Long-Term Technical Analysis

As was promised in my previous "Simple Trading Strategy" post, I am bringing to your attention some points from my personal longer-term technical analysis.

Various techniques are used to analyze the stock market long-term trend. Some analysts focus on 5-year to 10-year charts, others focus on economic factors, etc. I would like to draw your attention to the interesting on my opinion fact that could be seen on daily charts (1 bar = 1 hour).

In the S&P 500 chart below (the Nasdaq 100 and DJI charts are very similar to the S&P 500 chart), you can see that the stock market has been in a recovery movement since the first half of March, 2009. This is when the "2008 Stock Market Crash" ended. Since then, the stock market has been in a steady upward movement, interrupted by shallow corrections from time to time. If you take a look at these corrections, you will see that the further from the bottom indexes (S&P 500, Nasdaq 100, DJI and other indexes) are, the smaller are the overbought signals that are required to push the stock market into a downward correction. You can see that this divergence between price's new highs and technical indicators (price makes new highs, but smaller, overbought indicators signal a correction) on the S&P 500 chart below on SBV, Stochastics and RSI. I think that you may find the same tendency with other technical indicators as well.

The S&P 500 Chart with elements of longer-term technical analysis

Such divergence between price and technical indicators is nothing new in technical analysis. You can see something similar more often in smaller timeframes. It usually can be seen before a stronger change in a market trend. That means that the stock market is not the same as it was six months ago when a majority of shorter-term, overbought signals were ignored, while indexes continued their rally. I am not saying that the market will crash tomorrow - not at all. The indexes and the market may continue to move up. What I want to say is that the market may become predisposed to a change in its behavior.

If this divergence between new price highs and technical indicators continues to develop in the same direction, there could be several possible scenarios: we may face a stronger downward correction than we saw and then the recovery may continue; we may go into a sideways market like we were in during 2004 after a strong recovery in 2003 that followed the 2000-2003 stock market crash; we may fall into a slow depression like there was after 1929 crash; or there could be something new.

There is still another possible development. In the same S&P 500 chart above, you can see that we had two waves of divergence between price and indicators where the second wave was smaller (less Bullish) than the first one. There is a possibility that a third wave of divergence might develop that could be smaller than the second one.

Another factor that could support the above-mentioned possibility of changes in stock market sentiment is timing. It soon will be a year since the recovery began. That means that the period of "expectation beating reports" could be over very soon. During the crash in 2008, many public companies reported losses and, by the end of 2008, everyone had lowered their expectations. Furthermore, in 2009 everyone has had "expectation beating" reports that have attracted investors and money into the market and which feed the recovery. How many companies do you think will report an "expectation beating" increase in profit in 2010 in comparison to 2009? If not many, other economic factors (unemployment, sales, GDP, borrowed money from China, etc) may begin to play roles in the market's direction.

I don't want to dig deeply into a fundamental analysis of the economy and economic factors that move the long-term market. I just want to say that I see some predisposition to changes in long-term market sentiment and market behavior. Since I am not a long-term trader, I am not going to attempt to predict where the market will be in six months. What I'm trying to define right now is where the market may continue its move. Will it move up by going into a third wave of divergence or will it begin to change its trend direction? I think it could become clear by simply monitoring higher-timeframe index charts within the next couple of weeks.

What affects me is how the market reacts to the overbought and oversold signals and how I should adjust my trading strategy in order to avoid encountering an unpleasant situation. If I see that the market starts to react differently to trading signals generated by my technical analysis (my trading system), I usually take a look at longer-term index charts to see the general market stage. Right now, I am looking a little ahead. The indexes (S&P 500, Nasdaq 100, DJI and other) still move up more easily then dropping down and we still may see new highs and further upward movement. Yet, from a prospective of my technical analysis, I see that we are in a period in which the stock market could become predisposed to changes in the long-term trend.