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Complexity Analysis


Topping is typically a process, and often a long one


Editor's Note: The following analysis was offered this morning via Scott Reamer's technical service. We share this vibe with educational intentions only. For more information regarding Scott's unique approach, please click here.

What a difference three trading sessions make. With the spike low last Thursday morning on the London bombings news, the blue chips have rallied 3.1% and the Nasdaq 4.3% in a straight line, surpassing several layers of important resistance, doing so on strong volume, strong breadth, strong ticks, and with momentum confirmation, and tracing out a nearly complete impulsive move.

Such stock market bounces have followed the 9/11 attacks and the Madrid train bombings in 2004 as well; whether the bounce is the result of moral hazard or a fresh liquidity injection in the capital markets is moot. Key resistance levels did not hold, the form of the recent rise is impulsive (meaning with the larger degree trend), and the internals of the advance are not to be dismissed; they were strong.

The weekly and daily indicators we use and plug into our model have suggested repeatedly that ANY decline from around these areas could well be the start of a significant bearish trend. The probabilities for such an outcome have been significant based on our models so we will not ignore it. And the fact that the market can't go down well and certainly doesn't go up well reinforces that conclusion. Case in point: the NDX closed yesterday at 1547; this index first touched that level back on January 16, 2004. Thus 542 days have passed and the Nasdaq index has gained precisely 0%. Nothing. For its part, the DOW too has gained precisely no ground since January 6, 2004. This is not to say that active traders haven't been able to make money long, short, or both. But the fact that these markets have made no headway in that time reinforces the idea that the market has manifestly NOT gone up well. And in our work, this process - of unsteady gains and losses, or minor uptrends and downtrends - is a topping process, not a bottoming one.

For the last several quarters we have been looking to identify where - with some precision - a top might form. At each point along the way - in Q1:04, in January 2005 and again in March 2005, our models have suggested that the probability was meaningful that a peak was in. And though each time those increased probabilities produced a bearish trend, it never declined in earnest.

Just as the market has not gone up well, so too has it not gone down well. At each peak since Q1:04, the market's 'critical state' has grown more critical - more unstable - despite prices that make new peaks. The massive overlap of price highs and lows since Q1:04 is the single most important factor to understand in the stock market now. This overlap - which is a sign of weakness and slowing upward momentum since 2003's lows - has, paradoxically, produced higher net bullishness; has produced more desire for risk-taking; and has increased complacency.

The SPX looks like it has several possible targets, starting from 1230 and going up to 1260, with some 'good' targets in the 1237 and 1247 areas. Before we argue for the potential for a long trade to new annual peaks in the SPX and NDX, we will want to see what form of correction takes place in the next several trading days. If it is corrective looking and finds support at natural levels, trading longs would make sense though this is not advice. If indeed, higher annual peaks are in order for the SPX and NDX, support in the SPX 1200-1206 area and NDX 1500-1525 (DOW equivalent is 10300-10400) will be found late this week or early next.

No positions in stocks mentioned.

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