GROWING UNDULATION
Weekly Review with Fernando Gonzalez
Online Trading Academy
April 3, 2007

Several weeks have gone by since we've covered the US Equity Markets, and it's about time that we do, particularly in light of some very interesting developments in price behavior recently. The sell-off on February 27th was a real shocker to most participants, as such a violent one-day decline had not been seen in over 4 years. As negative as it might sound to the investing community, a huge sell-off such as that is really a welcome one on the part of the (short-term) trading community, as it breathes fresh volatility into the markets, and therefore a more vibrant trading environment.

Since then, the average true range of the S&P500 (at 5-day setting), had jumped from 9 to over 20 points per day. It has since declined, but appears to be leveling-out now at about 13 points. That translates to over 40% increase in short-term volatility. Now that can mean many things to many people, but for the short-term trading community it's great news, as the room for opportunity has expanded. For the investing community however, the added volatility, particularly that the most violent move (see chart below) was downward, spells trouble for the markets just ahead.

Let's take a look at the charts:

CHART NOTATIONS:

- The Daily chart of the S&P500 above addresses the short-term and intermediate-term time horizon.

- Note that the uptrend on the left side of the chart here is one of the most consistent uptrends seen in the S&P500 on the Daily scale in over 30 years. Whenever markets experience an unusually long period of consistent price behavior, it is almost always ends in a sudden and violent way. In this particular case it is no different, as the end came on February 27th with a sharp decline, and the alibi this time was a huge sell off in the Asian Equities markets.

- Now an uptrend, particularly this very consistent one, does not end in one day. Plenty of remainder momentum is likely to continue to linger, and thus produce a "rubber-band" effect in reaction to the initial shock. At this point, we measure the saturation of that "rubber band" effect or "bounce" with a Fibonacci retracement and support and resistance. We observe that the S&P500 had found resistance deep into the bounce at the .786 retracement area (red line), and just over a prior support point (blue). This support level is particularly important as it was the last swing low before the high was created.

- The shock sell-off in February is characteristic of left-shoulder behavior (as-in the common Head/Shoulders reversal formation). I am not quite sure if the market has enough momentum to continue with the trend to take out the high point in February (to produce the "Head"), this will be very difficult to anticipate. Let's use the .786 retracement as a key marker, and look for the market to take-out the highs if it is able to sustain trade above the .786 retracement mark.

- For all other price action, the bears are carrying the upper-hand now in both the short- and intermediate-term markets, and we shall look for further progress to the downside, and towards new lows. S/R on the way are marked accordingly, while the grey area is a neutral zone.

CHART NOTATIONS:

- The chart above represents the 3 period Average of NYSE TICK Highs on the Weekly intervals. We address the Intermediate-to-Long-Term time horizon here.

- Note that the average weekly highs of the TICK are in an area that is no longer sustainable, and therefore suggest downside risk that exceeds upside over this particular time horizon. In plain English, it's bearish, particularly since the market has been strongly upwards over the course of the last 6 months.

CHART NOTATIONS:

- The Weekly chart of the PHLX Semi-Conductor Index addresses the Intermediate-Term time horizon

- The Semi-Conductor, or "SOX" index is a key sector that has a tremendous effect on the Nasdaq. Note that the market has flat-lined over the course of the last 6 months. Given the nature of this market, it is not likely to last much longer inside the range and an explosion in volatility is likely to happen over the course of the next several bars. Let's use the marked S/R lines as directional guide and realize that this "flat" condition in the Weekly SOX is "corrective" of a larger downtrend that started in 2006.

OTA Lessons from the Pros 04032007 Growing Undulation - Fernando Gonzalez