Chart Symmetry

Much has been written over perhaps as much as the past 5-6 years about the unreasonable and unsustainable levels reached by stock prices on Wall Street. I have seen articles from as early as 1993 in which warnings of an imminent collapse were mentioned; by 1996 the warnings had become more strident and by 1997 even Greenspan was on record with talk of "over-exuberance" in the stock market.

Yet the Dow Jones and other indices just kept on rising. The market capitalisation of Wall Street reached $15 trillion dollars or twice the US GDP and at its high the Dow Jones had exactly doubled since the start of this last major leg in the bull market in December 1994. After taking about 100 years to reach its end of year value in 1994, the Dow gained as much again in just over 4 years!!! A magnificent performance, but this merely added to the urgency of the dire warnings some commentators were publishing.

Of course, the 47% gain in the Dow from the end of August 1998 – just after the steep fall in stock prices on fears of further problems in South America and particularly in Russia – only served to prove these doomsayers wrong and consolidated the credibility of the many more prophets who spoke of the "Goldilocks years" and the decade of wealth, health and happiness that lies ahead now that financial crises and inflation are something of the past. Even the worst troubles to hit the global financial system in as long as anyone cared to remember could be contained with relatively little fall-out and a temporary setback to some economies in the Third World. Japan had suffered for many years, but now that their government was at last listening to good advice and really doing something about the problems with the economy, good growth is just around the corner.

At this point in time, when the Dow Jones Industrial Index had retreated almost 5% from its high in mid-May, it could be an interesting exercise to evaluate whether this is the final high the doomsayers have been waiting for such a long time. If, this time, Wall Street had finally made its long term top, the immediate future for gold may also just begin to show a golden edge on the dark clouds born of despondency and intervention!

The Dow Jones Industrial Index. Daily close

The most impressive feature of the daily chart of the Dow Jones is a large megaphone, F-M, where line F is the steeper derivative of line M. (Readers who are not familiar Chart Symmetry and the terminology used here, can read an explanation of the methodology in the following article in the G-E archives:https://www.gold-eagle.com/south_africa/regional_analysts/joubert020699.html )

Megaphones are typically strong formations that contain sustained and volatile price movements. Here a break upwards has occurred and in principle this is a very bullish indication. The possibility of it being a false break – and that there will be no further bull market – can be considered at the hand of additional information.

The first, as yet inconclusive evidence that it could be a false break is the presence of the channel A-B. In most cases where a break later proves to have been false – i.e. the price does not fulfill the promise of the break and then returns to the dominant pattern in due course – one can usually identify another significant chart pattern that requires the apparent false break for it to be completed.

The steep bull channel, A-B, has also been derived from the gradient of line M. To be confirmed as an important chart formation, the channel required a final move that could only happen after a break higher from the megaphone.

This has now taken place and the Dow then reversed lower within the bull channel and has also broken back into the megaphone. While this strongly suggests the break higher has been false, full confirmation of this suspicion requires a break lower from bull channel A-B to signal a new bear trend in existence – not merely a correction within that bull channel.

With line B currently at 10088 points, we effectively require a decisive break below the psychological 10000 point level to obtain this confirmation. The likelihood of this event and some factors that could influence it are explored in the rest of this article.

Standard & Poor 500 Index. Daily close.

As is to be expected from rather similar indices, the chart of the S&P500 shows the same large megaphone as the Dow Jones. The definition of the megaphone is a little different, as the master line was taken as the top resistance line of the chart formation, but the result is the same. All the other lines were then derived from this master line.

Here, though, the Index has not broken higher from the megaphone. Further, it is not possible on this chart to define a good bull channel, similar to the channel A-B on the chart of the Dow. A bull channel that does seem to fit well, M-P, has line P parallel to M. Note that the full development of this channel does not require the temporary break above the megaphone that was needed for the Dow Jones.

Line F2 is the second steeper derivative of line M. M-F2 forms a rising wedge – the reversal pattern at the end of an extended bull (or bear) market well-known to all technical analysts.

Wedges usually consists of five legs before the break takes place. When a break occurs before leg 5 has been formed and completed, the following move generally turns out be quite volatile.

Observation of the chart shows that the S&P has broken lower out of the wedge while still on leg 4 of the pattern. Leg 4 needed to reach line M again before the S&P could turn lower into leg 5. This premature break therefore still has the potential to become a steep and sustained bear trend. The first indication that this is happening would be a break lower from the channel M-P, which contains the whole bull market except for the major correction that followed news of and reaction to the decay of the Russian banking system in August-September 1998 – which established the large megaphone!

