Sunday, May 31, 2009

Stock Market Crash Stages

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As was mentioned before (see my "Side Way Market in May" post) the indexes continue to move in the corridor defined by May 8, 2099 high and May 13, 2008 low. Now, the indexes are close to the upper edge of this corridor: the Nasdaq 100 index has hit this level yesterday, the S&P 500 is still about 10 points below this level and the Dow Jones Industrial is approximately 70 points below.

Only one nice trading session is needed for S&P 500 and DJI to hit this level and if it is broken it could mean that we may see further move up. However, I consider that the odds of the bounce down again are still good. The stock market (when I mention stock market I assume the main U.S. indexes which associated as market barometers: DJI, S&P 500 and Nasdaq 100) has been in a sideway move only for a month. To see the picture better, I may recommend checking higher timeframe index charts - from 1-year to 7-year views.

From the higher timeframe charts we may see that the stock market has been in recovery for 2 months (from the beginning of March to beginning of May 2009) and the whole May the market was basically flat. By comparing recovery after 2000-2002 stock market crash to the current recovery I may say that:

  • The recent stock market crash was stronger;
  • We had 3 bounces from the bottom in the previous recovery: August 2002, October 2002 and February 2003 (war in Iraq was lunched). We had 3 bounces from the bottom in the recent crash as well: October 2008, November 2008 and February 2009;
  • The first recovery wave in 2003 was 3-month long and then the market was in 2-month flat stage. The current move up was 2-month long and we see market in sideway move for a month only;
  • In 2003, after 2-month of flat stage, the stock market went up again.

To better understand the stock market crash, recovery process and what could be expected next, I would divide the stock market crash into the following stages:

  • Recession: The market is heavily overbought and it starts to move down. As a rule this move down is prolonged in time and this move down is not very scary. See period from July 2007 until May 2008 and period from August 2000 until March 2002. In this period a many investors start to sell, yet there are still investors who buy.
  • Crash: As a rule during the recession the bad stuff about companies and economy is revealed and depending on how bad "the truth" is we have strong or extremely strong panic selling. The recent "discovery of truth" about financial companies' manipulation was much scarier than the "discovery of truth" about internet bubbled companies in 2000-2002. In this period we see panic selling - everybody selling and only small part of investors buy. In this period bad, weak and "fraud" companies go bankruptcy and good companies become under evaluated. This period is short and drop down is strong.
  • After Crash Clean-up: The market still can go down and we may see bounces from the bottom. In this period investor are still selling, yet, the panic is not as strong as it was during the crash. Many investors (professional traders who see under evaluated companies) start buying attracted by low bargain price, yet, the number of Bullish traders is not big enough to reverse the trend. During this period we still may see "bad" companies go bankruptcy, yet, it's not very scary since, usually, it is an expected bankruptcy and many traders are already prepared to that. For this stage I would refer to periods from July 2002 until February 2003 and from and from October 2008 until March 2009.
  • First wave of recovery: There is no panic selling any more. There are still sellers, yet, the number of buyers attracted by low price of good stocks become quite big to move stock market up. Even if we see bankruptcy during this period it will not affect strongly up-trend because all the "bad" companies were already removed from the major indexes. The companies are still under evaluated, yet not as strong and we start to see positive signs in the economy. At the end of this period we may see sideway move or small correction. It could be strong up move in short period of time: see periods from March 2003 until June 2003 and from March 2009 until May 2009.

As I understand (I could be wrong), we are at the end of the "First wave of recovery" and we still may see side-way market or even some drop down (automotive clouds are still on the "stock market sky").

In my next post I'll go back to the shorter term index charts (S&P 500, DJI and Nasdaq 100 charts) to show what my technical analysis tells about shorter-term trends and current market sentiment.

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