What does a buy signal look like?

A buy signal should show up at a market bottom, or close to the bottom, and be the opposite of a sell signal. But how can a market bottom, or top for that matter, be determined? The fact is no one can pick tops or bottoms try as they may. Just like no one can tell you what will happen tomorrow. But we can read signs in the market. Just as the weatherman makes predictions, so should we be able to make predictions by the signs in the market.

The trend is your friend until the end when it bends. Tops and bottoms occur at the end of a trend. So we should look for bends in the market for both buy and sell signals. But what is a trend and what is a bend? Very simply, a trend is a series of higher highs and higher lows in an uptrend and lower lows and lower highs in a downtrend. A sideways market is usually a period of consolidation in the larger time frame trend although it can also mark tops and bottoms when it represents a failure of the market to penetrate support or resistance.

Markets move in cycles or waves and have peaks and troughs. The peaks are the highs and the troughs are the lows. And also, a trend can be said to be “intact” so long as it does not break a trend line. So then, a bend in the trend is when we get some change in the above. A few examples will help here. Please note (my disclaimer) I am not making recommendations to buy or sell any securities.

Since the change in the long term trend must occur first in the shorter time frame lets begin by looking at a 20 day chart of 4 hour periods of the S&P500. This chart clearly shows that the fast band of moving averages has crossed over the slow band. I previously gave an introduction to this type of analysis here. A buy signal occurs when the fast band finds support on the slow band. A sell signal occurs when the fast band finds resistance at the slow band. For a change in the trend to occur, what we have called a bend in the trend, the fast band must cross the slow band. Anytime this happens it is worthy of note. Click on chart to enlarge.
If we look at the shorter time frame, the 4 hr chart above, this change will occur before it occur in the longer time frame such as the daily charts below. The 1 month daily chart show that the moving averages have not crossed on this time frame.

A 3 month daily chart shows us the last time the fast band crossed the slow band.

A 6 month daily chart gives us an even better view and shows the top of the market back in October.

In conclusion, the shorter time frame we have used here, the 4 hr time frame on the first chart above, can be used to give a heads up signal for the daily time frame. If a person trades according to the daily time frame this will give fair warning of a trend change. The same idea can be applied if a person makes trades according to a weekly chart.

The Key Reversal Pattern

StockCharts.com defines a Key Reversal pattern as a pattern where prices sharply reverse during a trend. In an uptrend, prices open in new highs and then close below the previous day's closing price. In a downtrend, prices open lower and then close higher. The wider the price range on the key reversal day and the heavier the volume, the greater the odds that a reversal is taking place.

I want to thank my friend Lee for pointing out to me the recent key reversal pattern that has shown up in so much of the market. This pattern can be seen simply by looking at price alone and requires no other indicator. The pattern can show up in different time frames and is one of the best patterns traders can use for a timing signal of when to get into or out of a market. A few examples will help here. The following charts are of a weekly time frame.

My favorite market to watch is the S&P 500 and I will start here. In a sense it represents the entire economy. The following chart shows that the far right candle, which reflects the weekly price range (actually 4 days this week), went below last weeks low and above last weeks high. This is called an Outside Key Reversal and is a very powerful signal. Also, note that the market closed at the very line I have talked about before at that 1330 area. I have called this the line in the sand. If the monthly close is above this line it is likely we will see further increases in the market and a rally. Click chart to enlarge.

This next chart is of the Dow Jones Industrial Average Index. It also shows a very bullish pattern just by looking at the most recent candles. The DJIA is higher now than when the market opened this month and has a good chance to close up for the month.

The Russell 2000 Index is a measure of 2000 small cap companies and also a riskier market than the previous two charts above which reflect the large cap market. If a risky market is going up then that means investors feel confidence to invest in riskier assets which is very bullish for the market as a whole. Here we see the week before last was a doji pattern and last week was again very bullish.

