Price and Time Overbalanced

SPX – 1097.50

DJIA – 10,236

January 28, 2010

“There is no rule about anything in the stock market save perhaps one. That rule is  the key to market tops and bottoms or the key to market advances or declines will never work more than once. The lock, so to speak, is always changed.”

-Gerald Loeb

Price and time overbalanced for the S&P 500 (SPX) yesterday. When this happens after a three-section advance, it indicates the a change in the primary trend. Could the SPX high of 1150.44 on January 19 mark the top of the cyclical bull market?

I sense the managers who run big money, bulls and bears alike, expect higher stock prices in the first half; so do most of the technical analysts I respect. For example, The Wall Street Journal reported yesterday that Jeremy Grantham turned bearish again but he still thinks stocks, led by quality, head higher in coming months. Technical evidence arguing in favor of new recovery highs include an all-time high for the New York Advance/Decline line for the week ended January 8 and the largest number of 52-week highs the same week. The SPX’s annual swing chart also turned up.

Regarding price and time, overbalance is an important technical tool developed by W.D. Gann to help determine the main trend in conjunction with 3-day swing charts. Price overbalances when an active market falls further than it has on any decline from the low and vice versa on rallies from the high. Time works the same way; it is more important than price but indications by both are necessary to determine a change in trend.

I’ve only seen a few analysts use price and time overbalance and none that  measure it like I do. I won’t share the specifics but I will share the source, the first three chapters of Gann’s commodity course, the most important of his writings (dealing with trend, discipline and money management) written just before he died. To find my measurement technique, you’ll also have to read his books- Forty-Five Years in Wall Street or How To Make Profits in Commodities; I forget which book and I’m not about to wrestle with either again. Gann was a prolific technical analyst, promoter and writer, difficult to comprehend but he developed a myriad of esoteric tools tied to pre-Euclidian geometry. He has quite a cult following, including multi-book texts devoted to supposedly unrevealed astrological techniques. This is a cult dedicated to predicting future tops and bottoms, but I’m dubious regarding their trading success.

The overbalance rule says to expect a change in trend when price and time overbalance after a three section advance, and when confirmed by the 3-day swing chart. From the March 2009 low, it looks like a two leg advance but using weekly net volume figures, I count three sections. The first section was the rally from the March 6, 2009 low through the high on June 8 2009, the second section from the low on July 8, 2009 through the high on October 26, 2009, and the third section from the low on November 2, 2009 through the January 19, 2010 high.

To confirm a change in the primary trend as indicated by price and time overbalancing, the SPX’s 3-day swing charts needs to carve out a pattern of a lower high followed by a lower low. At this point, its 3-day swing chart has had six swings in a bullish higher high, higher low pattern. The last 3-day swing high was 1150.44 and the last low swing low was 1029.35 on November 2, 2008.

I suspect yesterday’s low (1083.11) could be the next 3-day swing low, which often occur just after an overbalance signal. It was a harmonic day, the wave count on hourly charts looks complete and it reversed around the November 27 low (1083.74) with Fed comments and an eloquent State of the Union address behind us. It may have been the low of the first short-term decline in a new cyclical bear market (my bias). I expect the next rally has to carry far enough to reinforce Wall Street’s “higher prices lie ahead” bias, perhaps between a 62% SPX retracement at 1124.72 and where prices first sliced beneath the rising trendline around 1130. Net volume overbalanced on January 22 indicating downtrend with peak readings of (69.6) for the NYSE and (50.7) for NASDAQ. If these figures are surpassed by positive readings on the next short-term rally, it would raise doubts about the overbalance indication. If not, it will give more confidence in laying out short sales when the rally fades.

The 21-day rule indicated downtrend and last Friday and it would take a rally above the 1150.44 high in the next 14 trading days to reverse that indication. The Market Trend Indicator (MTI) is Neutral. It has yet to signal downtrend and it hasn’t since the week ended March 20, 2009. The SPX is under its 1107.76 18% weekly exponential average and the DJIA is under its 18% average at 10,343. The New York Advance/Decline line is 2,075 net advances above its 18% average.

