USE 45 DEGREE TRENDLINES TO FILTER P&F SIGNALS -- USING FIVE-BOX REVERSALS AS ADDITIONAL FILTER -- THE S&P 500 CONTINUES FIFTH WAVE ADVANCE WITH NO SIGN OF TOP -- NEXT POTENTIAL TARGET IS 1250 TO 1300 ZONE
USING TRENDLINES AS FILTERS... I received so much feedback on my Tuesday point & figure message that I'd like to use this article to answer some of the questions and elaborate on the technique even further. My Tuesday message showed two versions of the Consumer Discretionary SPDR (using two box sizes) as shown in Charts 1 and 2. One reader asked about the buy signals given on both charts in January 2009 and how they could have been avoided. Actually, the initial buy signals were given in November 2008 at slightly lower levels. Even so, those premature buy signals were quickly reversed with new sell signals in February (which were then followed by good buy signals during April when the market finally turned up). One way that the January 2009 buy signal might have been avoided is by watching the red down trendline. Down trendlines on p&f charts are drawn at 45 degree angless from a previous peak. They're far from perfect, but are helpful in filtering buy and sell signals. Generally, p&f buy signals are suspect while the price is below the red resistance line. That was the case at the start of 2009. In fact, the one box version in Chart 1 failed right at the resistance line. By contrast, the April buy signal on Chart 1 occurred after that resistance line was broken. Chart 2 also shows the red line broken during April 2009. I'm not suggesting that all bad buy and sell signals can be avoided, but 45 degree trendlines can help us to eliminate some of them.
Chart 1
WHAT DO THE RED NUMBERS AND LETTERS MEAN? ... Another reader asked what the red numbers and letters mean. The red numbers from one to nine mark the start of a new month. That's how I can tell that the spring 2009 buy signal took place during April (red letter 4) on both charts. Chart 2 shows the latest upside breakout taking place this February (red letter 2). The red letters A,B,C mark the last three months of the year (October, November, December). Chart 2 shows an upside breakout at 29 during November (letter B). The letters and numbers are there to give time reference and have no forecasting value.
Chart 2
HOW ABOUT A FIVE-BOX REVERSAL ... Still another reader asked about using a "five-box reversal" instead of the traditional "three-box reversal". That brings us to another way to vary the sensitivity of a p&f chart. The most common way, of course, is the vary the size of the box. A second and less common way is the vary the reversal criteria. Charts 3 and 4 show the difference using the same Consumer Discretionary SPDR (with a 50-box size). Chart 3 uses the traditional three-box reversal, while Chart 4 uses a less-sensitive five-box reversal. The five-box reversal version in Chart 4 gave fewer signals (and eliminated a lot of bad ones). The down side is that the good signals came a bit later. For example, Chart 4 missed the bad buy signals given during the fourth quarter of 2008 which is good. But its April 2009 buy signal came at a higher level that the three-box reversal chart. The five-box reversal did not give any sell signals over the last year, while the three-box chart did last July. One bad side of the five-box version is that hasn't given any new buy signals since then. One way to get around that is to use both versions. Use the five-box reversal for major signals, and the three-box chart for shorter-term purposes. It also looks like the red and blue resistance lines don't work as effectively on the five-box reversal charts. As is the case with other technical tools, p&f charts offer a tradeoff. Less sensitive charts (bigger box sizes or a five-box reveral) give better signals, but they tend to come later than on a more sensitive chart. That's the price paid for less "noise" and fewer "whipsaws". There are lots of other ways to refine point & figure charts, some of which I'll touch on in future messages. If you wish to learn more on the subject in the meantime, consult the Stockcharts Chart School.
Chart 3
Chart 4
SUPPORT AND RESISTANCE LEVELS FOR THE S&P 500... The strong market rally that started during February continues uninterrupted. Virtually all U.S. stock indexes are now in new recovery highs (the NYSE Composite is very close to doing so). The next three charts are intended to show where potential support and resistance levels may be located for the S&P 500. The daily bars in Chart 5 show that initial chart support exists near the January high around the 1150 level. [Broken resistance levels usually become new support]. The hourly bars in Chart 6 shows last week's mild pullback finding initial support at 1152. The tougher part is finding the next potential resistance level. The weekly bars in Chart 7 show a potential resistance zone ranging from 1250 up to 1300. That overhead price range also approximates a 62-66% retracement of the entire bear market. From an Elliott Wave perspective, the stock market appears to be in the fifth wave of a five-wave advance [three upwaves (1,3,5) with two intervening corrections (2,4)]. The bad news is that the fifth wave is usually the final part of the bull market and is usually followed by downside corrections of some magnitude. The good news is that there's no sign of that fifth wave having ended.
Chart 5
Chart 6
Chart 7