The Nasdaq really reflects the broader market in that it contains some 5000 companies and is heavily weighted in technology companies. The chart of the Nasdaq looks similar to the Russell 2000 in that the week before last shows a doji pattern with a bullish candle for last weeks price action.

I want to include a chart of GLD which tracks the price of gold by approximately 1/10th. Gold has seen a dynamic run up but here again we see an Outside Key Reversal pattern, except this time it is to the downside. In this instance, prices went above last weeks high and closed below last weeks low. In fact, prices closed below not only last week but the past 4 weeks lows. It would appear that the gold bubble has burst. Money that went in to gold as a safe haven has come out. But where did it go?

In a previous article I mentioned in the Three Sector Hypothesis that our economy has moved from agricultural or resource based to industrial and manufacturing to a service sector economy. This is reflected in the fact that the financial sector, which is a large part of the service sector, has been hard hit by the housing crisis and seen share price drop considerably. If the market is at a bottom, it is because the financial sector is at a bottom. For a final chart let me show you what could be a very good long term investment. This is a very dynamic Outside Key Reversal chart of the financial sector. Thanks again goes to my friend Lee for pointing this chart out to me of the ETF of the financial sector. The symbol is IYF.
Finally, I want to include a Market Summary so we can follow the performance of the markets up to this point.

Could it happen - An Inverted Head and Shoulders?

A head and shoulders formation is a chart pattern in which there is a top, a higher top, and a lower top. This forms a triple top and is a topping pattern seen in market chart patterns. A line drawn below the lows of these tops is called the neckline. The distance from the neckline to the top of the head is said to be the distance a move could take in the other direction once the neckline is broken to the other side. The same pricipal holds for an inverted head and shoulders, an upside down head and shoulders. A 20 day 4 hour chart below illustrates this idea. Will it happen? I don't know but I believe it is possible. We will just have to wait and see.

Anatomy of a big move up

When the fed lowers the interest rate it makes stocks look attractive as if they are a better investment than a bank yield. It is very possible yesterday’s low at 1256.98 marked the bottom of this cycle. It did reach the range I mentioned here a few weeks ago. And I am looking for the low to be this week regardless based on cycle analysis. So what will give us confirmation that a wave count has begun to the upside? We will need to see higher highs and higher lows. The slow band of moving averages I have displayed here (20 day 4 hour chart)will have to act as support for the fast band. We are at that Support/Resistance line, the line in the sand, I posted here.The fast band has yet to rise above the slow band so we will just have to wait and see.

Divergence as an indicator

When an indicator such as the RSI or CCI makes a low and then some time later makes a higher low while price makes a lower low then we have divergence. It can be seen in the chart below where price and the indicator are not in congruence. This incongruence usually mean that price is at an extreme and not in accord with the indicator and so will turn back up if the indicator continues to rise. Also, note that the last candle, the one on the far right, has appearance like a hammer. Sometimes refered to as a hammer bottom. Click chart to enlarge.

The 20 day chart of 4 hour time periods show the momentum is still to the downside. This is a 5th wave pattern in Elliott wave analysis. At the end of the 5th wave two outcomes are possible: An ABC correction, or a new wave count. We will have to wait and see.

Support and Resistance – An introduction

In financial markets support refers to the price at which price has come down but will go no lower and resistance is the price at which price goes up to but can go no higher. If we look at different time frames we will find that support and resistance also applies to each time frame we are looking at. And if we apply the support and resistance of the different time frames on the same chart there are areas of overlap which are called convergences.

These area of support and resistance can be visualized on a chart and represent the turning points at which price goes to and then turns from to go in the other direction. These price points are also called pivot points. The question is: Can they be determined ahead of time to make trading decisions on? Well let us test this idea and find out. Below is a 20 day chart of 4 hour time periods which I have drawn a line across to illustrate support and resistance. You can see that there is a pivot point slightly above the 1330 area. Also note that once a support has been broken to the downside that it serves as resistance to an upside trend. This resistance must be crossed for the trend to change to an uptrend. This is a line in the sand. Click chart to enlarge.

