Shades of 1993 in the Nasdaq

This column was originally published on RealMoney on Nov. 23 at 12:12 p.m. EST. It's being republished as a bonus for TheStreet.com readers.

Some say that stock movements are completely random, and that trying to make sense of them is about as constructive as digging for gold in your back yard.

Others swear that there is a rhyme and reason for every move.

I'm not a member of either camp.

I do look for repeating patterns because I think directional changes are indicative of the changing emotions of market participants.

There is also a time component, as emotional commitment tends to wane with the passage of time.

When I see a familiar pattern, I try to discern the most likely emotions accompanying each move -- is the uptrend steady and dependable, or is it steep and choppy?

Different emotions will produce a distinct pattern.

One pattern that I have been following with some curiosity is the similarities between the current market and 12 years ago.

My friend Fari Hamzei of HamzeiAnalytics.com has been keeping analog charts of the major indices. They are eerily similar to today's market.

For example, let's look at a comparison of the Nasdaq Composite index in 1993 and 2005.

See how the prices track so closely? I've highlighted the last significant peak in each line.

Now, compare the breakout that occurred at the end of 1993 to the breakout that is occurring now.

Seems to me that both breakouts derive from the same emotional sequence: A pullback after the peak (yellow highlights) driven by weary bulls who had pushed prices as far as they could go.

The market needed to rest. But these pullbacks didn't really establish a lower low -- the bears didn't take control of the market.

So the resulting rally after the low (blue highlights) was largely driven by excitement that the uptrend was intact. "Let's put more money to work. The bull is alive!"

That brings us to the end of November -- the breakout to a new 52-week high. With this much excitement, can the market push higher?

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In 1993, the bulls got tired soon after the breakout. So much buying pressure was used up just to run from the prior low to the prior high that there wasn't much emotion (hence, energy) left. So the breakout was short-lived, and the Nasdaq trickled sideways for the balance of the year. It's all ebb and flow.

I'd say the chances are high that the Nasdaq will repeat the December pattern shown above -- a sideways trend for the balance of the year. Why? Because current emotions should approximate 1993 emotions -- the preceding ebb and flow has been the same. So am I putting my money on this pattern? Not really. It's just another bit of information that colors my bias. I'll let the market action be my primary guide, using various pieces of data like this as a filter.

Because the Internet seems to be garnering a lot of attention these days, let's check out charts of some online companies.

The Chinese Web portal Sohu.com (SOHU Quote) is once again bouncing off $15 on its weekly chart. Aside from the failed rally earlier this year, each time Sohu has reached $20, it has promptly reversed. But the big problem with this chart is stop-placement. Do we put it at $14? That's way too wide for me. Let's look at the daily chart for a bit more detail.

Look how the stock ramped up to $18 within a couple of days of the early November breakout. Over the next week or so, the stock consolidated on some low-volume days. But Monday, the stock broke out yet again. That gives us a better stop level -- just beneath the breakout point. If Sohu falls that low, there's no reason to hold this breakout candidate, because the breakout has failed.

The Chinese Internet company TOM Online (TOMO Quote) began trading sideways in October after a prolonged uptrend. In light of the cyclicality of volatility, I'd say that this latest breakout at $20 -- followed by a successful test of the breakout -- has some legs. I'd put a stop just beneath $20.

The employment site Monster Worldwide (MNST Quote) has been moving up nicely after a breakout earlier this month. You'll notice that my suggested stop is not at the initial breakout level of $32.50; it's beneath $35. That's where the stock last consolidated, so that's where additional buying pressure would be apt to come in if the stock pulled back to give folks a second chance to grab it.

Bankrate (RATE Quote) is another recent breakout. Tuesday's volume was more than four times the average. It closed in the upper half of the intraday range, which is encouraging because it indicates insufficient selling pressure to halt the uptrend. I wouldn't want to hold this stock if it pulls back beneath $30, so I'd put a stop just beneath that level.

Have a great Thanksgiving. And as always, be careful out there.

P.S. from TheStreet.com Editor-in-Chief, Dave Morrow:
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