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February 23, 2010

Swingin' DX

The purpose of technical analysis is to help filter out noise and control emotion such that a trader can position on the right side of powerful moves and ignore all the shakes and wiggles. Unfortunately many traders take TA to an extreme by using a scientific approach in their interpretation. However, the very fact that technical analysis is open to interpretation should reveal that a scientific approach is misguided. I've seen dozens of blog writers and scores of commenters post charts looking like something out of an aeronautical engineer's handbook: a mess of indicators all supporting the notion that if index XYZ breaks 123.45, the bull market is over. So if the index prints 123.44, we should sell everything and go short?

I don't think so.

The point here is that when price marginally breaks an important moving average or trend line, it means nothing. Price must power through support/resistance for the action to command any credibility. Hence my hesitation at celebrating Friday's SPX close above the 65DMA. Price needed to move resolutely through the moving average to confirm an impulsive move out of a yearly cycle low, but the conquest was marginal and the action was hardly impulsive. Since the action was so timid, I was looking for some follow-thru confirmation. I think its safe to say the action this week failed to confirm the break:

S&P 500 daily chart moving average

Now, I don't think we need to throw all our analysis out the window just because markets posted one nasty down day. The launch out of last year's low was littered with such days, and each one of them saw bears trying to catch a resumption of the crash. Such action is designed to relieve people of good positions, or worse, get them on the wrong side of the market. The only information we can derive from this moving average rejection is that a test of the low is still possible (but not guaranteed, of course). Another factor supporting the notion of a bottom test is the fact that buying-on-weakness figures have not shown a large commitment from institutions to this rally. Seeing some BoW under today's action would have been encouraging, if not expected, for today's move to prove to be a stand-alone shake-out.

As difficult as it may be to weather, a test of the low may be the best thing that could happen to our outlook because it would certainly dismember enough traders to place sentiment in the role of tailwind. If the SPX were to approach the February low, it would also be nice if it did so in conjunction with some heavy BoW sessions. On the other hand, perhaps we'll just see markets surprise everyone and launch tomorrow. It all really depends on where sentiment currently lies and what the dollar does.

dollar index chart swing high

dollar chart historical analysis

How many apparent swing highs will be required before the DX turns down? Anybody's guess, but we are due... and approaching overdue... for a cycle top, so I imagine the turn will come soon. Interestingly, the S&P 500 and gold are 3-4% off their lows while the DX is printing new highs. The divergence is encouraging, as it betrays where stocks and PMs really want to go. At the risk of sounding like a broken record (does anybody out there remember what a record is or what it sounds like when it's broken?), I still expect the dollar to break lower, and I still expect stocks and gold to launch when it does.

 

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