Issue Date: 2004 AUG 07  

Chip Anderson: LAW #4: KNOW HOW FAR TO BACKTRACK
John Murphy: BOND DROP HELPS GOLD, SECTOR WARNING SIGNALS
StockCharts Web Site News: DATA FEED PROGRESS REPORT
Richard Rhodes: DISCRETIONARY VS STAPLES RATIO BEARISH
Carl Swenlin: THE PRICE OF OIL VERSUS STOCKS
Arthur Hill: THE BIGGER THE VALUE, THE SOFTER THE FALL

HARMONICS BUNDLE ON SALE! -- Many parts of our economy (crops, shipping, energy demand, etc.) are tied to the movement of the sun and moon. Learn how those natural cycles reverberate throughout the financial world in unexpected ways and how you can use that knowledge to improve your investing skills. To get you started, here's a three book bundle for one great price -40% Off!

Hello Fellow ChartWatchers!

The major markets sold off dramatically at the end of the week due, so we are told, to wild speculation in the oil market. The Dow closed at 9815 which is significant because it is less that the 9852 low that it set back in May. This is the "lower low" level that I pointed out in our last edition. Despite all of the teeth gnashing in the financial press, nothing has really changed - yet. The markets are in a downtrend and lower-lows are to be expected. If the current pattern holds, the Dow may bounce some next week, but be prepared for more new lows before its next significant rise.

All our analysts are bearish these days (something that contrarians love BTW!). After I go over John Murphy's "4th Law of Technical Trading", John looks at the real reasons behind this week's fall, Richard sees a rough road ahead for consumer spending, Carl looks at the Oil market, and Arthur Hill examines the A-D lines of popular ETFs.

 

LAW #4: KNOW HOW FAR TO BACKTRACK

Murphy's Law #4: Measure percentage retracements. Market corrections up or down usually retrace a significant portion of the previous trend. You can measure the corrections in an existing trend in simple percentages. A fifty percent retracement of a prior trend is most common. A minimum retracement is usually one-third of the prior trend. The maximum retracement is usually two-thirds. Fibonacci retracements of 38% and 62% are also worth watching. During a pullback in an uptrend, therefore, initial buy points are in the 33-38% retracement area. - John Murphy

The concept of "retracement" is closely related to the concepts of support and resistance that we looked at last week. When there are no obvious support or resistance levels near the current stock price - maybe because the stock is breaking out to new highs for example - you can often use percentage-based retracement levels to "invent" new support or resistance levels.

To create a percentage retracement level, measure the most recent significant move that the stock made - i.e. the distance from the top of the last important "peak" on the chart to the last important "trough" on the chart. Now, mentally consider that distance to be "100%". By multiplying that number by the appropriate percentage, you can determine where these new "invented" support/resistance levels are.

For instance, as John indicates, stocks often reverse at the 50% retracement level. Thus, you'd multiple the distance you measured above by 0.50 (50% - the same as dividing by 2) to determine how far the stock would need to move (from the previous peak or trough) to hit that retracement level.

If that sounds like a bunch of needless math to you, you're right! And you're in luck - StockCharts' ChartNotes annotation tool can do most of the work for you quickly and easily. Start by creating a SharpChart of the stock you are interested in, then click on the "Annotate" link located just below the chart. In a couple of seconds, our Java-based annotation tool (which we call "ChartNotes") should appear with your chart loaded up and ready. It should look something like this:

To study retracements, first click once on the "Fibo Retracement" tool from the top toolbar (marked with a blue square). Next, move your mouse to the previous significant peak or trough (on the GM chart above, let's study the big move in December 2003). Then, click and hold down your mouse button while dragging the pointer to the next significant trough or peak. As you drag, we automatically display the important retracement levels and their values. When you have your mouse in the proper place, simply lift up on the button to finalize things. You should see something like this:

(Note: To duplicate this exactly, you'll need to move your mouse horizontally to the right edge and then use the "Expand Right" tool a couple of times.)

