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HEAD & SHOULDERS


The Nasdaq Bottom This Spring?

02/19/02 10:16:15 AM
by David Penn

Technical reasons abound for another countertrend rally.

Security:   IXIC
Position:   N/A

Most of the reasons for an economic recovery in 2002 are based on fundamental reasons. Increased liquidity from the eleven Fed funds rate cuts, the Bush tax cut and month-to-month signs of earnings growth are all part of the bull's arsenal for the first part of the year. But there are technical reasons, including some powerful long-term reasons, for a significant stock market rally in 2002. Those bears who've benefited from major legs of the 73% decline in the Nasdaq over the past 18-odd months may finally find real reason to run for cover.

There is no reason to understate the bearish case on the Nasdaq. The September 11th war rally, as powerful as it was in its 30% rise from September to December 2001, only retraced 19% of the overall decline in the Nasdaq from its bull market peak of 5132 in March 2000. As far as countertrend retracements go, a 19% retracement is slightly more than half of what would be considered a major retracement--major retracements starting in the 33% range. Currently in a downwardly cast line, the Nasdaq would likely retest the September 2001 lows if it is not able to move strongly above the summer 2001 highs (Nasdaq 2328).

Should support hold at 1700, a breakout rally could take the Nasdaq to a test of the January 2001 highs.
Graphic provided by: MetaStock.
 
But, as it often happens, the bullish case for the Nasdaq is built on the back of the bearish case. The lows of September 2001 may well have represented a bear market confirmation. A bear market confirmation is a Dow theory method for determining when a major decline has crossed over into bearish territory. More than relying solely on a fixed percentage to establish when a bear market has occurred (i.e. an advance of 20% or more from the bottom; a decline of 20% or more from the top), the bear market confirmation approach considers the low point of the most recent correction in the last bull market as the point beneath which any subsequent bear market must pass.

That may sound complicated, but the idea is clear in the chart of the Nasdaq provided. The low point of the most recent correction in the last bull market is 1345. This point was reached in October 1998, in the wake of the Russian debt/Long-Term Capital Management crisis (the actual market "crash" occurred two months prior). The current low point in the Nasdaq is 1387. The bullish case is that this low point, reached in the wake of the September 11th terrorist attacks in the U.S., does in fact represent the bear market confirmation (even though the specific "target" of 1345 was not hit), and that a major retracement is likely.

More support for the bull thesis comes in the potential head and shoulders bottom the Nasdaq began developing early in 2001. With a head formed by the April 2001 peak, the September 2001 trough and the December 2001 peak, it looks like a short correction that did not take out those September 2001 lows could complete the reversal pattern. The resistance area or neckline for such a formation would slope downward somewhat, but would be more or less along the 1950 area. The sloping neckline is drawn connecting the April 2001 peak with the December 2001 peak.


What is most interesting about the upside potential for a head and shoulders bottom reversal at this time is that the target for a breakout, about 2865, would represent a 39% retracement in the Nasdaq's primary bear market (the 73% drop from 5132 to bottom at 1387). This is significant insofar as the Nasdaq's primary bear market, now 18 months old, has yet to experience a major retracement or countertrend rally. At the risk of saying simply that the Nasdaq is overdue for a major countertrend rally (of which the September 11th rally might well be a part), the Nasdaq is overdue. An advance to 2865, perhaps not incidentally, would take the Nasdaq to a test of the January 2001 highs.



David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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