Sunday, October 30, 2011

"Then the third phase begins..."

Evidence suggests that stocks are in a bear market.

The upper chart is the ratio of the equally weighted S&P 500 to the popular, market cap weighted S&P 500. This ratio is a measure of internal market strength. Note that a big divergence between the actual S&P, the lower chart, and the ratio has formed.

The green box noted "major topping formation" is synonymous with "distribution" in following quotation from Edwards and Magee's Technical Analysis of Stock Trends. It describes this year very well.

"Primary Downtrends are also usually (but again, not invariably) characterized by three phases. The first is the distribution period (which really starts in the later stages of the preceding Bull Market). During this phase, farsighted investors sense the fact that business earnings have reached an abnormal height and unload their holdings at an increasing pace. Trading volume is still high, though tending to diminish on rallies, and the “public” is still active but beginning to show signs of frustration as hoped-for profits fade away.

The second phase is the Panic Phase. Buyers begin to thin out and sellers become more urgent; the downward trend of prices suddenly accelerates into an almost vertical drop, while volume mounts to climactic proportions. After the Panic Phase (which usually runs too far relative to then-existing business conditions), there may be a fairly long Secondary Recovery or a sideways movement, and then the third phase begins."

The third phase is another down leg.

1 comment:

  1. In Wave 5, you would expect the large caps to outperform.

    In Wave 1, you would expect the small caps to outperform. We could be seeing either case right now.

    RUT has outperformed over the past 10-15 trading days, and so has $SPXEW.