Technical Outlook is Still Bullish

Tue, Feb 15, 2011 - 11:29am

Suppose I told you that there was no device or method ever invented that will allow us to predict the course of the markets? Suppose I told myself the same thing (and I have) -- then what would be the point in studying the market and writing these sites? Actually, I do follow the action of the stock market, and I follow it closely. Here's the real story:

Periodically, certain patterns or formations appear in the stock averages and in the patterns of individual stocks. In technical analysis, we are always dealing with probabilities. Every veteran in this business is aware of the old adage: "The market can to anything."

However, when a specific pattern forms, let's use a "head-and-shoulders" pattern, we assume that (1) this is a top and (2) that the odds are that the item will break down from this formation. There's no guarantee that the item will break down, but the odds are strongly in favor of the item breaking down.

Next, let's take the example of a rising trendline on ratio paper. We know that as long as a given item is advancing along, or above, the trendline, the direction of the item is towards higher levels. In other words, the rising trendline tells us that the rate-of-growth is steady and the direction is due north. However, if the item closes below the trendline, we know that the rate of growth has reversed, and the new direction is probably down.

All the above is based on experience and case histories. But note that nothing tells us when a head-and-shoulders pattern is about to be formed. And nothing tells us exactly when an item is about to reverse direction and break below a rising trendline.

Of course, we can use momentum studies as an aid to telling us WHEN. And we also have our over-bought and over-sold studies. But there is no certainty in technical analysis. All I can say about technical analysis is that it's a lot better than nothing or the process of hoping or guessing.

Back in the late-50s when I first started writing Dow Theory Letters technical analysis was dead, or I should say that it was frowned on and despised by market analysts. Many called it "market voodoo" or "technical nonsense."

I wrote my first Barron's article in December, 1958. That article was based on Dow Theory, and the thesis was that a great bull move lay directly ahead. The piece was written amid a period of deep bearishness, since a recession and severe market correction were in place at the time.

My piece was greeted with what Bob Bleiberg, Barron's editor at the time, said created the most interest of any article that he had ever published. I had placed a small three-inch ad in Barron's in the same issue that my article appeared. During the following week I received over 300 subscriptions to my new service, "Dow Theory Letters." On top of that, Bob asked me if I would write a series of articles for Barron's on technical analysis.

Over the next 20 years I wrote about 25 articles for Barron's on Dow Theory and technical analysis. Between 1958 and the late-1970s technical analysis became initially accepted and then actually popular.

In view of the above, we note that currently the S&P is continuing to climb above an ascending trendline. In February, the S&P tested the trendline and bounced off it, heading into higher territory.

We also note that the S&P hit a new high (which was obviously bullish), and that no bearish formation has yet appeared.

Also, considering a 13-day rate-of-change (ROC) as a momentum gauge, we see the ROC declining through late-December and January, a potential indication of trouble. But then, most recently the ROC turned up.

Conclusion -- So far in 2011, the S&P has headed steadily higher. Despite being overbought, there are no obvious technical indications of danger. Often, what does not appear can be as important as what does appear.

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