Now, why do retracement levels work at all? What's the "magic" behind them? The magic is the natural human tendency to worry. For example, after a stock has risen for a while, it's natural that some of its stockholders will start to get nervous and start thinking about "locking in" their profits (i.e., selling). The point at which that actually happens is different for each individual shareholder, but statistically, shareholders act on those nervous feelings in three clusters - one around 38%, one around 50% and one around 62%.

In the case of the GM move last December, notice how many of the investors later "locked in their profits" (i.e. "gave up") around the 38.2% and 50% retracement levels of that big move (red arrows).

Retracement analysis lets you and I take advantage of this natural nervousness in others.

- Chip Anderson

BOND DROP HELPS GOLD, SECTOR WARNING SIGNALS

DROP IN BOND YIELDS HURTS DOLLAR, HELPS GOLD... Bond prices surged on Friday's weak job report. As a result, the yield on the 10-Year Treasury note tumbled to a four-month low and ended below its 200-day moving average (Chart 1). The sharp drop in U.S. rates pushed the dollar into a 2% decline. Chart 2 shows the dollar failing at its March high and ending under its 200-day line as well. The drop in the dollar pushed gold $7.30 higher and back over $400. Gold is also back over its 200-day average. That made gold stocks one of Friday's few winners. [The only other winners were rate-sensitive homebuilders and utilities].

EARLY 2004 SECTOR ROTATION WARNINGS... In my Thursday update, I chastised economists for missing the threat from rising oil prices earlier in the year, and made reference to earlier warnings that I had published on the subject. I thought it might be useful to list a few of those earlier messages, which discuss early sector rotation warnings. Two themes you will see repeated over and over is that leadership by energy stocks and underperformance by technology is a bad combination for the market. I've repeated those same warnings in recent messages. Those negative signs were written about as early as January and February. You can access those Market Messages by clicking on "More Archived Updates" in my Market Message section: --January 27: "Loss of Leadership From SOX Index May Be Bad Omen for Nasdaq" --January 29: "Tech Continues to Lead Market Lower -- Market Rotates to Consumer Staples" --February 4: "Loss of Nasdaq Leadership Could be Bad for Market" --February 10: "Rising Oil Is A Threat to Market" --March 10: "Sector Rotations Are Similar to Spring of 2000 -- Why Energy and Consumer Staple Leadership Isn't Good"

- John Murphy


Right now, subscribers to John Murphy's Market Message are reading about John's latest targets for the Nasdaq and the S&P 500. Shouldn't you have access to this information also? John's market insights are often invaluable, but you can get them for as little as $10.77 per month!
Subscribe to John Murphy's Market Message today!

 


- Advertisement -

 

DATA FEED UPDATE - We're continuing to prepare for our upcoming data feed transition which we mentioned several editions ago. At this point, the new hardware is in place and working well and our testing is almost complete. We are working on getting the final paperwork in place from the various exchanges and expect to switch over to the new "ThomsonOne" feed before the end of August. Our goal and our expectation is that you will not notice any difference between the feeds and we're working hard to make that happen. Still, data feeds can be wily beasts and so we ask your understanding if any unforeseen hiccups happen. Rest assured that we'll be working hard behind the scenes to correct things ASAP.

SURVEY SEASON - It's almost that time of year again - time for our end-user survey where you get a chance to tell us how we can do things better. Keep an eye out for a survey in your mailbox (or, heaven forbid, your spam folder) in the next couple of weeks. Can't wait? Feel free to send Chip an email (chipa@stockcharts.com) with any feedback you have (both good and bad). Did you let your membership lapse recently for some reason? Chip would love to hear why.

DON'T FORGET THE BOOKSTORE! - We've added almost 100 new and exciting books on financial analysis to our online bookstore in recent weeks. Be sure to check out our newest offerings by clicking on the "New Additions" link on the left side of the bookstore pages. Or, just click here.

