Friday, July 24, 2009

Broadening Top?

Just after the head and shoulders top that recently failed, the latest pattern in vogue is the broadening top formation. To be clear, it should not be called a broadening top. It should just be called a broadening formation. It is just as often a continuation pattern as it is a reversal pattern. From a purist point of view, this is not even a valid broadening formation as the lower line has only two touch points. To become bearish, we would need to see a move all the way down to the lower line, followed by a partial rise and then a breakdown.

The current phenomenon is a manifestation of the persistent bearish sentiment in the market. Notice how few people have mentioned the breakout from the inverted head and shoulders bottom pattern in the SP500 (Carl Swenlin is an exception). I calculate an average target of 1164 for the breakout from this pattern.

This rally so far is developing almost exactly as I had envisioned toward the end of 2008. And the degree of persistent bearishness is such that I think it is entirely possible that by mid 2010 the Nasdaq 100 will exceed its 2007 highs, and the SP500 may come close to retesting its 2007 highs. This does not reduce or negate my long term view that the bear market low will be seen in the time zone of 2012 to 2014 with the Dow approaching the 3000 level or lower.

So how is it possible that we are in a bear market with markets heading toward their previous highs? I believe the explanation is that we are in the largest X wave in the history of the stock market. This X wave is the connection between the first phase of the bear market which evolved as a flat in the SP500 and the second phase of the bear market which will most likely be a 3 wave decline. Once the first leg of that 3 wave decline is complete, we will be able to more accurately project the price and time of the final bottom.

As far as I know, I am the only person to put forth this hypothesis publicly. It occurred to me back in 2007 as wave C of the flat correction got underway. It has grown on me because it is about the only pattern that unifies the various cycles that I have previously described while maintaining the possibility of a potentially devastating outcome. The positive side is that we could also see only a retest of the 2009 low, which while perhaps disappointing to some bears would be a blessing to our nation and the world. I plan to post a paper on this analysis in the coming weeks.

The one thing that could prove this hypothesis wrong is a 5 wave decline from the top of the current rally that carries below the 2009 low.

3 comments:

dave said...

"So how is it possible that we are in a bear market with markets heading toward their previous highs?"

Actually, Ned Davis Research has done a fairly good job of articulating that we're in a cyclical bull mkt within a secular bear mkt without using EW or cycles per se.

Today's (Fri) mkt action is the greatest "suggestion" to date that we're in a cyclical bull mkt. Two important stks, AMZN & MSFT, to both the economy & mkt action itself were hammered in after hours trading yesterday as they were this morning's opening & the mkt shrugged - yawned.

If the mkt was going to sell off from a broadening top's upper trendline, today would have been the perfect opportunity to do so ... & it didn't.

Regards,
dave

dave said...

"From a purist point of view, this is not even a valid broadening formation as the lower line has only two touch points. To become bearish, we would need to see a move all the way down to the lower line, followed by a partial rise and then a breakdown."

How else can we get the 3rd touch of the bottom line, but to decline off of the top line ? It doesn't come with 3 touches out of the box. Patterns aren't like instant oat meal. They have to develop. I think given what happened to AMZN & MSFT Thurs it was reasonable to become leery before the mkt showed that it would shrug off their bad earnings...especially given that a broadening formation is just that the opposite of a symmetrical triangle or pennant & the moves/waves get larger rather than smaller.

Ironically, we could still get that broadening formation to flesh out & still have the rally continue weeks from now.

The mkt could be vulnerable to such after this bullish end-of-the-month/beginning-of-the-next-month period passes.

Regards,
dave

R. Craig Pritchard said...

Definitely agree that patterns need time to develop. I was remarking more on how quickly the pattern was mentioned on so many sites even though it has not fully formed, and after we just had failed bearish pattern. As if, traders were looking for another reason to get bearish right away, or justify holding short positions.

EWI called for another small thrust to complete the rally off of the July 8 low on July 17, over a week ago. Tonight they are again saying the same thing. They are probably right this time, but think of all the traders sitting on the sidelines waiting for that 5th wave to complete.

I'll not worry about the broadening formation until it is fully developed, and I will be looking to add on a pullback if it occurs.