Trends

Trading with the Trend

Trend following or "the trend is your friend" is critical to success in the stock market. The stock market is really comprised of many trends, some quite long (18 - 20 years) and others quite short (minutes). figuring out what trends we are currently experience and how we should take advantage of this situation is the purpose of this section. Each week I will discuss an important trend issue addressing economic, sector and technical factors. My goal is to identify the important trends for our investing portfolios and what strategy we should take to profit from them.

Trends - Pull Back or new Bear market? 6/9/2006

The recent market fall has many worried. Is it just a pullback and the cyclical bull market will resume soon, or is this a new cyclical bear market? According to many pundits, if the market pulls back 10-15% it is a pull back. If the market falls 20% or more then we have entered a new Bear Market. Well, let's look a little more closely into this potential change in market trends.

First, start with the big picture as presented in Market Cycles. In summary, history shows us that the stock market moves in long secular bull and bear market trends lasting 15 - 20 years on average. Within these long trends there are shorter cyclical bull and bear market trends that generally last 2-3 years. The last secular bull market began in 1982 and ended in 2000. We then went into a cyclical bear market from 2000 to early 2003. Starting in early 2003 we entered a cyclical bull market. The question is have we seen the end of this cyclical bull market and are we now entering a cyclical bear market?

The following chart is a classic example of a cyclical bear market starting in 1966 and lasting till 1982. Notice how it began at about 1000 and ended at about 800 while encountering several good cyclical bull and bear markets. Also, note in 1966 that the DJIA fell more than 25% touching 750, before rebounding to over 900. So, here is one example where the pundits were right. Also, notice that is is very important to stay on the right side of the cyclical trend to make money.

The following chart is of the weekly S&P 500 for the last 7 years indicating the cyclical bull and bear phases of market. The 65 week moving average acts as support during the bull phases and as resistance during the bear phases. As of Friday June 9, 2006 the S&P 500 is touching this important indicator. The 23 week Relative Strength Indicator (RSI) stays above 50 during bull phases and below 50 during bear phases. It looks like we will have a much better indication of whether we are entering a new cyclical bear market. However, I suspect we are entering a new cyclical bear market, but we shall see soon.

This next chart shows that the Nasdaq is nearing a key support level near 2100. When combined with the Stochastic and Ultimate indicators it gives us another picture to consider. First, the support level near 2100 needs to hold over the next week or so for the up trend to continue. Notice that whenever the Stochastic falls through 20 the Nasdaq rebounds. However, it is more difficult to say the same for the Ultimate indicator. What this tells us is that we may see further weakening or we may see a rebound. We will know more in the next couple of weeks.

Unfortunately, that is the nature of technical analysis. Sometime you must wait to see what happens. Making a decision before you have better information, like entering buys, often causes one to enter a loosing trade. It is still time to be cautious on both the long and the short side. I am waiting until I get a better indication of the cyclical trend. As a result, I am not buying and I am adjusting my stops on a more frequent basis for all outstanding long and short positions.