Friday, November 22, 2002


OMG - where to begin? This was the 7th week of the Oct 9-10 rally - and what a special week it was. And even more exciting, it set in place an even more exciting week next week. So where to begin?

OK - the most important. You ever hear the term "head and shoulders" pattern? Stock prices tend to mark certain patterns. And what certain recognizable patterns show is how the psychology of a recent stock price movement affects the immediate futuie movement. I'll get around to and explain in detail several basic chart patterns some day in the future when I learn how to post charts and diagrams and stuff, but for now let's stick with the descriptive and I'll keep it simple

Consider the chalk outline of a dead guy on the sidewalk lieing face down. Start at his left arm - mentally draw a line up the arm, making a right turn at the shoulder. Slope the line a little bit between the shoulder and the neck, then up the head, over and down the other side, dip slightly and out to the right shoulder and down the right arm. You have just drawn a "head and shoulders" pattern. Stock prices rise, hit a small high (1st shoulder), pull back slightly, head back up again to a higher high (the head), retreat again, down below the first smaller high, then up to the level of the first high again before dropping back down fior good. It's a common pattern, and is considered a "bearish" signal - the market had 3 chances to advance, it didn't, becasuse the 3d high was only as far as our 1st high, and so the bulls abandoned ship and the bears took over, buying demand dried up and prices went down.

Going into this week, up until Tuesday, we had a *classic* head and shoulders pattern going. The first high (left shoulder) was on Oct 21 when the Dow hit 8547. The second, higher (head) top was reached November when the Dow hit 8800. and the third (right shoulder) was started November 12 when the Dow's high was 8504 (on it's way down into the 8300s) and continued sideways through Tuesday the 19th when the Dow closed at 8474. But, suddenly, Wednesday, a strong rally started in the morning, and never really stopped for 2 days, pushing the Dow back over the 8800 mark, but, more importantly, completely breaking the "head and shoulders" chart mold and it's inevitable fatal down trend. I can't stress just how important this is for the psychology of the market. All the stuff during election week - the Republican election, Pitt's resignation, the rate cut - all the stuff that everyone expected would push the market up, and didn't at the time, finally came through this week. I'll explain why that is sometime in the future too - has to do with the concepts of "overbought" and "oversold" and various ways of measuring that stuff too.

Now let me explain why this is so important. Back in July, the market began a bottoming process that should be the end of the big bear market which started in March 2000. This particular type bottom is called a "W" bottom, because it resembles the letter (Duh). We hit the first downpoint of the W on July 24. Rebounded up to that middle high on Aug 22 of 9077, and dropped back down to the second low point on Oct 9. Now, one of the things that confirms the actual "W" bottom (also called the double bottom) is when the price coming up the far side passes that middle high point. If we had dropped down in the "head and shoulders" we could have destroyed the "W" setup and would have had to start all over on a different setup - but now, we are still on our way to "W" confirmation. And that is important. Picture yourself a money market manager - one of the big boys. You have to have certain rules and one, is that you don't buy certain type stocks as long as there is a bear market. A confirmed "W" bottom signifies the end of a bear market. and the buying rules for the big boys change in a good way.
Speaking of "big boy" rules, there's another basic big boy rule that we are also getting close to changing also - the 200 day moving average rule. One of the basic rules of the big boys is that you don't buy a company or a fund who's price is below the 200 day moving average. There are a couple of ways to figure the moving average - I won't bore you here with the details ,but right now the 200 MA for the Dow is in the low 9000 range - which also, conicidently, is real close to the confirmation of the "W" bottom. So theoretically, sometime next week, or the week after (I have predicted on Atrios' board a 9000 Dow by Thanksgiving, and I stick by that), we will get very close to passing 2 extremely important psychological values and have a very good chance of officially killing the long bear market.and maybe even igniting a December rally - but that's going to involve a discussion of "overbought" and "oversold" - so we won't go there yet :-)

Suffice to say, though, long live the head and shoulders!