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Advanced Technical Analysis

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Note: the following analysis is formulated as an assimilation of Fibonacci, DeMark, Elliott Wave and other technical indicators. It is offered as education and not intended as advice in any way.

This morning we are taking a more in-depth view of the three major indices: the Dow Jones Industrials, the Nasdaq 100 and the S&P 500. The reason for this is two fold: (1) we have not yet provided readers a longer term look at our indicators as they apply to these three indices on a weekly time frame and (2) the markets are at a critical juncture between being in a bullish trend to new annual highs or breaking down in a larger degree bearish trend as we have been suggesting. First, however, some observations about the action over the last 8 months.

What has struck us as most unusual about the technical action of the markets since the peaks that were registered in Q1:04 is that the market seems willing neither to go down well nor up well. Which is to say that a clearly defined trend has been sorely lacking, frustrating both bulls and bears alike. Why this is unusual is that the peaks in Q1 2004 registered in the SPX and INDU at important Fibonacci resistances of the 2000-2002 decline: the 78.6% resistance point for the INDU was 10775 and the index put in an intraday high 10753 on February 19th. For the SPX, the 50% Fibonacci resistance point for the 2000-2002 decline is at 1161 and the SPX made its peak this year at 1163 on March 5th.

Though we can't delineate here the myriad sentiment indicators that continue to show extremes at the peaks in Q1:04 and at current market prices, we think highlighting one will give you a sense of how bullish the consensus was for stocks at the time and continue to this day. The Investors Intelligence Advisory Sentiment bullish percentage stayed above 50% for 27 straight weeks in 1999 and early 2000 before succumbing to the bearish trend in stock prices. To September 24th 2004, this indicator of sentiment was above the 50% level for 101 straight weeks. Just to give you a sense of this indicator from an historical perspective, this sentiment gauge remained bearish for 46 straight weeks in 1994 and 1995. There are plenty of other sentiment gauges that one can look at: mutual fund cash levels, MBH commodity advisors bullish sentiment, VXO, put/call ratios, the AAII poll (whose moving average of bulls vs bears made all-time peaks in 2004 eclipsing the 2000 peaks of bullishness).

Our point in highlighting the sentiment background is simple: against a backdrop of momentum divergences, potentially completed Elliott waves, daily Demark indicators, extreme sentiment figures, intra-market divergences (as in 2000), and important Fibonacci resistances, it was entirely reasonable to expect the market to move decidedly down from the peaks in Q1:04 to erase some of the 2002-2004 percentage gains as well as some of the extremes in sentiment that were registering. Neither of those things have happened: the INDU is 6.6% off its 2004 peaks, the SPX down 3.1% and the NDX off by 4.3%. This is hardly the type of correction one would expect 6-8 months later if in fact the Q1:04 peaks were important cyclical bull market peaks. Further, the sentiment figures we cited earlier have hardly budged: they remain at bullish extremes relative to almost every major peak in stocks in the last several decades.

Having said all of that, momentum divergences, Demark indicators, extreme sentiment figures, intra-market divergences, Elliott waves, and Fibonacci resistance points are all probability-based indicators. Taken together, they suggest a greater or lesser likelihood of a trend reversing or staying the same. In the case of 2004, the probability was high that a reversal of trend could be near. And though the peaks were registered in Q1 of this year, a reversal of the bullish 2002-2004 trend has decidedly not taken shape.

So what now? All the important Fibonacci resistances from 2004 are still in place. The daily and weekly Demark indicators from those A1 peaks are still "valid". The weekly sentiment picture remains uniquely bullish to this day. And the daily and weekly momentum divergences are still valid. Given those conditions are all still present, the crux of the intermediate term (multi-week/month) view comes down to the Elliott wave count. And on this score there are two "counts": one bullish to new annual highs before a larger failure and the second one still bearish against the peaks registered in Q1:04.

How do we differentiate between the two? Price and price alone. Since the INDU, SPX and NDX each are in different stages of their declines from the Q1:04 peaks, each has a slightly different count. But suffice it to say that the next 2 weeks of trading will prove to be extremely important data points toward delineating whether we see new annual highs in the markets or we see an important and impulsive decline.

Relative to the INDU, the bounce from the October 2002 lows is best counted as an ABC zigzag, where the A wave up from the October 2002 lows completes at the 12/2/02 peaks, the B wave declines to the March 12th lows, and the C wave has been underway since that March 12th low. The open question among Elliott wave practitioners is whether this C wave off the March 12th lows for the INDU has traced out a complete "5" waves up yet. And herein lies the difference between the bull and bear intermediate term scenarios. Under the bearish count, "5" waves of the C wave up from March 12th completed at the February 2004 peaks. The series of lower lows and lower highs the INDU has registered over the last 8 months is, under this interpretation, the start of a larger decline to come that will take the INDU back below the 2002 lows in time. Under the bullish count however, the February peaks represented only the 3rd wave peak of this C wave off the March 12th lows. This interpretation makes the entire decline from the February highs to last Monday's low at 9708 a 4th wave overlapping correction. Needed now to complete the C wave up from the March 12th lows (and by extension to complete the entire correction off the October 2002 lows) is a move to new annual peaks above 10753 over the next several months. Should that new peak come it would almost certainly be on far greater divergences of momentum and against an even more bearish sentiment background.

