Market Shadows Newsletter

Welcome to the Market Shadows Newsletter Website! Here, you will find our full length technical analyses articles regarding the stock market, and our educational sections, which we commonly refer and link to in the newsletter. You can read the background information you may enjoy to fully explore our latest adventures in the Market Shadows.

Read this week’s full newsletter here: MarketShadows July 8 2012.

Lead Writers, Newsletter Makers and Regular Contributors of Fine Works:

Pharmboy

Jean Luc

Springheel Jack

Scott Brown of Sabrient

Lee Adler of The Wall Street Examiner

Allan Harris of Allan Trends

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Another Look at AAPL

Back on the 13th September, before AAPL peaked, I started talking about the bearish looking setup on AAPL, and I’ve been revisiting that regularly since. It’s well worth keeping an eye on as AAPL is now so large that it is a key market mover by itself. You can see that post here.

I was looking at it last week and saying that the first key support was the 200 DMA, which was touched on Wednesday, and then broken on Friday. On a break below there is possible declining channel support at Friday’s low but the main support levels are the possible head and shoulders (H&S) pattern necklines in the 567 and 520 area. Here’s that setup on the AAPL daily chart:

The main chart that I posted on 13th September however was the monthly (log scale) chart showing the main rising channel on AAPL since 2003. On that chart main channel support is at slightly over 400. Obviously that would be an ambitious target, but it’s worth noting that of the five previous instances where there has been a retracement after a monthly RSI negative divergence like this, only the one in 2011 was smaller than 42%. A fall from 705 to 400 would be slightly over 43%, so the drop would be within the normal historical range on AAPL.

I would be most surprised to see AAPL break the long term rising channel, and for that reason on my bear scenario I have been favoring a strong bounce from the 567 area, to form the right shoulder on an H&S that would target the 430 area, slightly above that long term support. If we don’t see a bounce from Friday’s low within the possible declining channel that I’ve marked on the first chart, then that is the most likely bounce level, with strong support in the 520 area at the next possible H&S neckline if that breaks. Here’s the long term rising channel on that monthly chart:

As with AAPL SPX is also near a very key support level, and after the very strong reversal from the 50 DMA and the middle daily bollinger band on Friday morning we might well see  first a move to test the lower bollinger band in the 1398 area, but the main target would be rising support from the October low in the 1385-90 area. If that is tested and there is a reversal there, then there will be a confirmed rising wedge from the October 2011 low. If we see that then this strong bearish pattern should limit any further upside over the next few months to the 1490-1500 area at the most, and on a break below it I’d be wondering seriously about a test of the 2012 lows:

The chances are a strong QE rally here are fading fast. No trade suggestions today as I want to see how next week plays out to establish a more definite trend.

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Speculative Buys

The big question in my mind here is whether there will now be a QE Infinity (QEX) rally. Earnings are poor, the economy is struggling, and the US approaches a close election with a possible major fiscal shock to follow at the end of the year if there is not a bipartisan agreement to either agree a long term plan to reduce the deficit (unlikely), or at least put back the decision and delay the fiscal cliff well into 2013 (more likely). Meanwhile all major US indices have now broken their support trendlines from the June low and while a bounce is likely soon, it may not last.

Should there be a QEX bounce? Obviously not. Printing money to boost the equities and the economy is neither a vote of confidence in the strength of that economy (or equities) by the Fed, nor a strategy that has led to sustained economic health in any economy historically as far as I am aware. Ben Bernanke’s strong personal record of failure as a vocal  supporter of Greenspan’s disastrously bubble-inducing policy of intervening early in any downtrend and never intervening in an uptrend is equally not inspiring. However printing money does lead to a flight away from cash into assets more likely to hold their value and past periods of QE have triggered strong equity advances. We shall see whether this round of QE can produce a similar result.

What we do know is that major highs on US markets in the past have been signaled by strong topping patterns and we’re not seeing that here yet. There are also two strong support levels not far below on SPX, with rising support from the October low in the 1380 area and the 200 daily moving average at 1377. As long as those levels hold the assumption has to be that SPX is in an uptrend. If they break then that will no longer be the case, particularly as the uptrend on SPX since the October 2011 low has so far taken the form of a bearish rising wedge, so a break below support would look very ominous:

Meanwhile however, the Fed has a strong track record of producing outsize returns on equities against an unpromising economic backdrop, and it’s too soon to think that has now changed. On that basis I have a couple of speculative buys to suggest this week, both on  Dow 30 component companies.

