Stock market technicians, sometimes referred to as chartists, regularly review and analyze the supply of and demand for stocks in an effort to identify recurring patterns that they can use to project future market activity.
Technical analysts also collect numerous financial statistics to determine the general psychology of investors. The aim is to determine if most investors are optimistic or pessimistic about the future direction of stock prices.
Technicians pay particular attention to long-term trend lines, price support and resistance levels, channels and "head and shoulder" formations, called thus because of how the lines appear on a chart.
Many fundamental analysts claim to ignore such data. But my experience reveals that technical analysis can be very helpful in determining major turning points in the financial markets. (It's likely a self-fulfilling prophecy, since such a large number of investors rely on technical analysis.)
I rely primarily on a vast array of economic and financial data to forecast the future direction of stock prices. However, I become more confident in my analysis when certain technical studies support those findings.
For example, if my fundamental models were to indicate that economic growth would slow considerably during some specified period into the future and that corporate profits would fall sharply — plus certain technical indicators suggested that stock prices were topping out — I would be quite confident that stocks were headed lower.
And that is exactly what my fundamental models, supported by certain technical indicators, are suggesting now.
In the chart below of the S&P 500 Index, a "head and shoulders top" seems to be forming. Point four identifies the left shoulder, point five the head, and point six the right shoulder. This formation began in May of this year — approximately eight months ago.
Interestingly, this same type of formation occurred between January and September 2000 and lasted for a similar period of time — nine months); see points 1, 2, and 3.
You can also see from the chart that the S&P 500 is currently trading above its upward-sloping channel, indicating (from a technical perspective) that stocks have recently been trading in over-bought territory and are therefore due for a decline.
In addition, the S&P 500 has broken below its 200-day moving average, which is now sloping downward — another sign that points to an impending bear market, according to technical analysts.
My research indicates that between now and the end of this year, the S&P 500 will likely hold above its next major price-support level of around 1,410. Nevertheless, my models also suggest that stock prices in general will fall sharply between January and March of next year, and that the S&P 500 could fall to around 1,130.
If the employment situation continues to deteriorate, stocks could conceivably decline even further, with the S&P 500 Index potentially falling to around 1,120.
Whatever the eventual outcome, my models strongly indicate that the path of least resistance for stock prices in general over the coming months is — DOWN.
So while the so-called Wall Street "experts" continue to debate whether gold prices will rise above $1,000 per ounce; if crude oil prices are headed for $150 per barrel or about to turn lower; or whether the U.S. economy is still strong or about to enter a recession, I'll continue to focus on finding ways for subscribers to The ETF strategist to make money.
Since the inception of this investment newsletter on September 18 of this year, our conservative and aggressive portfolios are up 2.9 percent and 8.4 percent, respectively, while the S&P 500 Index has fallen by 1.5 percent. Click here if you're interested in reading more about my market forecast and ETF recommendations
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