Using Moving Averages to Indentify and Follow Price Trends

This is the 4th post in the "Trader and Investor Education Series. All charts are expandable by clicking on them.

Clearly, no process of analysis or trading is foolproof and no one has a magic formula or crystal ball to know exactly what the markets will do next. For this reason, we develop tools that help us to both anticipate and follow changes in the supply and demand of investment instruments. We want to react objectively to the changes in the price trend, and moving averages are a great tools in this regard. Whether you are interested in long, intermediate, or short term price trends, moving averages can help you locate and follow the price action.

What is a Moving Average?
A moving average is just what the name implies. It is an average of price data for a specific period of time. "Moving" comes from the fact that the average changes in value every time a new unit of time is added to the period. Moving averages can be simple, exponential, weighted or centered. The average can be based on closing prices, highs, lows, or even the midpoint value of a price bar. Investors and traders need not perform these calculations themselves as they are a part of most charting platforms, including the free web-based platforms.

It should be noted that when price bars or prices are mentioned, I am referring to OHLC price bars unless otherwise mentioned. Open-high-low-close price bars (OHLC) are represented by a vertical bar that that shows the high and the low for the time period measured. There is a short horizontal line to the left of the bar that represents the opening price and a line to the right that represents the closing price.

For brevity sake, we will be discussing the use of simple moving averages calculated at the price bar close. As and example, a ten period simple moving average would be the average closing price over the last ten time periods, or price bars. A weekly chart with a 10-period moving average will therefore produce a 10-week moving average. A daily chart (referring to the price bar period, not the period visible on the screen) would provide you with a 10-day moving average; one minute data would give you a 10-minute moving average, and so on...

Below is an example of a 13period MA on a weekly bar chart. This13-week MA is the blue line running through the price bar series:



Trend Follower, Not Trend Predictor
In the past, we talked about basic trend identification using the sequential highs and lows in a price data series. We then talked about using trendlines for basic trend identification. Continuing in the trend following pursuit, moving averages help by smoothing out the trend.

Moving averages have no real predictive value, but help us know what the trend is doing right now. Moving averages aid us in following an emerging trend until it matures and reverses direction. Moving Averages can even be used as trailing stops for a trend you are positioned in. Although moving averages don't give us price targets, they do help us in following both up-trends and downtrends. Sideways trends are usually troublesome for moving averages, as they are for most trend following techniques.

Because the market is much smarter than any individual investor or trader, reactive tools & rules should be a large part of your trading and investing decision process, . Moving averages fit this profile. They were one of the first tools I found, and they are still one of the go to tools I use. They are that simple and that good at following price trend in any liquid and free market.

Moving Average Signals
There are three main moving average signals of trend: a single moving average penetration by price, double moving average cross, and a triple moving average cross. Its best to apply filters to these signals in order to reduces whipsaw trades. Whipsaw trades, or signals, are incorrect exit signals that result in a new signal to reenter the price trend you were previously positioned in.

Single Moving Average
Overlaying a price series with a single moving average is the most simple use of the tool. The signal to buy is when prices move above the moving average. The signal to sell is when prices move below the average.

As mentioned, we need to have a little bit of a filter to protect against whipsaw signals. Some people use percentage moves, but that is just requires another calculation. I prefer to keep it simple. The two filters I have used most often are: 1) The price bar has to close above the moving average, thus producing a signal to be executed after the next price bar opens. 2) The price bar(s) following the signal bar must exceed the signal bar, thus confirming the signal. The same filters would be applied to a downtrend. These filters let price guide you and aid in confirming the changes to supply and demand which are emerging in the market under study.

Let's take a look at the same chart we used above, with arrows showing signals generated using the second filter technique mentioned:


What do we see with this single moving average study? I see two key results: 1) There were ten signals generated, with many being whipsaw signals. These results tell us that the signal is two sensitive. 2) We also see that this system is always in the market. We are either selling it short or buying long. It would be preferable to reduce the whipsaws, knowing some are unavoidable, as well as producing a signal system that also had us out of the market at times when there was more potential for sideways, or counter-trend, price action.

