PRICE CHANNELS ARE BEARISH FOR BONDS AND THE DOLLAR, BUT ARE BULLISH FOR PRECIOUS METALS -- FOR A BULL MARKET IN STOCKS TO OCCUR, THE 40-WEEK MOVING AVERAGE NEEDS TO TURN UP -- THE 40-WEEK PRICE CHANNEL IS TOO HIGH FOR THAT TO HAPPEN IN THE NEAR FUTURE

50-DAY PRICE CHANNEL IS BEARISH FOR BONDS ... On Tuesday, I wrote about using 20-day price channels (or four weeks) for short-term trading purposes. I also suggested that price channels could be used in any market. Take bonds for example. Chart 1 applies 20-day channels to the 20- Year Treasury Bond ETF (TLT) and shows an initial sell short signal taking place in mid-January (blue circle). That bear signal is still in effect. To reverse that sell signal, I require that the TLT close at or higher than the upper price channel. That hasn't happened. [Prices touched the upper band intra-day in mid-January but didn't close there (blue arrow). Requiring a close at that level is a refinement that I've added over the years]. One of the reasons that bond prices are falling in the U.S. is the collapse in the U.S. Dollar which holds inflationary potential. Bonds don't like inflation.

Chart 1

VARYING PRICE CHANNEL LENGTH ... You can shorten or lengthen the price channel to make it more or less sensitive. One way to shorten the 20-day channel is to cut it in half (to 10-days). That makes for more sensitive (quicker) signals. Chart 2 applies a 10-day (2 week) channel to the Power Shares US Dollar Index Bullish Fund (UUP). An initial short signal was given in mid-March (red circle). That signal was briefly reversed in mid-April (green circle) before turning back down again. The most recent sell signal has been in effect since late April (second red circle). At present, the UUP would have to close at 24.95 or higher to reverse that short position. One way to lengthen the 20-day channel is to double it (Chart 3) to a 40-day (eight week) channel. That slower version gave a sell signal in mid-March (red circle) which is still in effect. A close above the middle line (25.03) would justify some dollar short-covering. A close at 26.00 or higher is needed to issue a buy signal.

Chart 2

Chart 3

GOLD AND AND SILVER ARE ON BUY SIGNALS ... In last Friday's "What To Do" paragraph, I wrote that "Some money has begun moving back into precious metals. That may be one of the best places to park some funds during the current market correction and as a hedge against future inflation". I also showed that silver prices were rising faster than gold. Both are on price channel buy signals. Chart 4 shows the streetTRACKS Gold Trust (GLD) hitting its 20-day day price channel in early May which triggered a buy signal (green circle). Silver iShares (SLV) also gave a buy signal in early May by hitting a 20-day high (circle). Chart 5 also shows SLV breaking through its February high. Stocks tied to gold and silver have achieved bullish breakouts as well.

Chart 4

Chart 5

LENGTHEN CHANNEL DURING TRADING RANGE ... I mentioned on Tuesday that price channels don't work that well during a trading range. Chart 6 shows why when the 20-day channel is applied to the Market Vectors Gold Miners ETF (GDX). Four bad short-term signals (whipsaws) took place between mid-February and mid-April when prices fluctuated between the upper and lower price channels (see circles). The fifth signal (a buy) in early May worked, but only after four previous losers. That creates a problem for a system traders. Here's how I learned to deal with that. After two successive bad signals (a buy in February and a sell in March), I assume the existence of a trading range and immediately switch to a longer 40-day channel. That helps prevent short-term whipsaws in a sideways market. Chart 7 shows that the 40-day channel eliminated the subsequent sell signal in mid-April. The price paid for that benefit was a slightly later entry on the buy side in mid-May. Like any other indicator, price channels have their strengths and weaknesses. If used properly, however, they help keep you trading in the right direction of any market. Another benefit of price channels is that they tell us something about the direction of various moving averages.

Chart 6

Chart 7

MOVING AVERAGE DIRECTION IS IMPORTANT... A lot of attention is being paid to the market's test of its 200-day (40-week) moving average. As important as that is, the "direction" of the moving line is just as important. To demonstate that, Chart 8 applies the 40-week moving average (red line) to the S&P 500 over the past decade. During the 2000-2002 bear market, for example, the S&P 500 rose briefly above its falling 40-week average (red arrow) before turning back down. It wasn't until the average itself turned up in the spring of 2003 that a bull market began. From 2003 to 2007, the S&P fell below its rising 40-week line four times (green arrows) before resuming its uptrend. It wasn't until the average turned down in early 2008 that a bear market began. That tells us that the direction of the 40-week average is an important determinant of the market's main trend. Chart 9 shows the S&P 500 testing a falling 40-week average (red line). For a major uptrend to exist, two things have to happen. First, the S&P 500 needs a Friday close over the red line. The second is that the red line itself has to turn up. That's where price channels can help.

Chart 8

Chart 9

40-WEEK PRICE CHANNEL ... When a 40-week moving average is calculated at the end of each week, two things happen. A new closing price (Friday's) is added and and an old number (40 weeks back) is dropped. In order for the 40-week average to rise, the new closing number must be higher than the old price 40 weeks ago. A 40-week price channel tells us how close (or far) the S&P must rise for that to happen as shown in Chart 10. Generally speaking, the 40-week average will start to drop (red arrow) when the S&P 500 hits a 40-week low (black circle). That's what happened at the start of 2008 when the S&P hit the lower 40-week channel and a bear market ensued. For the 40-week line to turn up at present, the S&P 500 must reach its upper 40-week channel line which currently sits at 1313 (last summer's high). That doesn't seem likely in the near future. Over the next few months, however, the upper channel will start to drop sharply as the higher numbers from last summer are eliminated from the moving average. Until that happens, the 40-week moving average will continue dropping. And a new bull market is unlikely as long as that is the case.

Chart 10