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Happy New Year! What a great cycle the calendar provides-every 365 days or so we get to start with a clean slate and refine our trading plan for the year ahead. If that was something on your holiday "to do" list, but you didn't get it completed, it's never too late. January 1st is just a date and you will benefit from constructive refinements whether they are completed by that date or another one. Just be sure to create a new deadline to remain accountable for what's needed.

We're past the holiday season - ahead of the earnings season, but smack in the middle of "market forecast season." You may be getting inundated with 2010 market opinions making it hard not to get caught up in the discussion. Why not? It's probably a topic you enjoy anyway. But while firming up your own opinion remember to remain flexible in your analysis throughout the year.

Speaking of flexibility, many strategies require it as well. You may need to change your outlook on a dime after already investing time, then money, into an outlook. Of course during the process you would have also identified scenarios that serve as alerts that the outlook is not holding up. If you have any trouble adjusting to those alerts keep in mind the expression, "it's not about being right, it's about making money," and the adjustment may be easier.

Market Trends

The new calendar year also presents me with an opportunity to change up my weekly article series. It seemed a great time to return to the topic that keeps on giving: market trends. It's rare to have a week when it truly feels as if there's nothing happening in the markets. The format will generally include charts or similar quantitative views of market data using primarily exchange-traded funds [ETFs] as proxies for a variety of market indices. When longer time periods are needed, the index will be used instead.

US Stock Market

Two widely followed indices that serve as barometers for the US stock market include the Dow Jones Industrial AverageSM (INDU) and the S&P 500® Index (SPX). A chart for INDU is provided here along with a chart for SPY-the most commonly used ETF proxy for SPX. Please see the information at the bottom of the article for more detailed ETF information.

The notion of the "big picture" is a relative one given your trading timeframe. In technical terms these are generally trends that capture a longer period of time using monthly chart and/or a compressed weekly chart. Opting for a line chart based on closing levels removes range noise during the period and makes it easier to identify the trend. Adding moving averages makes the trend identification process less biased. As a last technical note, a log scale chart will normalize the data so relative price changes can be viewed for longer time periods.

Rather than viewing just one type of chart for each interval (monthly, weekly ") for your market analysis, consider saving a few different settings to keep your work flexible.

Figure 1 is a monthly line chart for INDU using a log scale that captures approximately 40 years of closing data. Two support/resistance lines are included as well as vertical lines denoting a 39-week cycle. The most recent line is dated 12/30/09 and the next forecast line is 9/30/10. Keep in mind that cycle lows can occur within a trend rather than reversing a trend. In other words, the cycle low may not be a market low.


Figure 1: Monthly Line Chart for INDU (1969-2009)

Although the detail is difficult to see with this chart, the point for its inclusion is to identify the current primary trend as up. By keeping things simple on the chart you're forced to acknowledge what is happening in the market. Using the support/resistance lines drawn, you can note that the 9 month rise surpassed a potential resistance point in Aug 2009.

From a pure price perspective, the following scenarios should be considered when monitoring the primary trend:

1. Any price retracement should hold at the upper support line for the primary trend to remain intact. The line uses an 11/96 high, a 3/97 low and a 9/02 low in its construction.
2. Continued movement upwards and a longer-term top should surpass the Oct 2007 high for the primary trend to remain intact.
3. A break of the upper support line puts the primary trend in question. Such movement could lead to sideways price action for the index (see movement after the 1974 low on the left side of the chart) or warn of a new primary down trend.
4. The lower support line is monitored next. Sideways movement is favored if support holds. The line is a potential support area, using the 7/96 low and 2/09 low in its construction. The Feb 2009 closing low should be monitored to determine if a new primary downtrend is place.

While there are a lot of "ifs" that's the nature of the markets. Any of the scenarios identified could unfold and it's important for most traders to stay in tune with the primary trend.

I use a 39-week cycle in this chart rather than 40-week to tie it more closely to a 9-month period on the monthly chart. Using the forecast cycle low in Sep 2010 and extending the two support lines, there are a couple of intersection areas that can be used to identify index support levels near that timeframe. These include 9225 for the upper line and 7250 for the lower line. Two dynamic index levels (not time dependent) include 13,930 for the Oct 2007 high and 7063 for the Feb 2009 the closing low.

Figure 2 provides a monthly bar chart for SPY using an analog scale that includes about 16 years of data. While the upward primary trend is still pretty clear, 5 month (aqua) and 10 month (blue) exponential moving averages [EMAs] were added to provide objective tools that measure the intermediate trend (approximately 100 days) and the long term trend (approximately 200 days).

 

Figure 2: Monthly Bar Chart for SPY (1994 - 2009)

Upward movement in the two moving averages point to a bullish intermediate trend (5-month EMA) and a bullish long term trend (10-month EMA). The relative position of price, the shorter-term EMA then the longer-term EMA is the strongest possible trend scenario. A change in the relative position of these three data points provides traders with a potential warning about trend continuation.

The bars create more noise and distraction, but are helpful when considering intra-month market extremes and may provide more insight on potential areas of support/resistance. A fourteen month Relative Strength Index [RSI] momentum indicator is also included with bullish ranges (green) and bearish ranges (red) denoted. Please see the July 2008 Analytical Toolbox series on Andrew Cardwell for more information on use of these ranges.

Strong RSI movement through the 40 and 50 levels supported continued upward movement in SPY. The RSI 60 level is the next potential point of resistance to assess upward trend strength going forward. In the event RSI moves downward, the 50 level should serve as support to favor a pullback in SPY that keeps the primary trend intact. Failure of this support level puts the upward trend in question. At that point the potential for sideways movement or continued downward movement must be assessed.

Although there is nothing earth shattering in these charts from a 2010 outlook standpoint, you have to know where you are to weigh in on future scenarios. It would be impossible for me to start an assessment of the market without looking at some clean, longer-term charts of the broad markets. It's really important to stay grounded in "what is" for the markets before jumping to what might be.

I will definitely use different techniques and markets along the way in Market Trends, but had a pretty clear starting point given the fact that we're in the midst of outlook season. In my view, it's hard to know where you're going if you don't consider where you've been.

Chart Specifications

INDU Monthly Line Chart (log scale)

1st Potential Support Line: Uses the 11/96 high, a 3/97 low and a 9/02 low in its construction

2nd Potential Support Line: Uses the 7/96 low and 2/09 low in its construction

39-Week Cycle: Initiated 8/31/1960, Most Recent 12/31/2009, Next 9/29/2010

SPY Monthly Bar Chart (analog scale)

Exponential Moving Averages [EMAs]: 5-Month & 10-Month

Relative Strength Index: 14-Month with 9-Month Simple Moving Average [SMA]

ETF Information

SPY is the Standard & Poor's Depository ReceiptsTM (SPDR®) which tracks the widely followed S&P 500® Index. It is a unit investment trust that holds the same securities as the index tracked (names and proportion). These products can trade at a premium or discount relative to the underlying basket of securities. One distinctive feature of the general class of securities referred to as ETFs is the funds transparency with holdings provided to investors on the ETF website.

Clare White, CMT
Contributing Writer and Options Strategist
Optionetics.com ~ Your Options Education Site

Questions for Clare? Please visit the discussion board on the homepage of Optionetics.com.

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