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Let's take a global view of the major indices as we near the end of a wicked year for the financial markets. The monthly charts work well in this regard because we can clearly see the detours navigated by investors in the last two decades. Hopefully this macro analysis will offer insight about the day-to-day trials we face with the current banking crisis.
A basic tenet of technical analysis points out that noise levels decrease as we view price charts in longer and longer time frames. And there's such a cacophony of discordant sounds in December's financial markets that a little peace and quiet might go a long way in figuring out just what the heck is going on right here.
Frankly, I'm man without a plan when it comes to strategies for early 2008. The sharp volatility since July is overriding my usually bullish assumptions about the January-to-March trading environment. In its place, I expect to be a hand-to-mouth player, taking quick profits until a more reliable trend emerges. Let's see if the monthly charts show light at the end of this dark tunnel or a spring-loaded mousetrap ready to snap our necks when we move in to take the cheese.
The Dow Industrials entered a historic uptrend during the Reagan presidency, rocketing from 1000 to 11,000 by the turn of the millennium. The venerable average topped out in early 2000 and dropped into a bear market for the next two years. Notably, its downward path was punctuated by a series of strong recovery waves. The index started to move higher in 2003 as U.S. troops headed into Iraq. Price returned to the 2000 high in May 2006 and broke out in October of that year. This triggered a rally that lifted price another 2000 points in the next 12 months. But it was a tough ride, with volatile swings slamming the index lower after each upswing. This is a confirmed breakout with a healthy thrust above new support below 12,000. So any pullback that drops the Dow into that key level should be viewed as a historic buying opportunity. In the meantime, this year's price action shows indecision in the form of a developing triangle pattern that could break either way during 2008. Notably, long-term stochastics may be issuing a warning signal about declining relative strength next year. Note how the indicator pressed up to the 100 level in early 2004 and pulled back. It swung higher through 2007 but now looks ready to roll over. This reversal isn't confirmed yet, but close enough to advise major caution in the first quarter.
The subsequent decline was more brutal than the Dow's, with the index getting cut in half over the next two years. The bear bottom near 800 took a full nine months to unfold, with price finally surging higher in June 2003. The uptrend since then has been steady and relentless, with only minor dips that felt worse than they look on the monthly pattern. Index price action deteriorated in 2007, at the same time it finally returned to the seven-year highs. In fact, it's remarkable that the credit crisis hit the news wires with such perfect timing. It's one of those strange alignments that makes the study of technical analysis so intriguing and useful. Obviously, this is a potential double-top scenario. This year's volatile price action looks just like the 2000 reversal, although it's easy to overplay that observation. More important, long-term stochastics is sounding a major warning, with the indicator dropping below the overbought level at 80 for the first time since 2003. It's troubling that the rally between 2003 and 2007 carved out so few obvious basing patterns, which would generate notable support levels during a decline. Without these stopping points in place, a bear market could retrace at least 50% of the four-year rally. This yields a logical downside target at 1175.
The subsequent bear market ended in late 2002 after a staggering 78% decline. The following year turned out to be an excellent one for the Nasdaq, with prices quickly doubling in value. The pace then slowed into a stable uptrend that has now retraced 38% of the broken bubble. Unlike the S&P 500 index, the Nasdaq shows few signs of topping out at this time, other than the stochastics, which might be rolling over toward the midpoint. But the three-year oscillation in that relative-strength indicator still yields a relatively bullish pattern. The index could drop into the rising trend line and hit 2300 in 2008, but that would be a minor pullback compared to the downside risk noted on the S&P 500 and Dow Industrials. In fact, continued resilience in this broad index undermines the bearish argument that we're headed for financial Armageddon in the wake of this year's events.
Alan Farley is a professional trader and author of The Master Swing Trader. Farley also runs a Web site called HardRightEdge.com, an online resource for trading education, technical analysis and short-term investment strategies. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Farley appreciates your feedback; click here to send him an email. Brokerage Partners
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