The first is of those is Dupont (DD). DD peaked in 2011 and declining resistance from that high is main resistance now, and the level of the high a few weeks ago. From that high DD formed a head and shoulders pattern within a broadening formation which has broken down hard into strong support at the intersection of both the support trendline for that broadening formation, and rising support from the 2011 low.

This support on DD may well hold and offers an excellent long entry with considerable upside and minimal downside. My entry level would be 45 and my stop at 44, as 44 would be a clear support break that would likely be followed through in the next few months and might be followed through immediately. On the upside declining resistance from the 2011 high is in the 52 area and broadening formation resistance slightly over 53:

The second recommend is longer term on Amazon (AMZN). AMZN has broken down from a rising wedge from the December 2011 low and I’m expecting more downside. The obvious target is the strong rising support trendline from the late 2008 low, currently slightly over 200. There is a decent support level around 208 that fits with that trendline and I’d be looking for a bounce from that area. AMZN is therefore a buy at 210 with a stop at 200, by which time main support would have broken. On the upside a conservative target would be 230, but I’d be expecting to hold until I saw clear signs of reversal:

Meanwhile equities are now looking oversold short term and I’m expecting at least a bounce soon. The AAPL decline I was predicting last week has almost reached my entry level at 585 and the SLV decline I was predicting the week before reached my entry level at 30.7 last Wednesday.

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Fallen Heroes

Equities saw a strong bounce last week that was almost entirely wiped out on Friday. If strong support in the 1425 SPX area is lost next week then I would expect a further move downwards into the strong support in the 1385-1400 area that I was looking at last week. We are also seeing the retracement on gold and silver that I was talking about last week and I’m expecting more there as well.

This week I’d like to look first at USD, which has gone from being very technically strong before the run up into the QE Infinity (QEX) announcement to being very technically weak now. That was only to be expected as quantitative easing is in essence devaluation, and USD moved down strongly during both QE1 and QE2. USD broke strongly below rising support from the 2011 lows and the 200 DMA on the QEX announcement and made a low precisely at the May 2012 low and possible head and shoulders pattern (H&S) neckline there. Since then there has been a bounce into declining resistance from the high, tested twice so far and taking the form of a bear flag.

This setup may yet not play out, but on a break below the H&S neckline with any confidence the pattern target is at 73.1, effectively a test of the 2011 lows, a move that would most likely play out into Spring 2013. If that is going to happen then it would most likely reverse downwards now. If that isn’t going to happen then that strong declining resistance trendline from the high will break, though USD would need to recover over the 200 DMA at 80.67 and hold above it for the setup to start to look bullish again. If it does recover back over the 200 DMA, then a new bullish rising channel will have been established:

I have mentioned the bearish setup on AAPL a few times and AAPL is now getting to the stage where it is starting to look interesting as a long again. On the daily chart the 100 DMA broke at the second test on Friday, the H&S target is in the 590-600 area, and the main target is a test of the 200 DMA in the 580 area. The best entry would be close to that test of the 200 DMA so an entry in the 583-5 area would be a decent one. On the bull scenario there would be a strong reversal back up there, and in percentage terms the retracement from the high would be a bit larger than the last retracement in April/May 2012.

It’s worth mentioning though that on the long term AAPL chart there are five previous retracements in the last 20 years on strongly negative weekly RSI divergence like this retracement. While the last retracement was about 15% the next smallest retracement was 42% in 2006. You can see that long term AAPL chart here. AAPL may well therefore fall further, and if it does, then there are two possible H&S necklines below in the 567 and 520 areas. I would favor the higher 567 area neckline as it would fit with a possible drop into long term rising channel support on the LOG scale chart around 400. On a bounce from the 567 area I would be looking to exit in the 600-620 range, and on a bounce from the 520 area I would be looking to exit in the 600-40 range. Those targets are derived from the heights of the left shoulder bounces on these still currently theoretical H&S patterns:

As long as AAPL holds the 200 DMA area though, it would be a straight long play from major support there on a stock with a great market position and an unusually low (nowadays for a tech stock) historic P/E ratio in the 14 area.

