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September 28th, 2003
Table Of Contents:
Click on the section titles below to be automatically taken to that section:
Part 2: General Market Analysis
General Market:
The market had a major pullback last week with all three indices down significantly. This pullback was not a surprise at all given the extreme levels in the VIX and the Negative Divergence in the MACD indicators on all three indices.
In last weeks newsletter, I pointed out Negative Divergence was occurring in the Nasdaq, DOW, S&P 500, as well as Gold Metal and many gold stocks. In other words, the indices all formed higher highs, while their respective MACD indicators formed lower highs. It is prudent to be on the lookout for Negative Divergence after a stock or index has formed a higher high.
Because of this event, I'd like to illustrate the importance of Negative Divergence and it's uses in market timing. On the education section, I have a nice section on Negative Divergence, visit there for a more detailed explaination.
Note, I am not a big indicator fan, I am generally a chart purest i.e. I trade primarily off chart patterns such as triangles, wedges, flags, head n shoulders, etc. However, I have found that Technical Divergence can be useful in some cases, especially when it is confirmed by other technical situations that cause a synergistic effect.
Normally stocks and their respective mathematical indicators confirm one another. For example, usually when a stock forms a higher high, so does one of it's mathematical indicators, and vise versa. However, sometimes a divergence takes place where the stock price and the indicators do not match. Technical divergence can be thought of as an anomaly - in other words, the divergence can only sustain itself so long before the indicators and the stock price match again. Always be on the lookout for technical divergence especially after a stock has been in an extended up trend as it can be a good warning that a stock is going to change direction. Thus, Negative Divergence is usually seen after a stock has run-up from a prior chart pattern that has broken out.
Negative Divergence is a condition where a stock or security forms a higher high, but a mathematical indicator (such as the MACD, Stochastics, etc.) forms a higher low - hence, a divergence takes place. Traders should look for Negative Divergence when they are holding short positions as a signal to cover them. Positive divergence is very useful in that it often signals the end of a decline and /or buying opportunities well before the other more common chart patterns.
VIX analysis:
The VIX or Volatility index is ratio of put options to call options. It is a useful indicator because it indirectly measures market psychology. The VIX is like a contrarian indicator, when it's low, it means that more people are buying call options, and thus are bullish on the market. Contrarian theory tells us that the majority of people are wrong about the stock market, therefore when the masses are overly bullish, the market is usually topped out and about to tank, and vice versa.
The VIX can be used in two ways:
1. Usually the VIX is used to indicate when the psychological levels of the market are overly bullish or bearish. Overly bullish levels are in the mid 20s and lower, while overly bearish levels are in the upper 40' and higher. Traders use these levels to indicate when the market is at extremes, such as oversold or overbought. The old saying applies, when the VIX is low it's time to go, when the VIX is high, it's time to buy.
2. The VIX can also be used to forecast the market direction because of it's inverse correlation to the market direction. For example, by using technical analysis, if you decide the VIX is going to fall in the short term, the market will usually rise, and vice versa. Normal pattern or technical analysis can be preformed on the VIX an attempt to decipher short term market direction.
Current Analysis:
The VIX finally rallied big time last week off its extreme lows, caused by the big fall in the general market last week. Remember, when the VIX rises, the market falls, and vice versa. The VIX has major resistance at about 26, which is also near the 200 MA. There is also some minor resistance at about 25, via the dotted line. The VIX will most likely fall at one of these two levels, 26 or 25.
How is this useful? Because once this happens, the general markets will put on a hard over sold bounce. As you can see, this will likely happen sometime early next week. In other words, I would not be shorting until we get a nice oversold bounce in the market, and judging from the chart below, an oversold bounce in the market is near.
Below is a long term chart of the VIX. When looking at this chart, it now seems obvious why the VIX rallied last week and the market fell. The VIX simply bounced off multi-year support from extreme levels.
Nasdaq:
The Nasdaq really took a beating last week by falling over 100 points to close just below 1800. This is not surprising given the Negative Divergence in the MACD that I mentioned in last weeks Newsletter. The round # of 1800 did not hold as support, but rarely do round #'s hold as support or offer much resistance. The closest support is about 1775 (noted by the red dotted line) which was previous resistance and the high of the Bullish Flag in July. In my opinion, this is a very likely place to bounce. Also notice how the 50 MA also corresponds exactly with this support level, thus giving further confidence that 1775 is a support level.
Last weeks pullback occurred on fairly high volume which is not bullish, however this is still not the time to be shorting. In order for the Nasdaq to confirm it is in down trend, it will need to form a lower high and it has to put on a bounce to do this. In other words, the time to be shorting is after the next bounce occurs. I suspect the Nasdaq will bounce very soon (probably early this coming week) as it is near support while the VIX indicator is near resistance.
I have been laughing at many of the newsletter writers for months who have been trying to pick a market top. However, It seems this time they might finally be right. It is too early to tell at this point. However, If the market has already seen its highs, then it will take a long while for it to fall. This 'topping' process takes time to happen - in other words, don't expect the market to just roll over and die at this point.
Below is chart of the Nasdaq with corresponding Fibonacci Lines connecting the major lows and highs of the Nasdaq rally that began in March.
In this example, Fibonacci lines are used by first drawing a trendline between two extreme points (March low and September high). Fibonacci lines represent significant areas, or possible support and resistance levels, after a significant price movement (either up or down) - in this case being up.
After a significant price move (either up or down), prices will often retrace a significant portion (if not all) of the original move. As prices retrace, support and resistance levels often occur at or near the Fibonacci Retracement levels. Significant Fibonacci line #'s are 23.6%, 38.2%, 50%, 61.8% and are noted by the blue lines in the chart below.
