SUBSCRIBER E-MAIL QUESTION:
"You indicated on the weekend (in my 3/5 Index Wrap) a turn to a bearish market outlook at least for some further decline. I think you stayed bullish on the bigger picture. Are you still looking for lower levels and how low?"
There were two chart aspects that suggested to me last week, one being a 'macro' chart pattern so to speak and the other a 'micro' small view aspect.
The micro view is my anticipation for a second market decline that was at least equal to the first downswing; OR, alternatively, a second decline greater than the first. The common down-up-down or "a-b-c" correction is 1.): where the second down leg (c) ends up being at least EQUAL to the first decline (a) AND 2.): where the second downswing is 1.38, to 1.5 to 1.6 times greater than the first decline (a). That is, where a second decline in a down-up-down corrective pattern has a Fibonacci relationship to the first downswing.
The aforementioned scenario of a longer second down leg in a correction is not seen so much in a strong bull market. The two down legs in an a-b-c (down-up-down) correction are more likely to be equal as seen in my chart examples. A steeper decline on the second down leg 'c' is more likely, within a major bullish trend, AFTER a long-standing uptrend starts to see greater selling pressures, especially after the major indices get to an 'overbought' extreme.
My first chart is of the Nasdaq Composite (COMP) and the January correction is one of approximately equal down legs in an a-b-c corrective pattern. The letters are placed at the END of a particular price swing. The second down leg (c) actually carried a bit further than the first decline. To achieve 'parity' in the recent decline, I was projecting down leg 'c' on to carry to around 2650. However, there is also support around 2677; COMP got to 2689 as an intraday low yesterday (3/11/11).
There is a related target to around 2650-2645 in the Composite as implied by a 'measuring' implication for a bearish rising wedge in COMP, which I'll go over further on.
The S&P 500 (SPX) daily chart is shown next with my highlights and notations. As with COMP, the January a-b-c correction saw the two downswings ('a' and 'c') end up being approximately equal from peak to trough. To date (through 3/11/11), our most recent sell off in COMP has not carried as far as the first decline, as SPX has fallen 40 points from its intraday high (at point 'b'), versus the first down leg that carried 50 points from intraday peak to intraday low. My expectation was for a bottom around 1280 or lower, perhaps to the 1260 area. Stay tuned for how this expectation plays out.
I'll next get into downside projections based on a bearish rising 'wedge' pattern that is highlighted in both SPX and COMP.
BEARISH RISING/ASCENDING WEDGES
I covered the topic in depth in July on both falling bullish wedge patterns and the rising bearish wedge variety, as part of my technical analysis series (#9 in a series) that can be viewed/reviewed online by clicking the link HERE.
Formation of a 'wedge' pattern generally signals a trend reversal or correction ahead. The variation that exists with the pattern you'll see next is that of a broadening rising or ascending wedge. As can be seen in the archived article (link above), the more common bearish rising wedge is where stock or index prices move gradually higher and two converging trendlines slope up but narrow in to an end point or apex. In the 'broadening' rising wedge, the pattern is reversed, as wider price swings create a megaphone shape with the narrow end BEGINNING the broadening wedge pattern instead of near the end of the formation.
With the S&P 500 daily chart, the trendlines have the requisite 3 or more 'touches' to the upper and lower trendlines. Both trendline slope up, but more volatile price swings broaden out to create what we recognize as a megaphone shape.
The rule of thumb in measuring a downside objective for a bearish rising wedge of either the 'broadening' type or the narrowing in type is to look for a price target around the start of the formation; i.e., the lowest low at the beginning of the wedge pattern. This 'measuring' objective suggests a downside target in SPX to around 1253, although 1260 is another support area.
In an example of the more common bearish (narrowing in) rising wedge drawn from my (Essential Technical Analysis) book, next is a stock chart with a bearish ascending 'wedge' where the two trendlines converge or narrow in. This pattern in AXP creates an outline that looks like a 'reverse' megaphone shape with the mouthpiece at the top rather than the bottom. It has a triangular wedge shape.
A downside 'minimum' measured objective is the same for both the more common wedge pattern with trendlines that narrow in and the 'broadening' rising wedge formation with trendlines that widen or broaden out: expectations in both wedge variations are for a pullback to where the pattern BEGAN:
My final chart, of the Nasdaq Composite, doesn't have quite the same distinct shape of the Rising Broadening Wedge pattern that was seen above with SPX; the upper trendline doesn't have the common 3 (or more) highs that 'define' the trendline; at least in the conventional way of drawing trendline ONLY through the highest highs. However, more unconventionally, an internal trendline touching the MOST number of highs, takes on more of the expected shape.
With COMP, the 'measuring' implication for a minimum move back to the start of the ascending broadening wedge formation suggests a further downside objective to the 2650-2645 area. This objective looks quite feasible, especially given the weakness suggested by the recent (and second) downside price gap.
GOOD TRADING SUCCESS!