More Cyclical Evidence S&P 500 To Reverse Higher

07/10/09 09:01:20 AM

by Donald W. Pendergast, Jr.

The S&P 500 is due to make a 20-week cycle low near the end of this month; this is further supported by the current action of the 20-day cycle, also anticipated to bottom near the end of the month.

Security: .SPX, SPY
Position: N/A

Recently, I posted an article at Traders.com Advantage that provided substantial evidence of an upcoming weekly cyclical turn in the Standard & Poor's 500 ("S&P 500 Descending Toward Major Cycle Low," June 26, 2009). Further confirming this anticipated turn is the daily cyclical price action in the same index, which also features an average of 20 periods between major swing lows in its daily time frame. If you've already read that article, you know that there is a time/price convergence area that will likely witness a major weekly reversal in the S&P 500 and that late July 2009 is the probable time of the reversal. You would also be aware that the area surrounding 850 is the likely price where the current decline will find significant support before turning higher in another substantial weekly rally. Armed with this information, let's now shift into the daily time frame in the S&P 500 and see if we can analyze its own cyclical pattern to see if it coincides with that of the index's weekly time frame.

FIGURE 1: S&P 500, DAILY. The S&P 500 appears to be homing in on a major turning point by late July 2009, based on agreement in the dominant daily and weekly price cycles driving the index.

Graphic provided by: MetaStock.

Graphic provided by: WB Detrend EOD from ProfitTrader for MetaStock.

Figure 1 is the daily chart for the S&P 500; yes, the index is in a de facto daily downtrend (lower swing highs and lower swing lows), but there's more to this picture than meets the eye, and that's where an understanding of price cycles and internal strength measures in the broad market can be invaluable. So for starters, glance at the top of the chart where you see the black line labeled ".NYA internal strength." This composite indicator is a weighted measure of the internal pressure of the broad US market and uses such vital inputs as the advance/decline line, new highs vs. new lows, up volume vs. down volume and the rate of change of the S&P 500 itself. The output in this case is showing astute technicians that the internal strength of this market is remaining healthy during the recent round of declines since early June. This is also known as a "bullish divergence with price" (note the diverging lines on the indicator and on the main price chart for further visual confirmation) and is an early warning of the reversal that is likely to materialize within the next few weeks.

Since we have already determined that the weekly price cycle is due to bottom by the end of July, all we need to do now is to ascertain the dominant daily price cycle in the index and see if it is also in sync with the weekly cycle. If they are close, the odds of a major reversal are greatly enhanced. The last two price cycles in the daily S&P 500 have come in at 22 trading days each, but if you go back in time, you'll see that the average price cycle is closer to 20 trading days -- sometimes as much as 26 and sometimes as few as 15, but 20 trading days is a much more typical price cycle. Knowing this important fact about the cyclical nature of the index can help make timing stock market positions a lot easier and can also help eliminate many losing trades before they even start - a major boon to most traders still struggling to figure out just how the this particular market operates.

Currently, we're 11 trading days into the most recent cycle (measured from major swing low to major swing low), meaning that the little bounce over the past session or two is likely to be short-lived and the index is probably going to drop down hard again toward 850 or so as the full 19-22 trading day cycle plays out. As shown on the chart, a 19 to 22 trading day cycle will mean the major daily cycle low will be anticipated around July 21 to July 24, 2009, give or take a few days on either side. And since the weekly price cycle in the S&P 500 is also due to bottom at approximately the same time, this bodes well for the potential for a major reversal move, one that could carry well into the end of the summer of this year. At the bottom of the chart are a pair of cyclically useful confirmation tools, the WB detrend oscillator and the stochRSI (10) indicator. Both appear to have nailed the 11-day half-cycle, both indicators being near the bottom of their respective ranges.

Now that we've ingested all of that technical errata, what now? Well, if you're currently out of the market, good for you, because you're soon going to have the opportunity to deploy your trading account cash into the strongest stocks in the strongest industry groups and sectors once the anticipated reversal finally kicks in and billions of institutional dollars start propelling the broad US markets higher again. Once you see a confirmed bullish reversal, run all of the major industry group indexes (or a basket of diverse sector exchange traded funds (ETFs) or sector mutual funds) to see which have the strongest 13-week rate of change versus the S&P 500.

Once you've located the top five performing groups, run the same 13-week rate of change drill, this time running the component stocks of such top-performing groups against the group index itself. You should have a number of stocks to choose from at this point, so filter the output according to average daily volume and fundamental factors such as price/sales ratios, quarterly earnings trends, and price/book value, among others. Checking the daily and weekly price cycles on the stocks that remain would also be an excellent investment of your time.

Another major turn in the market is inevitable; if not now, then later. The big question is this: are you prepared to take full advantage of it? Following the steps outlined in this article might just help you cash in consistently from now on as these infrequent (two to three times a year) yet major reversals rock the markets, up and down.

Donald W. Pendergast, Jr.

Donald W. Pendergast is a financial markets consultant who offers specialized services to stock brokers and high net worth individuals who seek a better bottom line for their portfolios.

Title:	Writer, market consultant
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