The Nasdaq 100 (NDX) overbalanced price and time from its March 2009 low but not from its November 2008 bear market low. The NDX declined 5.6% compared to more than 5.9% for the DJIA, nearly 5.9% for the SPX and more than 6.3% for the Russell 2000 (RUT).

Harmonic Preview:

(High Probability SPX Turning Point or Acceleration Days)

January 27       (Wednesday)

January 29*     (Friday)

February 1       (Monday)

February 9       (Tuesday)

February 16     (Monday)

February 19     (Friday)

*An asterisk denotes a dynamic SPX price square in time; different factors account for the other dates.

I haven’t yet deleted yesterday’s date but I think it could prove to be the next short-term low. The SPX price squares are a process I also picked up from Gann. The veracity behind dynamic squares is tied to the belief that energy unity in its various vibrations and structures creates the multiplicity of all forms in the universe. Force-field theory holds that the material world is knowable only through its underlying patterns of wave forms, which is what pre-Euclidian geometry attempts to achieve with geometry and number. These dates are not the secret to stock market success, but dynamic squares are quite a phenomenon that often aid profitable trading and market understanding. I also cross reference my dynamic square projections with anniversary dates of important highs and lows, past 3-day swing highs and lows, and Bradley days and a few other dates tied to the sky.

In other markets, I think long-term government bond prices to test their January 8 low if and as stock prices rally. Following that, I expect a counter trend rally to carry above the short-term high on January 21. I also think the dollar (which just poked through its 200-day moving average) rallies further while gold falls a bit more, scaring out the weak hands to set up a buying opportunity.

So much for market analysis. Planned, deliberate speculation is more than that; it’s a matter of planning ahead, self control and money management. The rules are easy- trade with the trend, cut losses and let profits run. The trick is the psychology and discipline. I believe it’s imprudent to trade with time horizons less than one month because big winners are needed to overcome losing trades, skid and commissions. With discipline, you shouldn’t be in losers long but it also takes discipline and patience to stay with winners; handling profits can be as hard as cutting losses. Ideally, the trade goes in your favor from the start, buying and averaging up on the long side on breakouts and as reactions pass, and just the opposite when trading the short side.

As for the State of the Union address, I’m republishing a John Mauldin quote from October 30, “The time for good choices was ten years ago. Now we face the prospect of painful decisions, no matter what we do. It is not a matter of pain or no pain, of somehow avoiding the consequences of our bad decisions, it is simply deciding how much pain we will take and when or allowing the pain to build to a climactic event.”

Conclusion:

My leading indicator for the primary trend indicates the top of the cyclical bull market may be place; I think that would fool most. It’s important to pay special attention to the quality of the next short-term rally. We may be setting up an opportunity to put on short term positions will little risk when the rally fades. I would also establish shorts if the market breaks down from here and the MTI signals downtrend (with stops above the January 19 highs).

I believe some of the best short candidates are ETFs tied to cyclical groups or small cap indices. Potential short candidates include Russell 2000 iShares (IWM), Russell Microcap iShares (IWC), Real Estate iShares (IYR) and S&P 500 Consumer Discretionary SPDRs (XLY). For more leverage, traders could go long inverse ETFs including ProShares UltraShort Russell 2000 (TWM) and ProShares UltraShort Real Estate (SRS). I’ll probably add ETFs tied to the financial sector as well.

If you’re following my guidance, you were stopped out of ETFs tied to the SPX. For a rally from here, I think NDX-related ETFs are best- QQQQ and QLD (ProShares Ultra QQQ) make the most sense. The recommended stop point is under yesterday’s low. I generally use the range of the low day (with a stop a tick below that) as a cushion and size positions accordingly.

For investors, figure how exposed you want to be in the next bear market. It may have started. If technical characteristics on the next short-term rally are poor, I’ll probably recommend some selling when you can, not when you have to. Confirmation of a bear market comes with a lag (violation of long-term moving averages, moving average crossovers and Dow Theory).

The information contained herein is based on sources that William Gibson deems to be reliable but is neither all-inclusive nor guaranteed for accuracy by Mr. Gibson and may be incomplete or condensed. The information and its opinions are subject to change without notice and are for general information only. Past performance is not a guide or guarantee of future performance. The information contained in this report may not be published, broadcast, rewritten or otherwise distributed without consent from William Gibson.