Tuesday, April 1, 2008

A Real Market Bottom or an April Fool's Joke?

The financial media this morning is exclaiming that the worst might be over and the market may finally be rallying. This may be true, but what do the internals have to say and what should you do about it?

Here's what my charts are telling me. Today, the S&P did convincingly break through minor resistance as well as its 50dma (daily moving average). The VIX (volatility index) is bumping up against its 200dma which has been a major support level for it during this bear market. The Dow Transports (DTX), viewed as leading indicator of market direction, also broke through its 490 resistance level and is nearing the next point of major resistance at 500. The Dow Industrials, the Nasdaq, the S&P 100 (OEX), and the NYSE composite (NYA) are all also threatening to take out their resistance levels.

Sounds rosy, doesn't it? But hang onto your wallets thar' pardner, 'cause if you're a long-term investor, it might behoove you to wait. The reason can be demonstrated graphically by looking at historical charts of the S&P during both bull and bear markets. The first chart is a weekly graph of the S&P 500 during the previous bull market. It shows the two and half years just before the market ran out of steam. You can see that the 50dma acted as a support level, and although it's not shown here, it acted as a support level for the entire bull run.

The next chart is a continuation of the previous one and shows that now the 50dma has become resistance. Every time the market hit that point would have been a good time to short. You can see the market began its bear phase when it dropped below the 100dma, and began the next bull phase when it crossed above it in August of 2003. (Actually, the bull market could technically have been said to have started when it overcame major resistance earlier in April.)

The next chart shows the end of the recent bull market. Note that the 50dma acted as a support level here, too.

The final chart is just a short continuation of the previous one and it shows were we are today. Technically, the bear market began when the index broke its major support level of 1430 as well as breaking its 50dma. This January, it sliced through its 100dma which confirmed the bearish trend.

So what does all this mean? If you're a long-term investor, you might want to wait a few days or weeks to see if the index breaks above its 50dma. Very conservative investors should wait until the 100dma is broken before piling into long positions. You may be giving up some profits by waiting, but on the other hand, you won't be taking on additional risk.

You may have noticed that I included the CCI, the commodity channel indicator, in my charts. This is a good timing indicator that I'll be discussing in an upcoming blog, and I want you to become familiar with it before we dissect it.

I guess we'll find out shortly if today's market action was for real or just another April Fool's Day joke.

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