Use Charts to Get Into Focus

 | Feb 07, 2014 | 9:00 AM EST  | Comments
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Stock quotes in this article:

SPX

,

QQQ

,

IWM

,

DIA

On CNBC you've seen more than one technical analyst comparing the recent high in the stock indices to the high made before the 1929 crash. This is bringing out a lot of fear among market participants. You've also seen others who are convinced that this is a major buying opportunity. 

Who are you supposed to believe? Personally, I see merit in both scenarios, for reasons I will discuss. I'm also going to tell you that I don't know which scenario will play out. What I do know, however, is that you don't need to know ultimately where the market will end up in order to make money, or to protect yourself. What you need are trade setups and definition of risk and a plan to hedge your long bets when you need to.

What I do in my work is identify key decisions in both price and time where you can define your risk, and then I wait for technical confirmation to tell me whether the parameters are worth placing a bet against.

For example, on how you can protect or hedge yourself, I often suggest that you trail up stops when you get to extensions of prior swings. Over the years, I've noted that many moves tend to terminate, if only temporarily, at extensions of prior swings. I start watching when we get near a 1.272 extension of a prior swing and watch even more closely if we get to 1.618 or beyond.

You can see on this first daily chart, where the S&P cash made slightly more than a 1.618 extension of the Nov. 29 high to the Dec. 18 low. Since the market was in the "position" for a correction to unfold up at those extensions, it was a great time to trail up stops on long positions. On a daily chart, you could use the 5/13 ema crossover to tell you when to exit the buy side or buy some puts for protection.

SPX Daily
DynamicTrader

It looks like we saw that crossover to the downside on Jan. 24. On the way down, there was some support and timing to watch for a low about a week ago. This is where we only saw a bounce, but never cleared the resistance or got the 5/13 to cross back to the upside to support more than that bounce.

The second SPX chart shows you that the most recent low was made at time symmetry (14-day decline vs. a prior 14-day decline), above some key support parameters. Even though we're seeing a healthy bounce from this low, I'm not seeing indications that it is more important, and I still want to be alert for a failure and possible new lows. We are still below the 50-day simple moving average, and the 5/13 is still in a "sell mode."

SPX Daily 2
DynamicTrader

Next let's revisit the monthly chart of SPX, to tell you why I have a few concerns about the market myself.

SPX Monthly
DynamicTrader

On the monthly chart we have met a major 1.272 target off a major swing from the October 2007 high to the March 2009 low. In the same way that the S&P was vulnerable to a correction of the recent minor swing into the January highs on the daily chart, via the weekly chart we are also in that position. It does not mean that we will get a major downside correction, but we are certainly in a position where that could happen.

SPX Weekly
DynamicTrader

Another thing that concerns me is that the prior rally into 2007 lasted 60 months. The rally that started in March 2009 has lasted 58 month so far, which is similar in time, and that "timing" may also offer resistance to the huge rally we've seen since then.

With all this being said, so far the weekly chart shows me that the recent decline is still only similar to some of the prior corrective declines since the 2009 low. So for now, I continue to monitor both the price and time parameters for when we might put in the next intermediate low, but I don't plan on placing any major bullish bets unless I can see both key resistance cleared on the way up, and a 5/13 ema crossover to the upside would be a rather important signal for me.

Bottom line, I can identify some key decisions for you, not truly predict the future. One more thing I can share, however, is a picture of the PowerShares QQQ (QQQ) and the iShares Russell 2000 (QQQ) and the SPDR Dow Jones Industrial Average (DIA). These indices are all currently testing key support at this most recent low. Also, the DIA had timing at this last low too. Now the question is, can the market prove these lows more important? Let's wait for the technical to confirm before getting excited about it!

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