 

DISCRETIONARY VS STAPLES RATIO BEARISH

The weakness over the past several months is stark, which was made "more so" over the past two-day decline in all the major indices due to rising energy prices as well as a "punk" employment report. As a consequence of each of reports (and others) - our presumption is for consumer spending to remain weak in the weeks and months ahead...perhaps progressively becoming worse.

To understand this somewhat better, we turn to a very broad sector ratio we like to use - Consumer Discretionary (XLY) vs. Consumer Staples or (XLP). It goes without saying that if consumer spending is likely to weaken further, then consumer discretionary shares will weaken relative to the more necessary consumer staple shares. In fact, this has been occurring, but at still remains at historically high levels above 1.35. However, the emerging consolidation pattern below trendline resistance and the 40-week moving average argues for a new leg lower to have begun. If this is the case, then a move lower towards the 200-week moving average would be expected.

Hence, once again - it time to sell discretionary shares vs. staple shares, but remember...if a bear market has begun, then all shares are likely to decline...only the defensive staples shares will drop as quickly.

- Richard Rhodes

Special Offer! Right now Richard is offering a FREE 2 Week Trial at his web site: TheRhodesReport.com


- Advertisement -

THE PRICE OF OIL VERSUS STOCKS

Recently, the price of crude oil has taken the spotlight as having a major influence on the price of stocks. On the one-year chart above we can see that there was no consistent relationship between oil and stocks as long as oil was priced below $35; however, when oil moved above $35 in March, we begin to see a consistent negative correlation between oil and stocks.

Long-term resistance for crude oil is around $41-42. When crude oil reached that level at the end of July, stocks attempted another rally, in anticipation that crude oil would turn down again at resistance. Once crude broke to new all-time highs, the short rally in stocks failed.

If crude prices continue to move higher, I think we should be alert for the possibility that there will be another disconnect in prices. Specifically, if the price of crude moves well above $42, short price declines may not translate directly to a rally in stocks because prices will still be too high. This is not to say that stocks can't rally, just that gyrations in the price of oil may not transmit directly to stocks.

For the record, I have no opinion regarding the price of oil. As you can see on the long-term chart, it has moved into uncharted territory and is above historical resistance levels. It could be headed for a major blowoff, or it may have moved permanently into the bottom of a new long-term trading range.

- Carl Swenlin

Visit Carl's website -- DecisionPoint.com -- for the most comprehensive collection of market indicator charts on the Web. Breadth charts, Investor sentiment charts, P/E charts, even historical charts going back to the 1920s - DecisionPoint has it all!

THE BIGGER THE VALUE, THE SOFTER THE FALL

The AD Line is a cumulative measure of advances less declines within a given group of stocks. For example, the S&P Large-Growth ETF (IVW) has 335 stocks. If there were are 200 advances and 135 declines, then the difference would be +135 (335 – 200 = +135) and this would be added to the cumulative AD Line. The chart below shows the AD Line for the six different style ETF’s.

Despite the decline over the last few weeks, the AD Lines for two styles are holding up a lot better than the other four. Notice that the AD Lines representing large-value and mid-value are holding well above their May lows (green arrows). Conversely, the AD Lines for large-growth and mid-growth moved below their May lows and remain the weakest of the six (red arrows). Small-growth and small-value are holding above their May lows for now, but are quite close to these important support levels and clearly weaker than large-value and mid-value. Even though the overall market may decline, these AD Lines suggest that large-value and mid-value will outperform (advance more or decline less) than the other four styles over the next few weeks and months.

- Arthur Hill

For more of Arthur's insights, check out his Web site: TDTrader.com


- Advertisement -

Take the Online Tour - Get an overview of our various tools and how they work

Experiment with our Free Tools - Try our tools for yourself

Go to ChartSchool - Learn the basics of Technical Analysis or brush up on your techniques

Read More ChartWatchers - Check out the archived issues of this newsletter

Did you enjoy this newsletter? Send it to a friend!
Not a Subscriber? Sign Up Now!

SUBSCRIPTION SERVICES: Click here to unsubscribe or modify your subscription options.



Copyright © 2006 by StockCharts.com, Inc. All Rights Reserved.