Dual Moving Average
By using two moving averages of varying lengths, further signal filtration can be produced. This method is called a double moving average cross. When the shorter moving average crosses the longer moving average, you have a buy or a sell signal. We can add the second filter technique to provide further trend confirmation and filtering.



In the chart above, we took the same price series and the original 13-period moving average, and then we added a 40-period moving average to create a double MA cross signal system. The results were pretty drastic. We took signals down from ten signals to two signals! We have followed the majority of the two major trends and have greatly reduced whipsaw signals. We have success with the dual moving average cross with price bar follow through filter system.

Of course there are limitations with this system too. We are still forced to be either long or short the market with no signal resulting in a cash or flat position. Although, I'm sure being always positioned on one side can lead to long-term success given proper risk management and position sizing, I would rather be objectively signaled out of the market during counter-trend and sideways action if possible. This is especially true if you are trading leveraged products like futures contracts, which have an expiration date, or even the leveraged funds that are available these days.

There are a couple of ways a achieve the desired result of having a system that, in addition to producing signals to buy or sell short a market, also produces signals to liquidate the position and move to cash. We could create an algorithm for a trailing stop that would be more sensitive than the MA cross, and would therefore take us out of the position into a cash (or flat) stance. That is a method I actually prefer, but it is beyond the scope of this article. We are a addressing the use of moving averages here, so lets see what we can do just with the basic MA entry and exit signals themselves.

To create a moving average signal system that will tell us to buy, sell short, or liquidate positions, we could use an additional chart of a longer time duration with its own moving average. This would put us in line with the next larger degree of trend, and would tell us not to trade the signals we have that are against that larger trend. Another method we could use would be a triple moving average cross on the same chart.

Triple Moving Average
A triple moving average crossover will provide additional filtering. To get the triple average, you will simply need three moving averages of increasing lengths. When the fast average crosses the middle average, you have a signal that a trend may be emerging. A cross of the slower moving average by the middle moving average then gives you the signal to enter the trade. The liquidation signal is when the fast moving average crosses back over the middle average. In this way, you are slow to enter and quick to exit; locking in profits and only trading in the direction of the next larger degree of trend than the actual trend you are trading.

In the chart below, arrows mark the entry signals to buy or sell short, while "L" marks the signals to liquidate positions.

Note: there should be an additional liquidation signal between the last two sell signal arrows, but it somehow got left out.

The moving averages used in this chart are 4, 18, 40. With the triple MA we are definitely given signals to be in cash part of the time, but its not long before we are back in position. This does not seem to be much, if any, of an improvement over the dual MA from before. As long as your risk management profile would allow for fairly wide stops, the dual MA system appears to outperform this triple MA system. An important factor here is that the dual MA above is wide enough of a range to let the trend develop, with counter-trend moves and all -letting the market breath. If we were to change the lengths of the averages we could probably create better results with the triple MA method.

This is all well an good, but is it still possible for a more active investor or trader to participate in the intermediate term trend in a way that allows for locking in tighter profits? For those trading leveraged and time sensitive products, this is a real issue to consider. Perhaps we need to use the dual MA cross with a longer-term filter.

Long Term Moving Average
Using a long term moving average can help investors know when the risk of holding on to a long-term position is greater than the risk of exiting the position in favor of cash. Long term moving averages can also align the more active investor and trader with the larger, or primary, trend.


As we can see in the monthly chart above, a 12 month moving average has historically given a good indication of the larger trend's current direction. Investors, using this measure, with a closing price filter, alone would have had a couple of whipsaw signals, while being much more profitable than a diversified buy-and-hope approach based on fundamental analysis and recomendations.

In addition, traders could use this to filter out short and intermediate term signals on daily and weekly charts. Lets look at a daily chart below with a dual moving average and use it in conjunction with the 12-month MA chart above.

Dual MA and Long Term MA Combination

As before, the entry signals are represented by arrows and liquidation of position signals are represented by "L". We are using a 10-day and 20-day MA cross signal on the daily chart. The rules are to only take entry signals in the direction of the larger trend from the 12-month MA. Signals against the primary trend are used for liquidation signals.

