Good News or Bad News?

Do you want the good news or the bad news? Like everyone else I have been trying to make sense of the latest events in the market. Is this just an overblown exaggeration or are we headed for another Great Depression. Like everything in the market, we are probably somewhere in between. Since I cannot predict the future (I’m so sorry to disappoint you), I thought I would try to present both an optimistic and pessimistic view of what the long term charts are showing me. That way you can choose which outlook best fits your mood. Below is a long term monthly chart of the Dow Jones Industrial Average. Why did I choose the Dow? Because a 1000 point drop looks a lot more dramatic than a 100 point drop (S&P 500), why else?

 

The Dow has currently retraced the 2002-2007 bull market by about 50%. This 50% level is a key retracement area for trends. There are also areas of past support/resistance that confirm this 50% retracement area (see big black line). The strong bullish outlook would be that the worst is over and “happy times are here again�. If you believe that the worst is over and we can only go up from here, then this chart should give you the confidence to dive right in and start buying.

 

The next chart is based on Elliott Wave Analysis. R.N. Elliott produced a theory in the 1930’s that stated that the markets advance in 5 wave moves that are followed by 3 wave corrections. He also said that each of these patterns repeat themselves and form larger patterns. These “sub patterns� are often referred to as fractals. You can read more on this theory by using the following link: http://en.wikipedia.org/wiki/Elliott_wave_principle. I don’t believe that the markets fit into a perfect pattern, but I do believe that patterns are formed by human behavior. By this I mean that there are similar reasons why we buy and sell. When we are alone at are desks, ready to make a trade, we often feel an urgency to “get in right now� or a thought of “I’m missing the move�. This will often cause us to be more aggressive in our buying. We end up buying at prices that are higher than we originally anticipated. Although we feel that we are the only ones feeling this emotional pull, the fact is we are often part of a larger trading crowd that is doing the same thing at (often) the same time. This is why prices often surge upward (or downward) in steps or “waves�. These surges are often broken up by smaller three wave corrections (labeled ABC). These “corrections� are caused by uncertainty. This uncertainty creates a battle between the bulls and the bears for intergalactic domination (or just a continuation of the trend). If this is true, then the next move for the markets would be an upward rally, followed by an even larger move down (see chart). This upward rally would probably unfold in a three wave move because it would be “correcting� this latest move down.

 

This would be a conservative outlook for most Elliott Wave technicians. Since I am not a full blown Elliott Wave disciple, I reserve the right to take a sunnier approach. If the measures taken in the next few days and weeks only provide a short term fix to the banking problems, it is not difficult to see this chart as a possible conclusion to this mess. That gives us a Bull Market for the next two years, followed by a 4000 point drop in the Dow (I told you it sounds better when you use the Dow over the S&P 500). So the good news is that a Bull Market is coming. The bad news is that a larger Bear Market will then follow. Listen to your coaches and learn how to trade the market in both directions.

 

Now I did say that I can’t predict the future, didn’t I?

 

Jerry McCann