The reason I bring up this chart, is becasue if the 50 MA fails to hold as support, then a fall to one of the corresponding Fibonacci lines may occur. Also keep in mind, that any pullback up to the 61.8% retracement is considered a normal pullback within the up trend that started in March, though it would be very painful for the Bulls, as 61.8 % would be about 1500 on the Nasdaq. However, any pullback below the 61.8% retracement, and you can kiss the up trend started in March good by, and the Nasdaq would likely go on to test new lows.
Below is a good chart to illustrate the time frame it may take the Nasdaq to consolidate. Notice that the last consolidation took many months to complete. Also note how after the first high was formed, a second 'lower high' was formed. This is what I suspect may now happen with the Nasdaq and the market in general.
As you can see, this 'topping' phase takes a long time to complete. In other words, don't expect the Nasdaq, and the Market in General, to just roll over and fall off cliff. It will most likely be a long process.
Also notice that the Nasdaq retraced to a Fibonacci # of 61.8% on the last consolidation. This could happen once again. It would be a painful process that would bring the Nasdaq down to approximately 1500.
Below is a plot of the Nasdaq with both sets of Fibonacci lines for each major Nasdaq rally.
Below is the 60 minute chart of the Nasdaq. You can see that last weeks pullback finally took out the up trend support line. Closest support is about 1775, blue dotted line.
DOW daily chart:
The DOW also had a major pullback last week and did not stop at the 50 MA. Support is near at about 9200, but major support is at 9000. At this time, I doubt the DOW will fall all the way to 9000, I think it will probably bounce any day, probably early this coming week. Also note the Negative Divergence that was a tell tale sign of this correction.
Below is a 60 minute chart of the DOW. You can clearly see the up trend that was broken last week and note that a support level is approaching fast at about 9235.
The S&P 500 chart looks similar to the DOW. I suspect it will bounce sometime early this week.
Also note the large sideways conjestion pattern in the S&P, this will act as strong support and will not fail easily. 965 is mega support now.
The 60 minute chart of the S&P looks similar to the DOW, with support fast approaching.
Part 3: Gold Analysis
Gold metal finally pullback back last week and could continue to do so this coming week, 375 is the nearest support level. Again, this pullback was not surprising at all given the Negative Divergence in the MACD indicator - as Gold made a new high while the MACD made a lower high. Remember, you should always be on the lookout for Negative Divergence after a stock or index has had a major rally and forms a higher high.
How far will Gold pullback? We'll just have to see, 375 is the closest support, however I think this pullback will be temporary and not the start of a major pullback in Gold. I still think Gold will rally to the low $400s sometime this year. The US Dollar chart will be key.
Below is a plot of the gold metal on a longer term basis. Basically you see the same technical picture as above, but on a muli-year expanded view. Here you can see two triangle formations, triangles are simply consolidation patterns before a large price movement. Amazing to see two such beautiful triangle patterns together on a chart.
Below is weekly plot of Gold metal. The reason I'm including it is because you can see the bearish inverted hammer candlestick. These inverted hammers usually hint at a reversal or pullback.
On an ultra long term, gold is above a 15 year down trend line. If the recent consolidation on gold is broken to the upside, gold has a shot at $425. Again, note how this correlates nicely with my computed price target based on triangle height measurement - The height of the triangle is about $60 ($380 - $320 = $60), add this to the breakpoint at $368 = $425 to $430.
Again, Gold could continue to pullback here, but I think it will be temporary. The US Dollar chart is key
The HUI broke out of a "text book Ascending Triangle", with the breakpoint at 157.8 in July. This breakout level is significant for gold stocks, especially those in the HUI index. Anytime a multi year resistance level it is broken, an explosive price appreciation usually occurs, which we are enjoying right now. What's exciting is that a long term price target of the HUI is in the 200's based on height measurement of the triangle (75 + 158 = 228). The HUI could pullback at anytime to digest its gains, however I think any pullback will be temporary and I would use it to buy more gold stocks.
Unfortunately you cannot play the HUI directly like you can with the XAU, you can only play the stocks within the HUI, (components of the HUI)
Current Analysis:
The HUI came very close to hitting my price target of $220 last week - not too bad for my projection back in June/July. The HUI is in the process of pulling back, and it's hard to say exactly how far it will fall. However, I think it will form a higher low and rally to new highs later this year.
The HUI had a major pullback last week by dropping over 20 points from its high of $213. Again, this was to be expected given the Negative Divergence in the MACD indicator. I hope you are starting to realize the importance of this indicator when identifying major tops. The dotted lines are possible support areas for the HUI.
The XAU also took a big dip last week, though its chart doesn't look as over extended as the HUI did. The XAU is near support at 89.10.
Like the HUI, the XAU also fell hard last week per the Negative Divergence. The blue dotted lines are support levels.
One must not lose site of the fact that gold is in a long term bear market. Therefore, despite what individual gold stocks may do in the short term, many of the long term charts look very bullish, click on the stock symbols in the table below.
Weekly Long Term Gold Charts
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< $2
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$2 - $5
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$5 - $10
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$10 - $20
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> $20
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The US Dollar:
The US Dollar has been in a virtual free fall after breaking the up trend line. The Dollar gapped down last week and is approaching its June lows at about 91.80 - which is also the nearest price target. In the short term, the US Dollar could bounce to fill that gap, but it will only be a temporary bounce in my opinion and resistance at 95 will probably stop any bounce dead in it's tracks.
I US Dollar will likely retest and eventually breaks its June lows this year. This will bode very well for Gold Metal and Gold stocks in general, but will not bode well for the general market and the economy.
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