Using the monthly chart as a filter, the daily chart for dual MA trade signals, and adding the additional following price bar filter would have allowed a trader to catch most of the profits produced by the downtrend from the October 2007 highs. You will find overall positive results in both bull and bear markets, and throughout market history using this approach of filtering the secondary, or intermediate term, trend by the primary, or long term, trend with moving averages. This approach allows a filtered entry, liquidation to cash signals during counter trend moves, and quickened exits to lock in profits or cut losses short.

Conclusion
It appears that the use of the dual MA at the intermediate term, with the single long term filter would work best for locking in the most profits out of all the methods shown here. For many investors, using the wider dual moving averages on the weekly chart as was shown earlier would be extremely successful as well. The decision between these two MA systems would need to be based on investor time frame, personality, and product or market being used.

A similar approach in the stock market (all the charts shown were the S&P 500 index) would be to use a daily chart with 50 and 200 day moving averages in a dual MA cross method. Many participants in the marketplace watch the 50 and 200 day averages. You could use them in a cross to indicate changes in the primary trend. Go ahead, pull up your favorite charting website or software and put the 50 and 200 over the S&P 500 and you will see once again that a kid with a straight edge can outperform the market.

Technical analysis is the study of the supply and demand of the products we are investing in and trading. We are looking at and measuring price trend as it is bid up and bid down in real time, for the investing time frames we are interested in. Analysis of supply and demand in the marketplace is differentiated from fundamental analysis, in that the latter looks at what is currently assumed to be the causes of changes in the supply and demand of the instrument. In this way, fundamental analysis is at best several steps away from objectively determining whether to buy or sell an investment product. At worst, fundamental analysis can be terribly off, because the assumption of what is moving prices has its own pitfalls. In reality, fundamental data typically lags market price changes, and therefore we know that the market itself is the real time measure of societal optimism and pessimism about economic activity, and therefore the best gauge for investment decisions. The price trend does not lie. Fundamental analysts were publishing buy signals on Enron all the way down its slope of hope. Technicians were selling it short, or in cash. The same is true this time around.

A common misconception is that only short term traders should use technical market analysis. It is currently popular for long term investors to use "fundamental" analysis and a diversified buy and hope strategy, not dissimilar to a very slow game of roulette or craps. I have shown here, as in other posts, that long term investors should also use price trend analysis as their very first line of investment decision making. In fact, I believe they are best served by using trend analysis as their first and last lines of investment decision making.

Trend analysis helps the investor to step back and take a bird's eye view of the herding behavior of the marketplace, while watching for changes in the trend in order to act accordingly. If the goal is both capital protection and capital perpetuation, we need to be with 60% to 80% of the significant price trends within our investing time frame. We can either throw money at the market blindly in a buy and hope game of roulette, or we can approach the market with the tools appropriate to catch and ride those financial waves. Moving averages are wonderfully simple tools for identifying and following the significant price trends in financial markets.

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S&P 500: Look For Resistance Around 910, Leading To New Lows

On 1/6/09, we posted "Is the S&P 500 nearing the end of its short term uptrend?". The chart below laid out our expectations:

CHART FROM 1/6/09:

This is what the market looks like as of 1/20/09:


CHART FROM TODAY:
(Note: clicking on the chart should open up a larger version of the chart)

Trading and market analysis rarely work out that well, but we think we still have a pretty good lock on the technical patterns (emotionally driven buying and selling behavior) for the short, and intermediate term. The chart above continues to show our expectations for these two time periods. In the short term, we expect a rally towards an area around the 910 level. A decline towards 600 is expected in the intermediate term.

Make Or Break:
If prices rally significantly above 944 (where the label "C" is), and close above that level, we will have to reevaluate both our short and intermediate term opinions. The price trend is always right, no matter what anyone else says. If prices breakdown below 741, our outlook will be confirmed.

Something I find interesting in the chart above is that we have two trend lines converging, with a third in the range of the other two. The third one is the the dotted line downtrend line. Another downtrend line marks the highs of what we are calling a triangle consolidation. Then there is the uptrend line across the lows internal prices within the triangle consolidation. This uptrend line was a downtrend line that was breached, and should offer some resistance on a retest. Its resistance is right around were our Fibonacci proportional measurements are. Also the downtrend lines have already been confirmed as resistance areas, and they converge in this same area. These aspects and findings add to our pattern and Elliott Wave analysis to give us more reason to look for a resistance area around the 900-925 area. If all of these levels are broken to the upside, and hold, then 944 would probably be right behind it, and we would have to revise our outlook.

