Thursday, May 20, 2010

Dancing with the Stars

Although it is too early to tell if this is the start of a major decline, the behavior of the moving averages will reveal what structure the market is going to form. In the event that the current decline is the beginning of a multi-stage decline the interaction of the 21, 55 and 200 day moving averages will possibly indicate when the 'three wave' is ready to unleash its destruction.

It is rare that large sustained declines begin by falling from above the 200 day moving average. It is typical for the market to test the 200 day level--then rally and interact with the 21 and 55 day averages which then provide resistance instead of support. A few things usually occur before 'all hell breaks lose'. I have used a chart of the peak in 2007 with the current chart to suggest a hypothetical extrapolation of how events could unfold.
  • the market makes its original test of the the 200 day moving average.
  • the 21 and 55 day averages approach the 200 day average but turn back up as the result of a brief rally--bear trap.
  • after a brief rally fails, the 21 and 55 turn down and break through the 200 day. THIS IS WHEN THINGS GET INTERESTING. The market is now in a very precarious position.
  • at this point the market is in a position of tremendous vulnerability and when there is a confluence of cycles turning down the market will hit an air pocket--a volume vacuum--then it breaks.
  • often the bear offers alert investors a ride on his back down the steep slope. This opportunity presents itself when--after a fairly serious decline--the market rebounds and kisses the 200 day moving average good-bye. il bacio della morte.
  • it is at this point that the market is ready to collapse and aggressive action is warranted.
It goes without saying that if events do unfold in this manner, the market action will not be identical to the example from 2007--especially since this would be a decline from a intermediate top (2009-2010) and not a long term top (2002-2007). But the interaction of the moving averages will indicate that the structure is similar and that several down cycles are exerting pressure on the market.
right click graph for graphic enlargement options.

The moving averages love to dance with each other and if you watch them carefully they will tell you when its time to boogie. The natural cycles suggests that the period of maximum vulnerability will commence in late June and extend throughout the summer months.

The bullish % volume is indicating some serious deterioration which suggests that any ensuing rally at this point would have to have some incredibly strong up-days to repair the damage. The deterioration continues in an environment of complacency.

right click graph for graphic enlargement options.

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