SUBJECT: Market Direction
"The market looked good when the Dow rallied above 11600 and got to 12200 pretty fast. There was a stall after that and a 2 day crash. Prices have come back up but the direction we're going next seems impossible to figure with the crazy flip flops. How are you seeing things such as prospects for another run up or not?"
I'm mildly, not wildly, bullish at the moment based on a bunch of small picture items. The market's been going sideways for nearly 3 weeks; there was a sharp run up and then an equally fast break back to current support, creating a trading range patten, but what I mostly view as a consolidation of the prior advance from early to late-October. This view would suggest that there's another up leg coming.
There are a lot of things I look at technically. Of course I follow what is happening in the economy, especially as it might be or is impacting earnings. However, I don't try to PREDICT the direction of the trend by analyzing fundamental data, especially in forecasting the short to intermediate-term trend; e.g., 2-3 days on out to 2-3, or more, weeks.
There are a number of aspects or factors that I look at technically. The 'technical' approach looks at price and volume information only or on technical models or indicators that derive from price and/or volume information. An element that I use that is NOT formally part of technical analysis is attempt to measure market sentiment, or how bullish or bearish traders are.
In my (Essential Technical Analysis) book I included 10 items on a check list. I see now that my essential list can be pared down to 8 things. Wouldn't you know it...a fibonacci number! I build a technical perspective or point of view from a bottoms up approach. My checklist includes the following items:
1. Trend Analysis; 2. Looking at All Time Frames; 3. Predictive Chart Patterns; 4. Confirmations or Divergences; 5. Trendlines & Price Channels; 6. Retracements; 7. Moving Averages; 8. Overbought/Oversold conditions.
I'll explain the 8 points briefly, with an eye to current market patterns in the major indexes. Some of these (8) points may not apply or apply much. All 8 aspects get checked off so to speak but only some may be relevant at any given time.
Checklist Point # 1. TREND CONSIDERATIONS
This is to look simply as to whether the market is trending, consolidating a prior trend, or non-trending; i.e., a sideways move...when such a period is extended in time, this is a trading range market.
Currently, the intermediate trend of the market is UP, although in the case of the Dow you see a 'line' of resistance at 12200. It's possible that the Dow 30 (INDU) is going to go sideways again for a time OR is building a secondary top, but the pattern seen below looks most like a consolidation of the prior advance; a 'test' of this outlook is whether 12200 gets pierced or not. Conversely, a dip below 12000 and the up trendline suggests further slowing of upside momentum. A downside penetration of 11800 turns the chart more bearish.
The DEFINITION of a downtrend is a pattern of lower relative highs over time. A sideways trend is a pattern of 2-3 or more highs in the same area and 2-3 or more lows in approximately the same area, especially in terms of Closing levels. An uptrend is a pattern of higher lows and we see that with the INDU daily chart.
**ALL CHARTS REFLECT PRICES THROUGH YESTERDAY, 11/15/11**
Checklist Point #2: Look at ALL TIME FRAMES
Besides the daily charts, I scan the hourly and weekly charts and I expect them to 'confirm' a similar outlook as to the price trend. I look at hourly charts that go back weeks and take a close look at weekly charts periodically as needed. Continuing with the Dow as our example, INDU's weekly chart below is of interest. We were talking about my thought that we're in an uptrend in the market. A flag pattern is a relatively narrow consolidation close to the end point of a sizable prior price swing, either up or down.
In the 'bull' flag variation, there is a minor dip for a few trading periods back from the highs made after a strong upswing. This pattern often leads to a breakout above the prior high. However, the sideways narrow-range consolidation should not go on for more than a few trading periods or 'bars'; e.g., a few hours, 3-4 days typically in the case of a daily chart and 3-4 weeks on a weekly chart. If I am wrong in a bullish assessment here, look instead for a fall below 12000, then 11800, rather than a decisive upside penetration of 12200.
Checklist Point #3: Predictive Chart Patterns
This could be both in price and volume but mostly its price considerations in the case of the indexes. In individual stocks, the volume pattern is important as a secondary indicator; e.g., so called price 'breakouts' ought to occur on above average daily volume as confirmation. This point is to look at what technical/chart patterns have or are developing: rectangles, flags, triangles, double bottoms or tops. If any of these imply a further upside or downside objective that's important to 'measure'.
Relative to the weekly Dow chart immediately above, I interpret the recent narrow-range trade, close to the top of a sharp advance, as a consolidation of the prior uptrend. The extended sideways pattern in my first (daily) chart of INDU formed a rectangle. After the breakout move above 11650-11700 resistance, I interpreted the formation as a rectangle bottom with a potential further upside objective to at least 12400 as a 'minimum' target, an objective that's been nearly met as the Dow reached 12284.
Point #4: Confirmations or Divergences
Here is my reminder to look for any related indexes (or related stocks or sub-indexes like the semiconductor index SOX in the case of individual stocks) for similar price action to what is unfolding in the index I'm focused on. The concept of confirmation or 'divergences' applies to technical indicators like the Relative Strength Index (RSI) or my market 'sentiment' model. Prices going UP, RSI coming DOWN is a bearish divergence between price and internal momentum.
In the case of the Dow, I will be also looking at the S&P index and Nasdaq index charts. Let's say that I'm primarily interested in trading the Dow Index (DJX), I will want to also look closely at what the pattern is in the Nasdaq Composite (COMP) for example...as well as the other major indexes. Using the example of COMP, there is a definite 'line' of resistance at 2700-2750 and an even more definitive line of anticipated support (prior lows) at 2600.
If COMP were to advance to above the 2700-2750 zone, I'd be expecting a similar break out move in INDU to above 12200; if that doesn't happen it will OR, if the Dow doesn't follow suit, that could be an early warning that INDU is faltering.
I'll cover my second set of 4 technical 'checklist' points in a later article at the end of the week.
GOOD TRADING SUCCESS!