interesting thing happened.

Annotated Daily Chart of the SPX:

Based on what had happened with RSI on October 11, my October 13 Trader's Corner warned subscribers that they should make a plan for how they would deal with a possible price trendline break, if it should occur. RSI breaks sometimes precede price breaks, with RSI and CCI being two of the indicators that sometimes lead price action.

A break of that third trendline might be significant, that October 13 Trader's Corner warned. The corrective fan principle suggests that a break of the third trendline in a trending move means that the trend has ended, and prices could surge in the direction of the break.

If that trend had been a rally, the decline could be precipitous, the corrective fan principle warned. It was. However, when combined with the information provided by the corrective fan principle, the RSI trend line break allowed traders a few days worth of planning time, so it served its purpose again.

Through the last couple of years, the corrective fan principle has proven its worth many times, so let's see if it's yet predicting the end of the decline. Unfortunately for those long the markets, it isn't. Three trendlines haven't yet been established, much less all broken to the upside. In addition, a scan of the updated chart shows some question about the location of the second trendline.

Annotated Daily Chart of the SPX:

Typically, each of the three trendlines that comprise the corrective fan principle's three trendlines begin at the same point. In this case, the first two trendlines would be drawn as is shown by the solid red and blue trendlines. However, up until the time this chart was snapped on November 16, the blue RSI trendline corresponded closely to the dotted blue trendline.

So, what did I think after this chart was snapped after Friday's close on November 16? In summary, if we're using the corrective fan principle as a guide, the decline has not yet been concluded. A third trendline has not yet been established, much less violated to the upside.

All those questions arose about the location of the second trendline, though. Note that no such questions arise when studying RSI. RSI has established a well-defined second trendline. Up until November 16, that gave some credence to the dotted blue descending trendline, although, theoretically, it should be the higher solid blue trendline that comprises the second trendline.

As of Friday's close on November 16, RSI had been rising toward a trendline test. Theory would have suggested that, if there had been an RSI upside break the next week, the dotted blue price trendline might then form a supporting trendline from which prices might bounce. A bounce wouldn't have been guaranteed, however, since the longer-term downtrend would presumably have still been in effect. Prices might have instead slid down that descending trendline.

Was there an RSI upside break during the next week, this just-concluded Thanksgiving week? The chart below was snapped about ninety minutes before the close trading on November 23.

Annotated Daily Chart of the SPX:

So, the outlook turns even more clouded. The previous week, the RSI trendline was being tested at the same time that the dotted blue trendline was tested, so an RSI breakout concurrent with or shortly before prices broke above the dotted blue trendline would have tended to corroborate that trendline's importance. However, it no longer looks as if the two trendline breaks might be concurrent or nearly so. RSI was threatening to break through its trendline and may even have done so by the close.

What's the conclusion? The conclusion is that, if RSI breaks through that descending trendline, a relief bounce might ensue. If so, traders should trade that bounce only if they're comfortable trading a rally that's occurring in the context of a downtrend that appears to be intact so far, at least according to the corrective fan principle. Others should watch for rollover potential, either at the dotted or solid blue trendlines, if prices should rally that high.

One intriguing possibility exists. Perhaps we should be anchoring the three prospective trendlines at the 10/31 high and not at the 10/11 one. If so, the dotted blue trendline would be the first trendline. That first red trendline was so sharp that it doesn't fit well with the price highs and the first RSI trendline didn't have a lot of touchpoints, either. However, that first trendline is often constructed similarly and often doesn't appear to fit. This scenario, that of needing to anchor the three fanlines at the 10/31 high, doesn't seem the most likely scenario for now. I'm not going to discard it as a possibility, however.

We're left with lots of questions, but the corrective fan principle suggests at least one strong conclusion: the primary move right now is a downtrend. If we can trust its evidence, and lately we've been able to do so, we should position our trades accordingly.

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