As even non-traders know, the markets have been quite volatile lately, and I've been getting quite a few emails from people very interested to know what I think about the current state of the stock market. Obviously with the huge drops last week and this week, the stock market is primary on most people's minds. Those volatile swings had a lot to do with the government passing it's $700B bailout as well, so everyone seems to be watching the Dow these days.
I thought this would be a perfect opportunity to discuss a tool from the Techniques of an Astrotrader course. The Astrotrader course contains a long term forecasting method used to forecast the probable direction of the wave structure that unfold in markets. It is based on cycles, and the way those cycles unfold in freely traded markets is very interesting to study.
Please take a look at a recent chart of the Dow Jones Industrial Average:
This chart shows what the Dow has done over the last couple years, and since the price just closed at 9955.50, it feels like the perfect time to be discussing esoteric techniques, 5's and 9's having a special significance for me. ;-) The red cycle at the bottom is a long term cycle taken from the Astrotrader course. I'm not going to discuss how this cycle was calculated in order to protect the investment in this material by my fellow Astrotraders. However, I don't mind discussing the results of this technique, as well as what it has to say about the near term future.
That red cycle governs the major turning points in the Dow. When it makes a top or bottom, the Dow also makes a top or bottom. It's a very long term cycle, turning only about 2-3 times per year, but it has been very useful when analyzing the major trend of the market. If you take a look at points 1 through 5, you'll see that the market moved closely in step with this cycle all the way up to the July 2007 high. At that point, we were expecting a decline into point 6, but that's not what happened.
Markets always have a way of telegraphing when something unusual will happen, and with these tools, the way markets do that is by exhibiting frequency doubling. Frequency doubling occurs when instead of moving with a cycle beat-for-beat, the market will make two beats instead of the usual one. This has happened in every crash scenario I've ever studied, and tells the alert trader that lots of extra energy is flowing into the market. So as soon as the October high at point A was confirmed, we had a very good indication that the market was going to really start moving.
Since frequency doubling can practically just be thought of as twice as many beats, it's very easy to plot out the new cycle, and I've done that with the blue line at the bottom of this chart. That represents our high energy cycle, which the market has been following for the last year. It hasn't been exact to the day in it's calls (that's a job for the timing tools), but the forecast has laid out the turning point times for us very clearly. Government bailout or not, the cycle said we were down from August 11, and that's exactly what happened. We are currently at a very interesting point in this forecast - pivot low H.
According to this tool, we should bottom at or around point H, which has a date of Oct 1, give or take a week or two, and after that bottom we ought to be up until at least point I, on Dec 12. Remember, this is the general purpose blueprint, so it doesn't work out to the exact day - it just tells you what the market is trying to do. Right now, the market is looking for a bottom. Once that bottom forms, we'll be up until point I, when there will be a big decision to make.
Take a look back to the switch between the red forecast and the blue one. I've marked a bottom there as "Reset", which doesn't correspond to either of these forecasts. What I've found in looking at these cycles is that certain points in the cycle are the impulse moves, and others are the consolidation moves. When it comes to frequency doubling, the inversion points (halfway in between the main red cycle points) are always the impulse moves. That's why point A had to be a high and not a low - because the main trend was down, and the impulses needed to point down, not up. So the market gets on the right beat by bouncing at the "Reset" marker up into point A, so it can then be in tune with the energy. So that's why points A, C, E, and G were the big ones to watch and to load up on, while the counter trend points of B, D, and F were the ones to take profits on, but not necessarily hold onto. Aggressive traders trade all of them, but it pays to know what kind of a point you're in, as it will determine how much profit you'll be able to take out of your trade.
Anyway, point I, on Dec 12, is one of those inversion points. If it hits, it will be a great short trade. If it doesn't hit, it means the market is changing phases, and we'll be back on the original red cycle. In a high energy situation like we're in now, changing phases tells us that the crashing is over, and that the market will start behaving itself again. This won't happen until one of those intermediate cycle highs fails, so the criteria for this is very clear.
So that's a quick and dirty synopsis of what the Dow ought to do. Traders using this technique have a big advantage in that they have two critical pieces of information. The first is obviously the timing information as far as when to put on big positions, and the knowledge of which turning points will be the impulse moves. The second piece of information is watching the inversion cycle off the doubled frequency of the main cycle, which describes the character of the market. Knowing when a market just entered a high energy period tells a trader when to pay close attention to big moves, and knowing when a market has left a high energy period tells that trader not to try and make a million on each trade anymore. It's valuable information to have. Obviously, you then use your technical tools as a filter to buy and sell accordingly.
This is only one tool in my arsenal, but it's a great one. Stay tuned, and pay attention in December. Anytime I post dates in public places, we tend to have a frequency change, so according to the odds, that point will fail and the worst of this will have been right about today. Of course, if you do start seeing the market slip right around then, it might be a good time to buy some out of the money puts. ;-)
All for now. Happy Trading!
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