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Nasdaq Retracement: Three Not-so-easy Steps

12/14/00 01:43:16 PM
by David Penn

Looking for a Bush rally? A year-end rally? It's going to take a major retracement to make the dreams of Nasdaq bulls come true.

Security:   $COMPQ
Position:   N/A

At this point in the game, with the Nasdaq still 40% off its all-time high, most of those who have survived the downturn have just about had enough and are demanding that a bottom present itself.

For some, the appearance of a bottom in the Nasdaq is made all the more likely by the ascendency of George W. Bush to the presidency of the United States as well as Alan Greenspan's announcement that the Federal Reserve has shifted from its interest rate raising bias. But rather than stand peering into the well down which the Nasdaq has plunged, listening anxiously for the splash, there may be more profit in looking at just what any rally in the Nasdaq will have to overcome before the index and its bear can be considered out of the woods.

First, the Nasdaq bear. A bear market occurs when prices fall at least 20% from their recent highs. The current Nasdaq decline, 40% off its all-time high in March and 30% off its most recent peak in September, establishes beyond a doubt that the Nasdaq has spent 2000 in a bear market. In fact, the Nasdaq has joined the company of such notable downturns as the 1937-1938 Dow bear (off 49%), the 1973-1974 Dow bear (off 45%) and the Crash of 1987 (Dow off 36%).

And in the same way that the Nasdaq did not lose all 40% at once, but shed a quick 35% from March to May, rallied halfway back by September, then fell even lower in November, so will any Nasdaq recovery come in fits and starts, rather than all at once. These fits and starts are what the term retracement means: the process through which major movements in prices are briefly interrupted by rallies and corrections forcing prices temporarily in the opposite direction of the major trend.

Any longer-term Nasdaq rally will have three major hurdles to overcome--and strong price resistance will be present at each area of potential retracement
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There are three retracement levels that are especially relevant to any Nasdaq rally over the next couple of months. The first and most immediate task of a Nasdaq rally is to move to and hold its October highs of about 3,500. This would represent a retracement of 36% of the decline from the all-time high. While the 3,000 level seems to have some psychological meaning, there is much more price support in the area between 3,400 and 3,600, which includes both the October high and low, as well as the November high. No rise above 3,000 will mean much over the next few months unless it is part of a run to higher ground.

Secondly, a truly meaningful Nasdaq rally would need to take on the highs of July and August at the 4,200 level. Price support here is also significant, not only in the highs mentioned above, but also in the January high and lows that occurred between 4,000 and 4,300. What would make progress to this area all the more bullish for the Nasdaq is the fact that there is almost no historical "turbulence" in prices between 4,200 and the all-time high of 5,000 reached this spring. In hunting terms (and if the Nasdaq reaches 4,300 over the next six months you can believe the bulls will have their shotguns loaded for bear), it is almost a clear shot. Movement to 4,300 would also represent a major retracement of 68%.

And the last, not-so-easy step for any longer-term Nasdaq recovery or rally is, of course, the Vertical Limit of 5,000--which would represent 100% retracement and the end of a very bad string of months for the Nasdaq. There was a very small amount of consolidation in February at 4,500, a pause before the push to the summit. But if the Nasdaq makes it all the way to 4,300, it is not likely to let another 200 points become a major obstacle.

The size of that "if" is yet to be determined. If the retracement numbers of 36% and 68% sound vaguely familiar, it may be because they are close to the 38% and 62% used in Fibonacci retracement analysis. The 36% and 68% retracements are also roughly retracements by thirds--another popular, and simpler, method of gauging retracement. It is always a better idea to measure the likely retracement areas based on things like price support and resistance than by simply adhering to a pre-arranged set of numbers. But any way you calculate a Bush rally or a year-end rally, the Nasdaq has a lot of moving to do if any of these rallies are going to reverse a year-long bear.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine,, and Advantage.

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