The fact that the S&P has not broken higher from the megaphone, and also that its main bull channel is rather shallow, indicate that the break higher from the megaphone by the Dow Jones was false. The break lower from the wedge on the S&P confirms the break back into the megaphone by the Dow and strongly suggests a new bear trend.

Why did the Dow break higher?

It is interesting to speculate why the Dow Jones broke higher from the megaphone and the S&P did not follow suit. The answer most likely lies in the dual character Wall Street has assumed over the past year or so.

Discussions on the Gold-Eagle Forum around the Advance/Decline line shows that the bulk of the stocks on Wall Street has been suffering since April last year. The S&P500 is a better – if still less than fully adequate – measure of the market as a whole than the Dow Jones with its 30 mostly global companies.

Broader market weakness contained the S&P500 within the megaphone, while the recent surge in very selected stocks, such as IBM and the resource companies, carried the Dow Jones right through the top of the megaphone and – dare one say it? – to its appointment with destiny at the top boundary of the current bull channel, A-B. A further discussion of this topic follows at the end of the report.

The break back by the Dow to within the megaphone might well be the signal that the final surge in a narrow base of high-powered stocks is now over and that, despite high volatility that should continue for the near future, the market is on its way down.

While this pessimism about the future of Wall Street arises from the analysis of the daily charts of the Dow Jones and the S&P500, examination of the price-volume relationship of the Dow Jones is more ambiguous in its conclusions.

Price and volume relationship.

Some weeks ago, an analysis of the Dow Jones using the principles established through a market model that explains the relationship between price and turnover, (new readers can refer to the article at this link: https://www.gold-eagle.com/south_africa/regional_analysts/joubert042099.html reached the conclusion that Wall Street may well be entering a classical top reversal formation provided that turnover can remain high until the price has fully topped out.

The two-division chart shows the recent steep bull trend of the Dow in the upper half of the chart, with the dPdV® chart in the section below. As before, the pinkish bars are the MACD of the Dow Jones itself, while the blue bars are the MACD of the daily turnover in the number of shares.

The price shows a well-defined channel, only slightly different from channel A-B on the full chart of the Dow Jones, shown just above. This channel currently has good support for the Dow at 10140 points.

From the price-volume chart one can draw the following conclusions in terms of the market model, as explained previously:

A: Following the 20% drop in the Dow, as a result of concern about the situation in Russia, new demand entered the market to end the panic, as shown by the two occasions of a sharp increase in turnover at the end of the fall. The second and more pronounced jump in demand really halted the slide and set the stage for what happened soon after.

B: A third increase in demand – again indicated by the blue bars rising steeply above the base line – carried prices higher off the market base that had formed after the last stage of the panic and thereby triggered the final almost 50% run in the Dow Jones.

C: The fact that the steep rise from B to C did not top out on an increase in selling was positive for the bull market. This, and then the jump in demand indicated by the rising volume MACD at C, were warnings that the new bull market was due to resume after the slight dip in the Dow.

D: The next rise in the Dow Jones barely broke above a double top. This trend ended with the sharp increase in volume that signified a good deal of profit taking.

This occurred early in January and may have been the result of – and also reaction to – new 401K investment.

E: Demand remained at high levels – shown by the positive volume MACD – despite the decline in the Dow, and this sustained demand helped to stabilise the Dow in a sideways consolidation to reach support at line B again.

F: The next rise in the Dow was accompanied by an increase, first in demand and then in selling and the Dow Jones again leveled off slightly as a result of some profit taking. This set the stage for the final assault on the 10000 level and what happened subsequently.

G: The Dow broke and held above 10000 points, initially on relatively low turnover – most people standing on the sidelines? – and then, as the Dow continued to rise, both sellers and buyers flocked onto the market. Sustained turnover reached record levels as existing holders sold out to take profit, while new buyers were eager to join the Dow Jones on its way to 11000, 12000 points and higher.

The situation at the end of the bull trend, signified by the break below the base line of the price MACD (pinkish bars), is ambiguous. If the blue turnover bars had followed the turnover to indicate a top in the turnover at the same time – i.e. both MACD's break lower below the base line simultaneously – the existence of a final top in the Dow Jones would have been a classical example of the market model.