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Risk Off Again

Last week I was talking about most likely seeing more consolidation on SPX into the 1430-5 area, and the possible double-top on SPX  that would trigger a double-top target in the 1380.5 area on a break below both SPX rising channel support and the late September low at 1430.35.  There was a perfect touch and reversal on Wednesday at channel support but on Friday SPX broke below the rising channel and closed at 1428.59, slightly below the late September low. Obviously this looks bearish and it seems likely that the expected QE Infinity (QEX) bull move into Xmas that I was expecting from Wednesday’s low is either going to be delayed or possibly even cancelled altogether.

SPX is obviously oversold here and we could see a bounce, but looking at the SPY (SPX ETF) daily chart SPY is hugging the lower bollinger  band as it moves down. This is only the second time since the June low that the lower bollinger band has been tested at all, and only the third time in the last twelve months that SPY has started to ride the lower bollinger band down in this way. It’s worth noting that from the equivalent stage on the last two occasions this happened in November 2011 and May 2012, SPY fell a further 4 points (approx 40 SPX points) over the next few trading sessions before reversing back up. That would take SPY to a likely low next Wednesday or Thursday near the 138.6 double-top target and SPY would be a good speculative buy there if we see that happen for a likely bounce afterwards:

How credible is a plunge like that here? Fairly credible actually. Supporting it is a toxic looking head and shoulder top on the mighty and market-moving AAPL that has broken down, the bearish setup on CCI that I posted last weekend, the possible double-top within a triangle on the Australian Dollar (AUDUSD) that I also posted last weekend, and traditional weakness in October on precious metals, which have a strong positive correlation with equities and are poised on the brink of a likely short term move down here.

Longer term there is a lovely bullish setup on gold that I have mentioned before here, and which indicates to new highs over the next few months, so any retracement here will look like a good buying opportunity for both gold and silver. There’s no particular short term reversal pattern setup on gold here yet, other than the failure so far at strong resistance in the 1800 that I suggested was likely several weeks ago, but on silver there is a very promising looking double-top setup that just needs a break below pattern support to trigger the retracement.

I’ve charted that on the silver ETF SLV this week and I’ve done that on the 4 year chart to show the very strong trendline support from the late 2008 low that SLV bounced at in June. It also shows the possible double-bottom setup on SLV that will trigger a double-bottom target in the 47.5 area on a break above 36.44, and I think that break above 36.44 is likely in the next few months given the bullish setup on gold.

Short term I’m looking for a break below 32.4 to trigger a short term double-top target in the 30.7 area, with decent support not far below at the 200 day moving average in the 30 area. If this plays out as I expect it to then I would be buying SLV at 30.7 with a target at 47.5 that I may well move upwards when we are reaching it. My stop will be under main trendline support in the 26.7 area though more conservative stops could be placed either under the 200 DMA at 29.7 or under the 100 DMA at 28.7. A risk vs reward of 4 against a target gain of 16.8 doesn’t seem unreasonable however and main uptrend support on silver is at that trendline:

Some of my longer term readers will read this article and wonder why I have started charting ETFs here rather than indices and also suggesting trade entry and exit levels, which is something that I have rarely done in the past. The answer is that this newsletter is aimed at an audience who have not necessarily read much Technical Analysis and who are very interested in practical trade suggestions. Precious metals have the best looking setup of any index, commodity or currency pair over the next few months, so I’m leading with silver.

If we do see a meltdown on SPY to 138.6 in the next few days that would also be an attractive long entry for at least a bounce. One other thing to note about this immediately very bearish looking bollinger band setup is that SPY made a low both times a few days later that was then followed by a bull run lasting over three months and rising over 15% from that low. It’s still far to soon to dismiss the possibility of the usual bull run that follows a QE announcement by the Fed.

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Commodities and QE Infinity

There’s been some debate about what to call this latest bout of QE by the Fed. As it has no defined term QE Infinity is a better name than QE3, but what is the short version of that? I’m going to go with QEX for the moment I think.