On a side note, let me mention some things for those of you who are not personally familiar with how we utilize our methods. We don't put a lot of faith forecasts. We trade price trends. Forecasts are not always necessary to follow price trends. The cornerstone of our work is risk management. We are never so excited by an outlook as to trade large enough to ruin our accounts. Strict risk management rules are something we recommend you develop if you are trading and investing. When we see a clear price pattern, be it Elliott derived or other, we definitely utilize this to let us know where to best place entries and stops, but we never bet the bank on anyone's outlook, even our own.

Having said that, let me share our long term outlook. It remains the same: significant low around 600 that will not be the end to the secular bear market trend, which is expected to go much lower over the coming years. While the rally we expect around 600 could be large in terms of time and price, investors are advised to use it to get out of the stock market and into cash and metals. Cash in secure international locations does not seem like a bad idea either, but of course not really my specialty. Lets just say that fractional reserve banking will not be a safe place for your wealth if the markets really accelerate to the downside. Additionally, this country has been known to not only close banks, but confiscate its citizens' gold and silver during such circumstances. FDR did just this, and we know that Obama has stated that he has been reading from FDR's playbook. The markets seem to be playing by this book too, only on a larger scale!

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About the Publisher, Elliott Wave International
Founded in 1979 by Robert R. Prechter Jr., Elliott Wave International (EWI) is the world's largest market forecasting firm. Its staff of full-time analysts provides 24-hour-a-day market analysis to institutional and private investors around the world.

Can the Government Stop Another Great Depression?

The following article is excerpted from a recent issue Elliott Wave International’s Financial Forecast.

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By Steve Hochberg and Pete Kendall
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As Conquer the Crash so boldly counseled, prosperity entails managing one’s finances and livelihood so as to be in tune with a 1930s’ style deflationary depression. But conventional wisdom disagrees. “There’s no comparison” to the Great Depression, says the world’s leading financial authority, U.S. Federal Reserve Chairman Ben Bernanke: “I’ve written books about the Depression. We didn’t have the social safety net that we have today. So let’s put that out of our minds.” He cites as evidence a 25% unemployment rate, a one-third decline in U.S. GDP and a 90% decline in stock prices, all of which occurred during the 1930s’ depression.

Unfortunately, what Bernanke’s managed to do is put one important word out of his mind—yet. Like the rest of the “this is no depression” camp, he fails to note that his cited figures are the extreme readings of that era. Bernanke also ignores the critical fact that today’s bear market is actually ahead of where the stock market was at the same point during the 1929-1932 decline and that the economy is lurching lower in a manner suggesting strongly that it will have little trouble keeping pace with the economic contraction of the 1930s (see Economy & Deflation section below).

Another common refrain is that, in contrast to the early 1930s, there are now competent financial authorities doing everything in their power to unlock the credit markets and reignite the bull market in equities. It’s certainly true that the Fed is doing everything in its power, and even some things that aren’t, to reel in the crisis. The U.S. Treasury is doing likewise. By Bianco Research’s tally, the potential total of U.S. bailouts is closing in on $9 trillion. But these efforts are every bit as impotent as Conquer the Crash and the September issue of The Elliott Wave Financial Forecast suggested that they would be. Here’s the key quote from the September EWFF: “The bailouts keep coming at lower lows, signaling further declines ahead.” Incredibly to most people, since this quote appeared the Dow has declined by another 30% and various government financial wizards have put forward even bolder yet more haphazard “rescue” initiatives.

The ballooning bailout makes us more convinced than ever that it will fail. The whole “Keystone Cops” approach to “the rescue” strengthens our conviction. One day the bailout is aimed at jacking up asset prices; the next it is buying mortgages; the next it is rescuing the consumer; and the next it’s all-hands-on-deck to prop up whoever it is that happens to be failing on that day. The alphabet soup of rescue programs now includes ABCPMMMFLF (no, we didn’t make this up), which is supposed to “shore up” the $1 trillion asset-backed commercial paper markets. And still, credit spreads shoot higher.