If turnover had subsided well before the Dow had peaked, with the blue bars of the volume MACD below the base line for most of the current bull trend – as was the case between B and C – the bulls could have been confident that, all things being equal, there was still much life left in the bull trend.

H: Now, with the turnover falling away just as the Dow itself peaked, the interpretation is not clear cut. If turnover remains quite high or starts to increase again during this period of volatility, while the Dow mostly moves sideways, sellers could still come to dominate the market and trigger a sell-off. On the other hand, if demand falls away steeply and the Dow rallies again, as sellers change their mind and wait for better prices, a new bull trend could ensue.

We return to one other chart used previously to see if it could cast some light on this issue.

Dow Jones in ounces of gold.

Earlier in the year, when the ratio between the Dow Jones and the gold price was first examined, much the same chart was generated.

At the time, Dow/POG was testing resistance at the top of wedge F-M at the end of leg 4 of that wedge. Because such a large wedge is usually a strong formation, it was then anticipated that the Dow would decline – or POG rise steeply, or both – to keep the Dow/POG within wedge F-M and begin the fifth leg of the wedge back down to line M.

Of course, just the opposite happened – a strong Dow and a weak gold price – which resulted in a premature break up from the wedge. Such abnormal breaks tend to be volatile and it is therefore not surprising that the chart continued steeply higher – after a goodbye kiss on F – through the top of channel P-M to reach the top of a very large megaphone at F1. Both P and F1 are new lines, but are of course fully determined by M. The good fit at lines F and F1 simply follows the principles of Chart Symmetry, and thus illustrate some relationship between Wall Street and the price of gold.

Line A was shown in the earlier work as part of a steep set of lines. Line B passes through the chart in a very interesting fashion, acting as both support and resistance. While it seems that the chart has rebounded off resistance at line F1 – to indicate either a weaker Dow, a stronger POG or both – a sustained break below line B is needed to signal the first step in the process of returning to line P.

Friday's (05/28) closing value for the chart – calculated as the closing value of the Dow divided by PM fix for gold – is 39.3, while the value of line B for Tuesday, 1st June, after the long weekend, is 39.2. The value for line B rises to 39.5 by early next week (7th June).

Abnormal market forces

Both the price-volume relationship and to some degree Chart Symmetry rely on a normal situation of supply and demand in the market. When this situation is disturbed, the results that are obtained can be contaminated. We have already seen in previous reports that the POG does not comply with well-defined CS patterns. False breaks are frequent and this is not typical of normal markets. In this respect one could point a finger at manipulation and other external influences in the gold market that are not subject to normal conditions of supply and demand, as a probable cause of these chart aberrations.

Similarly, the sharp break higher above its megaphone by the Dow Jones could perhaps be due to the effect of the Day Traders. This phenomenon, of which there could now be as many as 10 million, is relatively new in the market and by all accounts do not use fully rational means to determine their buying and selling. The second half of April, when the Dow rallied further to break above the megaphone, the Nasdaq – favourite haunt of the DT's – had leveled off and was forming the second of what would become a triple top.

The sharp rise in turnover taking place on Wall Street showed that substantial new demand was present in that market. Since the DT's, if each one trades on average with $5000, could muster $40-50 billion, only a relatively small proportion of them would need to swing away from Nasdaq and into the banking and resource stocks on Wall Street – very popular around that time – to give the Dow Jones a big boost, thus leaving the S&P500 to lag within its own megaphone while the Dow was breaking higher.

Then, after the Dow peaked and the Nasdaq formed its triple top and started to decline, the DT's began to run into a brick wall when they wanted to take the markets higher. Now their ranks are being thinned out as they discover another phenomenon known as 'margin calls'. However, the remaining DT's can still muster a vast amount of funds and could still cause all US markets to begin a new rally – which would draw in at least some of the marginalised day traders in an (last?) attempt to recover the lost glories of the unending bull market. If this should happen, the great degree of volatility on the markets of the past few weeks could well continue for some time.

On the basis of the above analysis, though, and the way the different analyses fit together, one can be reasonable confident in calling a top to Wall Street and the question now is whether the market will have a soft or hard landing.

Given the nature of megaphone patterns and with the presence of the Day Traders as a confounding factor probably responsible for a good deal of the final euphoria in the Dow, the odds unfortunately do not favour a soft landing. Time will nevertheless tell.