Now let’s hit on what I think are going to be the important technical setups for Q4. First off, the Dow Industrials are close to hitting my initial 10,000 target. The head and shoulders topping pattern I pointed out earlier this year has worked out very well, and a move to Dow 10,000 would achieve the target for this setup. While that’s my initial target, I think, unfortunately, we could trade through that level to set up a capitulation low in Q4.


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To see why I think we still have significant downside in equities, just check out the longer term chart of the S&P 500 below. You can clearly see how the 2000 and 2007 highs have formed a double top. Right now we’re sitting at the midpoint of this big trading range. The credit crisis will most likely get worse before it gets better, and I don’t think it’s out of the question that a test of the 2002 lows is possible. The big question is whether this will happen quickly in a crash style low in Q4, or will we simply grind lower over the next couple of years? I would advise staying defensive because you will have plenty of time to put capital to work when the market proves it’s in a healthier state.


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Recently, Small Caps have held up relatively well as the US dollar strength has put more pressure on the larger cap equities with more international revenues. However, the Russell 2000 is looking toppy and could play catch up on the downside in Q4. The below weekly chart shows another head and shoulders topping pattern in the Small Caps. If this index closes below 650 it could signal the start of a downtrend into the low 500’s.


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Finally, I want you to focus on the US dollar in Q4. With the election looming, the greenback will certainly experience some volatility in the coming quarter. This is the battleground market for inflation and deflation, and we all know the importance of the dollar in global trade. Near term, it looked like the US dollar was trying to form a head and shoulders top. However, the strength on the last day of Q3 brought it close to offsetting this pattern. Window dressing anyone?

The neckline is around 76 and breaking that level projects back to the lows near 72. The fact that the US dollar has rallied in the face of this country’s worst financial crisis since the Great Depression is truly amazing, and shows the importance of flexibility and contrary opinion in the markets. If deflation worries continue, the dollar should remain well bid in a flight to safety as people reduce leverage and debt levels. This would also support my near term call for further downside in Gold.

However, Ben Bernanke and Hank Paulson might be forced to run the printing presses overtime and inflate our way out of a certain recession. If that’s the path they choose to take, the US Dollar will see significant pressure. In addition, foreigners could voice their unfavorable opinion and vote by selling US dollars. Keep in mind there is still long term resistance in the low 80’s. Regardless, the US dollar will be the focal point in Q4.


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In conclusion, stay defensive and manage risk. This might be the toughest market ever to trade and the rules of the game are changing constantly. The goal should be to preserve capital in times like this so we can make it through to the other side.