Sector Investing

[ReturntoSender]

Amateur Investors Weekend Stock Market Analysis (1/15/11)

http://www.amateur-investor.net/Weekend_Market_Analysis_Jan_15_11.htm

Last weekend I mentioned significant bottoms have occurred since 1900 when the 18 Period RSI smoothed with a 5 Month Moving Average has dropped below the 35 level (green line) and then risen back above it. I have enhanced this study by using a 3 Month Moving Average (red line) instead which led to one additional occurrence in the early 1900's for a total of 6 Signals. Also notice all were followed by rallies of 80% or more as well.



Of course the big question is can we use this data to figure out market tops? If we look at the unsmoothed RSI values (green line) and take the difference between the lowest RSI value and highest RSI value for each signal then we get the numbers in the chart below which have ranged from 32 to 48. Notice in 3 out of the previous 5 cases the total difference was in the lower to mid 30's while the other two were in the mid to upper 40s. Currently the RSI difference between the low and high is now at 36 so we are definitely in the alert zone for a potential nearing top based on previous occurrences.



Now when you look at all of the Signals since 1900 the two that most resemble the current move up from the March 2009 low are in the mid 1970's and the early 1900's (1915-1917). As I have talked about before the mid 1970's rally was accompanied by a sharp "ABC" type rally off of the late 1974 low. "A" was a 56% rise while "B" was a 12% pullback which was then followed by a 31% rise for "C" that led to a total gain of 80%. This was then followed by a 28% correction in which the Dow found support at its 61.8% Retracement Level (blue line). However as you can see the Dow basically got stuck in an extended trading range from 1976 through 1982 as it traded between its 1976 high and the 61.8% Retracement Level before finally breaking out in 1983.



Meanwhile if we look at the period from 1915 through 1917 you can see a similar sharp "ABC" type rally from the early 1915 low. "A" was an 86% rise while "B" was a 13% pullback which was then followed by a 22% rise for "C" for a total gain of 98%. This was then followed by a 40% correction during the next 14 months as the Dow held support at its 78.6% Retracement Level (red line) by late 1917. After the sharp 40% correction then an impressive 82% rally occurred during the next 2 years which was then followed by a 47% sell off which bottomed in late 1921. If we are going to go through a period like this in the coming years then expect more extreme volatility. Suffice to say it would be far better to see a pattern like occurred from the mid 1970s through the early 1980's which was less volatile versus the one below.



Finally if we look at a current chart of the Dow you can certainly see a similar "ABC" type rally from the March 2009 low much like occurred in the mid 1970's and way back in the 1915-1917 time period. "A" was a 74% rise while "B" was a 15% pullback which has been followed by a 23% rise so far for "C". Meanwhile a 61.8% Retrace (red line) from the Dow's current high would be around 8500 which would be a 28% correction while a 78.6% Retrace (blue line) would be around 7600 and a 35% correction.