Another program, the “systematically significant failing institutions program” (SSFIP), was established in November to deliver a $40 billion “equity injection” into AIG. The problem, which will probably become the focus of intense Congressional scrutiny at some later point, is that the injection was made in October, before the program even existed. The Wall Street Journal puts it this way: “Practically every day the government launches a massively expensive new initiative to solve the problems that the last day’s initiative did not.” At the latest economic summit in mid-November, the U.S. and other nations were reputedly “close to a deal to create a new ‘early warning system’ to detect weaknesses in the global financial system before they reach epic proportions.” Among the stated objectives: greater transparency. Of course, “sources spoke on the condition of anonymity because plans are still being worked out.” The real reason that these people want to remain anonymous is that like everyone else, they recognize the proportions of the unfolding epic and thus the futility of the bailout effort.

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Steve Hochberg began his professional career with Merrill Lynch & Co. and joined Elliott Wave International in 1994. He became co-editor of The Elliott Wave Financial Forecast for its inaugural issue in July 1999. Pete Kendall joined Elliott Wave International as a researcher in 1992. He has been co-editor of The Elliott Wave Financial Forecast since its inception in July 1999. He is also the director of Elliott Wave International’s Center for Cultural Studies.

Is the S&P 500 nearing the end of its short term uptrend?

In our last S&P 500 post, we stated" "we are neutral the intermediate term and expect prices to meander a bit right here, possibly creating a trading range between the two dashed lines." 1007.52 and 741 were the levels of the dashed lines. Currently prices are in that range with the current internal pattern high being today's intraday high of 943.85. We now believe there is a fair chance that this level will be very close to the high of this entire intermediate term sideways consolidation pattern that began on 11/21/08.

Below, we break it down from the long term to the intermediate and short term for you.



Using a monthly chart above to locate and determine the long term trend we are in, we see that simple tools like a 10-month moving average (in blue) and a couple of trendlines show us to be in a long term downtrend. Therefore, any investments or trades we make will be based on this objective and factual back drop. I hear talk on the street of how now is the time to buy stocks, real estate, etc, etc... The street is usually wrong. The market tells the truth - we are in a major bear market, and it is not over yet.



On the daily chart above, we see that prices are deep within the range between 1007 and 741. We also see that prices are approaching an intermediate term trendline (dashed) across resistance in the market over a period of several months. If prices cannot substantially penetrate this line of resistance, they will fall. Also present on the chart is a short term trendline (thick red) sloping against the lows of recent weeks. This line is short term support in the supply and demand of the market. A break of this line further indicates the weakness we currently suspect.

Make or Break:
If prices move above the 1007.51 level, as marked with the thick blue horizontal line, then we will have to go back to the drawing board in the short and intermediate term. If prices break the low of 741.02, as marked with the thick horizontal red line, then our outlook is confirmed.

Any positions sold short here, or after a trendline break would need an initial stop loss order placed at the 1007.52 level. If prices then broke the 741.02 level, we would shortly move these down to the high mark preceding the trend breakdown.



The Elliott Wave Principle, in our opinion, is the most comprehensive form of technical market analysis. Therefore we use it extensively. The chart above is my current highest probability Elliott count. The idealized pattern that this count would produce over the intermediate term is drawn out for you. As in the chart prior to this one, a break above 1007.51 would require at least some revision. Even if we get some revision, remember the long term back drop is bearish.

Don't worry; we will be bullish when the long term backdrop leads us in that direction. The goal of the investor should be to preserve, and then perpetuate capital. We do that by letting the market guide us.

Note that the Elliott Wave case presented in the chart above leads to a low in the future that would be labeled (5) of [1]. The [1] should tip you off to what we expect after that. If not, then just look at the sequence of numbers leading down to the (5). [1] is one degree of trend larger than the (5), which also had a (1) that preceded it. If prices move forward in a way that is significantly dissimilar to the idealized count presented above, it will likely change this outlook. We are never married to an outlook. We follow the price trend and use the tools we believe are relevant for that task.