I’m working on the assumption that QEX will be able to boost equity prices over the next few months, and short term after Friday’s sharp reversal at the test of the 2012 highs, I’m expecting to see some more consolidation that would ideally test rising channel support on SPX in the 1430-5 area before starting the main move up into the end of the year.

It is worth mentioning however that there is now a possible double-top in place on SPX that would trigger a target in the 1380-5 area on a break below the late September low, so I’d be watching that rising channel support slightly above there carefully for a possible break below:

What about commodities however? With the slowdown in global demand and in China particularly I’m much more doubtful about the prospects for commodities during the next few months and the setup on the CCI broad commodities index certainly looks bearish short term, having just peaked at a perfect retest of the broken rising support trendline from the 2008 low:

There are three obvious paths from here on CCI. The first path is failure here and continuation of the bear market on commodities from the 2011 high. The second path is a decline here to form the right shoulder on an inverse head and shoulders pattern (IHS) that might then break up later to signal a retest of the 2011 high. The third path is a break over 605.48 to a higher high to signal the end of the downtrend.

Of these three paths one of the first two seem more likely here, and those both start with an immediate decline. The path and duration of that decline is likely to be mirrored in AUDUSD, with the Australian currency very strongly linked to hard commodity prices.

AUDUSD is testing the valley low and trigger level on a short term double top within what is likely to be a symmetrical triangle, though the lower triangle trendline needs a third touch for confirmation. On a break below support at the 2010 high in the 101.75 area the pattern target and triangle support would be in the 97 to 97.25 area:

What will happen to commodity prices over the next year? It seems doubtful that QEX in the US is going to push hard commodity prices up in the face of sharply declining global demand for them. On the other hand the effect during QE1 and QE2 was very powerful We’ll have to wait and see, but if CCI reaches the ideal right shoulder low in the 545 area and AUDUSD reaches triangle support in the 97 area, those would certainly be the ideal long entries for a possible retest of the 2011 highs on both.

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QE Winners and Losers

I’ve been holding off talking about the likely winners in QE3 until the likely initial retracement on equities had played out, and that looks close now so I’d like to talk this week about the effect that QE has had on various investment classes in the past, in the expectation that we may see similar moves this time.

The chart below shows the losers from QE1 and QE2 charted against the SPX chart. Equities were a big winner both times so SPX is just on this chart for reference. The losers were the US Dollar (USD) as the chart background and bonds, represented on this chart by the $USD index and TLT respectively.

I’ll be looking more at QE2 as a model as QE3 looks more like it so far and was also implemented in a bull market period where equities had already come a long way up from the 2009 lows. In QE2 USD was already declining sharply into the QE2 announcement and was bottoming out as QE2 ended. Bonds were also already declining into the announcement but bottomed out halfway through QE2, starting a large bull run into a high in July 2012:

The next chart shows the winners from QE1 and QE2 charted on the SPX chart. The big winners were equities and gold. These were already rising strongly into the QE2 announcement, as like QE3 it was heavily trailed into that announcement. Both retraced somewhat after the announcement with the longer retracement on gold.

Oil and copper both did well in QE2, though less well than equities and gold. Both retraced slightly after the announcement and then rose strongly into about halfway through QE2 and topped out there. There were big declines after the end of QE3 on equities, copper and oil, with gold continuing to rise after the end to make a major top two months after QE2 ended:

What are my picks for QE3? Equities and gold again, with the best bullish setup here on gold.  We may also see gains on copper and oil, but both are tied more strongly to the real economy, and that is in significant trouble here, so while they may hold up at least, gains are likely to be limited.

I’m expecting more downside on USD and bonds, but we may see both rally further before the declines really get going. Continuing trouble in the Eurozone is supportive of USD at the moment and there is a large 68% bullish falling wedge on TLT that is warning of a possible retest of the 2012 highs there in the next few weeks.

My retracement target on SPX has not yet been hit, and that ideal target would be at the support trendline of the perfect rising channel from the June low and the 50 day moving average. Both will be in the 1415 area early next week:

What effect will it have that QE3 is open ended rather than having a set end date like QE1 and QE2? It’s too early to say, though the Fed scores at least some points for noticing that the ends of both were the triggers for large declines on equities after they ended. We’ll see whether they can avoid the same happening in 2013.

