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The Technical Setup For the Market

Since the beginning of this crash, I've been trying to figure out how low we'll go and when we'll retrace a big part of the downward pattern. I've been watching various intermediate term technical set-ups and what I think has happened is that since this is a crash and not a typical correction, we need to look for a more secular sort of pattern to the market.

I've written before that market returns are made up of two components: earnings and sentiment. Technical patterns fall under the sentiment category as the swings in prices represent emotional highs and lows of investors. Given the highly emotional state of the market currently, the technical picture plays a huge part in the success of an investment portfolio, much more than temporarily depressed earnings.

So, with that, I started reviewing more indepth but less frequently observed patterns. The pattern that seems to most closely approximate our current market action is the Wycoff Spring. As described by Barry Ritholtz, a Wyckoff Spring occurs when a market average (or stock) falls below its trading range, and makes a new "panic low" — and then "springs" back into its previous range.Its a relatively rare situation, one that is usaully associated with a sell off.

As you can see in the template for the Wycoff Spring above (Source: San Francisco Technical Securities Analysts Association), it starts with a big selloff that ends with a bounce higher before it moves back down to establish a low (in our current situation, it would be the October 10th low). It then moves into a trading range as investors get excited or depressed by any news that sets their emotions to buy or sell. Next, some piece of news happens to get it to sell off into a new panic low that is below the previous selloff low (in out situation, that would be last Thursday – see point 8 on the template), before bouncing back into the trading range ( Friday's action – point 9 on the template).

If the pattern holds true, then we should work our way back to the pre-crash levels of the markets (on or about mid-September levels) in a few weeks. That will be back to roughly 20% down from the market highs from the current 40% down levels. Not the best news ever, but certainly better than what we've had the last 9 weeks.

Realistically, we could certainly be anywhere in the pattern, like point 7 and immediately after, with a long way to go before we get to the spring higher. In any event, we are working our way through the bottoming process and eventually we will work our way higher at which point we will be implementing the recession asset mix discussed several posts ago (swapping into higher dividend equities that will pay us to endure the time requied for the economy to make it back to positive territory. Given the seriousness of the problems we have, it will likely take some time and the dividend income from these equities will provide help us weather the storm.

Hang in there!