If we are correct in this outlook, then realize what the wave [2] movement will produce. Many will believe the worst is over, that the new administration is solving the problems (as if that were possible), or that the economy is in the early stages of a new major bull market. Based on the outlook we have been presenting, we believe that the wave [2] rally will be a mental trap that will lead to more eventual losses by investors. This belief does not mean we will not trade some of the rally. We probably will, but wave [2] simply means months to a year or more of recovery that will not make a new market high before leading to the worst, which is yet to come.

On the street, I continually hear talk of how now is the time to buy stocks, real estate, whatever... Is this the case? We don't think so.


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Using Trendlines for Basic Trend Identification

This is the 3rd post in the Trader and Investor Education series.

Prices move in trends. They move up, down and sideways. Money is made and lost as these trends persist. Profit or loss depends on wether you are with the trend or against it. We want you to be with the price trend. Trendlines are basic tools we can use to identify price trends at all degrees of duration.

An uptrend line would be drawn against price lows or troughs. A downtrend line is drawn against price highs or peaks. When an uptrend line is broken to the downside, it serves as a warning that the price trend may be shifting from bullish to bearish. A bullish trend is signaled as possibly beginning when a downtrend line is penetrated to the upside. This may all sound really elementary, and it is, but the fact is that most investors do not respect price trend in their investing behavior. Respecting price trend gives you an objective edge in the marketplace. Therefore we are starting out this technical analysis educational series with basics, which, by the way, are sometimes a lot more useful than more complex methodologies.

A price trend is a change in price behavior represented by the y-axis over a period of time represented by the x-axis of a chart. By drawing a trendline against lows, we are simply labeling the support area in the supply and demand ratio that prices have shown. The trendline against highs would then be representing the resistance area in the supply and demand of the instrument we are interested in.

To show applied use of price trendlines, we start with a monthly bar chart (each bar=one month of price action) below. You will see the long-term trends in the S&P 500 stock index over the past 14 years.

I find this to be an interesting study because the common belief is that prices always go up over the "long term". Meanwhile, in January 2009, we sit below the price level of January 1998! In the time between 1994 and 2009, we have had two long term (one year to several years) bull markets and two primary bear markets, the last of which is not indicated as complete at this point. If you had held cash for the past 10 years, you would be able to buy more of the S&P 500 index today then if you would have remained invested in the index for the decade in question. This flies in the face of the mainstream buy-and-hope philosophy of investing. Now if you would have simply followed the primary price trends, by buying the uptrends and selling short (or using one of the few bearish mutual funds) in the downtrends, you would have made significant gains to capital during this period. We are talking about around five total round trip (enter & exit) transactions for the conservative investor, certainly not sitting watching the charts day in and day out. Even just buying the uptrends (2 round trips) and sitting on the sidelines with cash in the downtrends would have resulted in substantial gains. Not gains, because you are on a routine contribution schedule, but gains to original capital!

In the monthly bar chart above, the primary trends are drawn with solid trendlines, while the intermediate term trends are drawn with dash trendlines. There is one sub-intermediate term trend drawn using a dotted trendline. The alphabetical labeling is in place so we can talk about the lines clearly, which we are going to do by breaking the chart down to the weekly bar level in a series of charts below.



Trendline "A-A" is drawn across the lows in the S&P 500 from 1994 to the break below the trendline in 2000. Prices moved in a powerful bull trend from the 450-470 range to the 1550-1300 range. There were corrective reactions along the way that would have changed short term and intermediate term trend signals, but the long term signal did not change using this method until late 2000 and early 2001. The actual break point depends on if the investor took the original break or waited for some of the retesting of the trendline to see if it was going to turn into resistance where it had previously been support. Trend A-A was a gain of over 150% to original capital, assuming no additional positions were taken using shorter term trend signals.

Realize, that traders using proper risk managment and position pyramiding type programs to add to their positions on the way up would have had exponential gains to original capital. We will get into that in a latter post. For now we want to keep it simple and teach the basics.