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Dow Theory Divergences

I’ll be doing a post next weekend on the effect that QE has had in the past on equities (up), bonds (down) and commodities (up). As I’m expecting equities to retrace over the next week though I thought I would talk this week about the current Dow Theory divergences and why these are worth keeping an eye on.

Dow Theory is one of the oldest of the technical analysis schools, and was derived after his death in 1902 from 255 editorials written on the Wall Street Journal by Charles Dow. Dow Theory watches divergences between two Dow indices which are the main Dow Industrials index (Dow) and the Dow Transports (Tran) index. The theory in essence regards the Dow as representative of equities and the Tran as representative of the real economy. Divergences between the two are signals that change is in the air and that a major reversal may be coming. These divergences can persist for a while though before that happens.

On the chart below there are two divergences, long and short term. The longer term divergence is that the Tran made new all time highs in 2011 that have not yet been confirmed by the Dow also making a new all time high. Dow is within striking distance of making an all time high however, and if we see the usual QE-fueled bull run happen, then that divergence may well disappear soon.

The shorter term divergence is that Tran has seriously underperformed Dow since that 2011 high, and at the close today was 9% below the 2012 high, and almost 13% below the 2011 high. Tran has failed to confirm the new high on Dow over the April 2012 high. The divergence has grown very wide this week as Dow has traded sideways and Tran has been hammered by downgrades of major Tran component companies due to weak sales and profits there:

In the short term Tran broke down from a large symmetrical triangle and closed below a three month trading range on Friday. Having already given back 80% of the gains from the June lows, a test of those June lows on Tran now looks close and likely. With Dow at new highs for 2012 and up almost 13% since the June low the contrast between the two is stark. This reflects the divergence between the real economy, weak and very possibly going into recession, and equities, actively being supported by a Fed determined to increase asset prices in the hope that will also ultimately boost the economy. Here is the very bearish looking Tran daily chart showing Friday’s breakdown:

Does that divergence between equities and the economy still matter in this environment? I don’t believe there has been a period before in the history of Dow Theory where the government / Fed was nakedly supporting equities in the teeth of a deteriorating economy, and it may be that this current divergence is signalling an equities high that the Fed can and will prevent, or at least delay, from happening. That equities high in the absence of QE3 may well have been signaled by the huge bearish topping patterns across many indices and commodities that have formed over the last two years but have been breaking up over the last month in the face of QE3.

From a technical standpoint, ignoring the very bearish look of the Dow Theory charts, at least some more upside on equities during QE3 looks likely. As QE hasn’t had much noticeable effect on the real economy in the past, that will stretch the divergence between the real economy and equities further while equity buyers suspend their disbelief in the face of QE3, and we will see how far that can go before the markets revert to the mean.

From a fundamental standpoint, sustained and increasing divergences between bullish equities and a weaker real economy have a name, and that name is speculative bubble. These aren’t usually deliberately created by the Fed, though the last two in 1996-2000 and 2003-7 were certainly helped along by overly loose Fed policies. Bubbles tend to take markets to high valuations and burst with very steep declines, as we saw in 2000-2 and 2007-9. The tops of the last two bubbles were very well signaled with topping patterns on SPX and hopefully this will be the case here too. When those topping patterns appear it will be time to exit swiftly.

Short term more retracement looks likely but that was only to be expected in any case. At the start of QE2 there was a run up on equities in anticipation of the heavily trailed QE2 announcement, a spike into overbought RSI territory and over the daily bollinger bands on the QE2 announcement, and then a deep retracement over the next three weeks before the main QE2 bull run up got started. So far SPX is following the same script as you can see from the chart below with the QE2 period highlighted in blue:

The Tran chart is a warning here that the retracement over the next week or two may go further than expected. Many analysts are expecting the 1435-40 area on SPX to hold, and there are major support levels underneath at 1415-20 and 1395-1400. The post QE2 retracement on SPX retraced all the way to test the lower bollinger band on the SPX daily chart. That was at 1380 at the close on Friday and I’d expect that to be in the 1395-1400 area in a week or so. That may well be the target for this retracement as well.

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