There are mathematical formula for the pivot points as follows: Let P = price, H = high price for that time frame under consideration, L = low price for that time frame, and C = closing price for that time frame, and R1, R2, S1, and S2 are the respective support and resistance levels, then

P = (H + L + C) / 3
R1 = (P x 2) – L
R2 = P + H – L
S1 = (P x 2) – H
S2 = P – H + L

In the days ahead I shall make a calculator for these levels for the daily, week, monthly and convergence levels.

Big Up Day In Market

One day does not a trend make. Again, the trend is your friend until the end when it bends. Did the market bend today? With the S&P500 up 3.7% you could make that case. The Dow had the biggest single-day point gain since July 2002. There was a bounce on the news the Fed will pump $200 billion into the financial markets through “term securities lending facility” (TSLF) as a way to combat the credit crunch . Hoping to ease the credit crisis, the Fed -- acting with the European Central Bank, the Bank of Canada and the Swiss National Bank -- agreed to loan investment banks money in exchange for debt, including slumping mortgage-backed securities. The market responded favorably.

There was a double bottom in the market with yesterdays low of 1272 and the low back in January as can be seen in the chart below. And we did get close to the projected low I made here.
However, I also look at a half day (4 hours) chart using the GMMA indicator. According to this model a buy signal occurs when the fast band of moving averages crosses above the slow band and the price comes back, on the first pull back, to find support on the slow band. We had such a signal not too long ago but if failed. In order to get a similar signal the market will have to rally significantly. My feeling is that the market is still headed lower but not much. There is a cycle bottom projected for March 22 or 23 according to a market timing model I am watching. We will just have to wait and see.

Market Summary - Market Indices

Year To Date(YTD) performance for these major indices. Click to enlarge. List includes the Dow, Nasdaq, S&P500, and Russel 2000 by symbols: $DJX0X $COMPX $SPX0X $RUT0X

Triangle Breakdown and Elliott Wave Pattern

The symetrical triangle pattern noted previously has broke to the downside as expected with the break of the red line shown below:
Markets move in "Wave Patterns" as noted by Ralph Nelson Elliott who developed the concept in the 1930s which now bears his name as Elliott waves. R. N. Elliott's analysis of the mathematical properties of waves and patterns eventually led him to conclude that "The Fibonacci Summation Series is the basis of The Wave Principle."
The wave pattern is basically 3 steps in one direction and 2 steps back. Our current market shows that we have completed the 2nd step back, known as the 4th wave, and are now entering into the 5th wave which will make a low for this cycle. I would project the low to be somewhere between the prior low (a 3rd wave low) of 1270 and 1250.

Market Direction – Up or Down?

My last post shows that reading the market is not so easy and may give rise to false conclusions about market direction. I stated in my last post that a 60 day chart of 4 hour time periods of the market gave a buy signal. And also the post before that shows a Bull Confirmed Status on the Point and Figure chart. However, the market has continued to tank going down dramatically so what is up with these buy signals?

The fact is the longer term direction of the market is down and the longer term direction rules! We said this at the beginning of the blog back in January. See here. So while the fast band of the GMMA indicator did get above the slow band on a chart using 4 hour time periods the longer time frames still rule, i.e., the daily, weekly and monthly time frames. And since Friday was the last day of the month we can now look at what other time frames are telling us: the monthly, weekly, and daily.

I want to develop a charting graph that displays this in graphical form. I have an idea that would display price movement in graphical form showing something similar to the following diagram:

While the above graph is only very approximate it still displays the point that the longer term direction of the market is down.

How then is one to trade the market? It depends on your time frame. Then trend is your friend until the end when it bends. Since I trade longer time frames I am looking at the monthly direction (a market close above or below the SMA 12) as my guide to the direction of the market. Obviously, before a change can occur on the monthly level and weekly and daily change will have to occur first. We will look at these relationships in the days ahead.