Following the break of trendline A-A, prices entered a powerful downward phase, where demand for stocks declined exponentially. This period is labeled trendline B-B. It is important to note that trendline B-B could have been drawn tighter, which may have resulted in a whipsaw (exit trend on false signal, then reenter). This whipsaw would have occurred around March of 2002. Even if one was whipsawed, the original exit would have resulted in profit as well as the final exit following signal to reenter the trend.

Durring primary trend B-B, prices declined from the 1500-1300 range down to the 770-950 range.

I can't leave this period without mentioning common rationalization. Many believe the declines of this period were due to the attacks on our country in September of 2001. On September 10th, prices were at 1092.54, having declined from a high of 1552.87 in March of 2000. The most recent bear rally high had been in May of 2001, and was a price level of 1315.93. The markets were in free fall before 9/11. After 9/11, the markets reopened on 9/17 and continued the downtrend only to bottom on 9/21 at a low of 944.75 before undergoing the largest bear market rally of the entire trend. Social mood, not external factors, controls prices. Following September 11th, proactive and prudent investors would have been looking for reasons to close the sold short positions they had held for quite some time. They would have had the knowledge that pessimism would have been near a crescendo at the intermediate term. We will talk about sentiment and contrarian analysis at another time, but I could not leave this trend without directly challenging the still common rationalization of the downtrend during the period. Two things over the years have really gotten under my skin: 1) when people, who are investors themselves, say "oh, you gamble for a living", and 2) when peole say "well, I lost.... after 9/11." At the very least, objectively following the price trend will keep you from making the same mental mistakes and rationalizations, because you will simply stick with the trend until it in the end when it bends.

Following the upwards penetration of trend B-B, prices entered an uptrend that was a bit weaker than the previous two trends. We see this in the decrease in momentum shown by the break out of trendline C-C, that was followed by a less aggressively sloping trendline c-c (lower case). Trendline c-c, had its own subtrend labeled in blue italics as trend c-c. This period between the break of trend C-C and the final break of trend c-c would have caused the investor a little more concern and analytical trouble than Trend A-A and B-B, but it would have still been possible to identify and stick with the trend.

Following the break below trend line c-c (lower case), the market entered into primary trend D-D and intermediate trend d-d. Prices declined from a range of 1570-1370 to the current range of 1007-741. In one year, trend D-D and d-d wiped out five years of long hard gains in the market. An investor maintaining an objective stance with the trend could have at the very least saved himself or herself from substantial declines by moving to cash early into trend D-D, and definitely when the d-d line was tested with downward resolution. Trendlines are very basic, but can help you out perform the market over a long period of time. When I first began studying technical market analysis, I heard the phrase "a kid with a ruler could beat most of the "fundamental" analysts on Wall Street". I thought it was funny, and now I am trying to help you learn that it is true.

Trends D-D and d-d are still in force, so the market is still technically in a primary and intermediate term downtrend. Market prices are the results of supply and demand of living breathing human beings, and like humans, markets go into resting an corrective phases while still in trend. So far, the moves off the lows are showing no signs of being anything but a consolidation of a trend that is still in force. This is not a forecast, but a commentary using the methods discussed in this post.



We have been discussing the use of trendlines to identify basic price trends in markets. We have been mostly looking at long and intermediate term trends. Trendlines work in the short term too. In the daily chart above, trendline e-e is a short term trend within intermediate term trend d-d. Trendline f-f is another short term trendline. Penetration of e-e with follow through has led to the formation of f-f. Both of these are still within intermediate term trend d-d and long term D-D, all of this gives us knowledge that the shorter end of the intermediate term price trend is neutral. This was our expectation as discussed in the last S&P 500 report, as you can see from clicking here.

While following along with this Trader and Investor Education series you might be interested in books on the subject. You can find links to our amazon powered bookstore on this page, where you will find books we recommend in Technical Market Analysis. Just choose the Technical Market Analsysis category at the right of the page of the bookstore page. We also have books on Austrian Economics and other topics of related interest. For authoritative books and exceptional forecasting services on the Elliott Wave Principle, which we believe to be the most comprehensive form of technical analysis, choose from the Elliott Wave links placed directly on this site.

Remember, that technical market analysis is the study of the supply and demand of the investment instrument of interest.