The dividing line between these two Elliott wave interpretations is fairly clear: from Monday's lows in the INDU at 9708, a small degree "5" wave advance (hourly charts) has been put in that, no matter what the trend, is likely to undergo some sort of correction in the next several sessions. At yesterday's INDU peaks there were divergences of breadth, momentum, and ticks and hourly Demarks were present as well: all suggest that the 4 day move up is weakening and due for a pullback. The only question for us is: how much of a pullback.

If this correction finds support in the 9800-9915 area, bounces hard and moves to new peaks above 10250, the bullish interpretation would be operative calling for a 5th wave of C to new annual peaks above 10753. If however, the INDU falls impulsively over the next several sessions and declines below 9800 and subsequently below 9700, then the bearish interpretation becomes operative, calling for an eventual decline to the March 12th lows. So there are the key price points for the INDU in the next two weeks: above 10250 is extremely bullish, below 9800 is extremely bearish. The more conservative approach would be waiting for one of those price points to confirm the larger trend is the right strategy. A more aggressive view based on the analysis, suggests weakness in the INDU from current prices for a move to at least 9800-9900 (not meant as advice). Trade powering through 10128 would negate this bearish near term view and force us to stand aside.

For the SPX, the details are largely similar to the INDU: the weekly chart shows both the bullish and bearish counts that could be operative. And like the INDU, either the C wave of the ABC zigzag off the October 2002 lows is complete and the bear market is about to star in earnest or the C wave is not yet complete and we'll see new highs above 1163 in the next several months. The dividing line between these two Elliott wave counts are also straightforward.

From the 10/25 lows, the SPX too has put in what appears to be a clean "5" waves up on an hourly chart to yesterday's peaks. Momentum, ticks, and breadth all diverged at yesterday's peaks and hourly Demarks registered as well suggesting, again, no matter what the larger trend, a correction of this 4 day advance is imminent. The key for the SPX trend depends on how much of a correction we get. Declining below 1100 would strongly endorse the bearish interpretation for a substantial decline. Finding support however in the 1104-1115 area and then bouncing hard to new peaks above 1138 would endorse the bullish interpretation for a move above 1163 to new annual highs in the next few months. So here too, the dividing line is simple: below 1100 is intermediate term bearish, above 1138 is intermediate term bullish. Again, the conservative view suggests waiting for either of these price points to be violated is the best strategy. More aggressively a good risk / reward scenario suggests weakness from current prices for a move toward the 1105-1115 area (with trade moving above 1136 negating the bearish view)

For the NDX the weekly chart holds the same type of alternate Elliott wave counts: either the corrective bounce off the October 2002 lows has completed at the January 20th peak at 1559 or one more new high above that point is forthcoming before we can start to look for a substantial decline. And like both the SPX and the INDU, the NDX is either on the verge of confirming the bullish interpretation of the wave pattern or confirming the bearish one. Price will help us determine that.

Specifically, as our intraday note on Wednesday of this week suggested, the two most important levels for the NDX are 1478 and 1515. The NDX is showing even larger divergences in momentum, breadth, and ticks than the SPX and INDU off of both its August lows and compared to the price action through the entire month of October. Hourly Demarks are also present. The key to the NDX interpretation over the next few months rests on how the NDX reacts to these divergences.

Specifically, "5" waves up from the lows registered on 10/26 are largely if not entirely complete, along with relevant divergences. Either this "5" waves up is the end of a larger corrective double zigzag bounce off the lows from August 13th (and thus will decline substantially soon) or it is the start of the next impulsive wave to new annual highs.

The dividing line between these bearish and bullish interpretations lies largely in how prices react over the next few sessions. If prices decline below 1440 and then again below 1430 that would suggest the larger bearish interpretation is operative: that the bounce from the August 13th lows was a corrective double zigzag and prices should fall rapidly to new annual lows. If however, the NDX is able to find support in the 1450-1465 range and then bounce impulsively above 1500, that would tend to bolster the bullish intermediate term Elliott wave count that calls for new annual highs above the 1559 peak. The dividing line for the NDX then is thus: bullish above 1500 after a pullback and bearish below 1440. Again, the conservative view suggests waiting for either of these price points to be violated is the best strategy. More aggressively, weakness from current NDX prices could suggest a move to the 1450-1465 area over the next several sessions with only trade moving thru 1503 negating the bearish view.

No positions in stocks mentioned.

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