This may be one of the most important posts and charts I have posted in a long time. Market index analysis has a habit ( at least to me) of being MOST of the time fuzzy around the edges. But occasionally it starts to crystallize into a clearer picture and better form that helps build confidence on a certain forecast. It is a matter of making speculative forecasts, trying to identify key levels and then attempting to see whether the tape action starts to confirm your own forecast. If it does not then one must change tack and work with alterative scenarios. It is always good to have a small handful of scenarios to work with, both bullish and bearish otherwise it may leave you in a vulnerable position.
The current market is akin to a 200 car train that has no braking ability. It is sheer price force and momentum and this is to be respected and acknowledged before anything else. Having said that, it is also well known that no market can continue to go vertical forever. There must be a pause so that the market can form a pivot point for a new base that can eventually push the market higher. Markets build cause and then use it up. When they are done using it up, they need to build new cause. Of course after being in a market that seeming only goes up, it is always EASY to forget about any necessary looming correction.
I have been picking on the nasdaq composite a lot lately and for good reason. The nasdaq composite index is approaching a key level that represents the start of one of the greatest bear markets of all time. This level was of course the late October 2007 peak in the market that preceded a long duration persistent trend bear market.
The key with the Nasdaq is the issue of how this 2007 peak will be dealt with?
- Will it simply be exceeded and ignored ?
- Will it turn on the exact tick of the previous 2007 high at 2861.51 ?
- Or will it AT FIRST be exceeded and then eventually succumb to supply forces at a later time?
Unfortunately we will not know the exact answer until it actually happens, but we can come up with some scenarios and attempt to get a better feel for the market as we approach this previous all time high level.
Just to cut to the chase… my currently preferred and expected scenario is that the nasdaq composite will at first exceed the 2861.51 high and then maybe ‘stand above’ this all time high for 1 to 3 weeks before turning down sharply into a violent approximate 10 to 20% correction.
Why do I prefer this scenario ? I prefer it because of the current super strong upward momentum. I also prefer it because it seems like it is the most deviant scenario the market can impart. Markets were never known for being friendly or easy. Rather they like to trap people and then pull the rug from under their feet. So the nasdaq at first exceeding 2861.51 and then eventually correcting 1 to 3 weeks later seems like the ideal scenario. That type of scenario would probably even trap a lot of the expert technicians and maybe even turn the most bearish ones into new bullish stances right at the worst possible time.
The other scenarios are still possible however but seem less probably to me now. The nasdaq simply turning tail right near 2861.51 would make it way to easy for everyone. It is too scripted and convenient.
The scenario of the nasdaq pushing through 2861.51 without any correction whatsoever seems very very improbable to me. I am going to be extremely shocked if that happens.
Ideally a top will be confirmed with a WEEKLY candlestick reversal pattern if at all possible. For example a weekly bearish engulfing that then would be confirmed.
We can look at two other market indices to see what they did in similar situations. Below are the weekly Jakarta Composite Index, the nasdaq composite and the Bombay Stock Exchange.
The nasdaq composite chart is in the middle and these are all weekly candlestick charts.
Note that each index has large head and shoulder bottoming formations and that each also has a previous very important previous swing high. Note also the neckline red dotted line that is an important as a potential support and stopping area assuming a correction will come down that far. In the case of the Jakarta composite index and the Bombay stock exchange long term chart, both of them came back down to the neckline area to test support.
At this time I have no way of knowing whether or not the nasdaq composite can correct all the way back down to the red dotted neckline or not.
Now look at how the Jakarta Composite index at first exceeded the previous swing high and then crashed after a 3 week delay. In the case of the Bombay stock exchange we see that it made an almost perfect double top and was not able to exceeded the previous swing high in any form.
I believe this chart perspective is very instructive and helps to create a framework around a possible short position. The problem is that identifying which top scenario is the valid one will require a lot of ‘hand holding’ at first. We simply need to see how the market reacts to the resistance zone and preferably observe this on the WEEKLY basis because the daily may cause too many whipsaws.
For example we could easily see a 1 to 2 percent pullback on the daily price chart once we hit 2861, but that still may only be a very minor reaction before an eventual upside breakthrough.
I need to see clear signs on the weekly charts that this market wants to start rolling over and turn tail. When that becomes clear then a short entry is much more ideal.
Remember that top building is a process not an event. So this means that enough patience is required as we come into this important resistance zone and one must use constraint until a clear enough signal is observed.