Stocks & Indexes

By Colin Twiggs
November 4, 2006 2:30 p.m. AET (10:30 p.m. ET)

These extracts from my daily trading diary are for educational purposes and should not be interpreted as investment advice. Full terms and conditions can be found at Terms of Use. The next newsletter (an update on Gold, Crude Oil and the Dollar) will be on Tuesday.

The Big Picture

The Dow is trending upwards and a new high on the Dow Transportation Average would confirm that we are in a bull market.

Crude oil encountered support at $58/barrel while the dollar continues to weaken against the euro. Gold has done surprisingly well in the circumstances, rallying to $626 after a breakout above $600.

Probability of recession in the next four quarters increased to 41 per cent, according to the Wright model. A climb above 50% would be cause for concern.

USA: Dow, NASDAQ & SP500

The Dow Industrial Average displays a sequence of six red candles, signaling that sellers have wrested control despite reasonable buying support. Recovery above Wednesday's high would indicate that the retracement has ended, but a fall below Friday's low would signal a test of major support at 11700 (the former 10-year high).

Medium Term: Respect of support at 11650/11700 and the 100-day moving average would indicate that the target of 12700 (calculated as 11650 + {11650 - 10700}) is still achievable. Twiggs Money Flow (13-week) turned down sharply, signaling short-term distribution, but remains above zero.

Long Term: The Dow continues in a primary up-trend with support at 10700.

The Dow Jones Transportation Average pulled back to test support at 4600 but remains in a strong (intermediate) up-trend. Recovery above 4800 would signal a test of 5000, while a fall below 4600 and the 100-day moving average would warn of trend weakness. A break above the May high would signal reversal to a primary up-trend and confirm the existence of a bull market.

The Nasdaq Composite Index has so far respected resistance at its April high of 2370 and is now testing (intermediate) support at 2320. If support holds, that would be a bullish sign. Breakout above the April high would have a target of 2720 (calculated as 2370 + {2370 - 2020}). Failure of support at 2320, on the other hand, would warn of a secondary correction, especially if followed by a fall below the 100-day moving average. Twiggs Money Flow (21-day) signals short-term distribution, but continues to ride well above zero.

The S&P 500 reversed at the upper trend channel (drawn at 2 standard deviations around a linear regression line). Expect a test of the center line -- note how this coincides with support from the (May) previous high and the 100-day moving average.

Medium Term: The target for the latest rally is some way off at 1425 (calculated as 1325 + {1325 - 1225}). Reversal at the upper border of the linear regression channel, however, indicates that the present slow up-trend is likely to continue. The sharp reversal in Twiggs Money Flow (21-day) signals short-term distribution, but the indicator remains positive in the long term.

Long Term: The S&P 500 remains in a primary up-trend with support at 1220.

LSE: United Kingdom

The FTSE 100 displays long-legged doji candlesticks and increased volume at [T] and [Th], signaling strong opposition between buyers and sellers and warning of increased volatility. The lower border of the narrow consolidation coincides with the first line of primary support (from the April high) enhancing its significance. If support at 6100 holds, that will be a bull signal for the index, while failure would warn of another secondary correction.

Medium Term: Target for the breakout is 6700 (calculated as 6100 + {6100 - 5500}), but Twiggs Money Flow (21-day) exhibits a bearish divergence, warning of medium-term weakness.

Long Term: The primary up-trend continues, with support at 5500.

Nikkei: Japan

The Nikkei 225 gapped down sharply at the start of the week, but appears to have found support around 16400, indicated by 3 blue candles with longish tails. Respect of the lower border of the trend channel (drawn at 2 STD around a linear regression line) and the 100-day moving average would be a bullish sign.

Medium Term: Twiggs Money Flow (21-day) shows short-term accumulation, but the longer term is more uncertain.

Long Term: The index is in a primary up-trend with support at 14200.

ASX: Australia

The All Ordinaries displays strong volumes over the last week, signaling profit-taking at the previous high. Buyers prevailed, with short retracements respecting the new support level at 5320 (the previous highest close) and also 5350 (the previous intra-day high). Further retracement remains a possibility, but as long as this respects 5320 the index is in bullish territory.

Medium Term: Breakout above 5350 signals a test of the upper border of the trend channel (channel lines are drawn at 2 standard deviations around a linear regression line). The target is calculated as 5800 (5300 + {5300 - 4800}). Twiggs Money Flow (13-week) continues to hold above zero (signaling long-term accumulation) and the latest surge confirms that buyers dominate.

Long Term: The All Ordinaries continues in a primary up-trend with support at 4800.

Your vision will become clear only when you look into your heart.
Who looks outside, dreams. Who looks inside, awakens.

~ Carl Jung

Technical Analysis and Predictions

I believe that Technical Analysis should not be used to make predictions because we never know the outcome of a particular pattern or series of events with 100 per cent certainty. The best that we can hope to achieve is a probability of around 80 per cent for any particular outcome: something unexpected will occur at least one in five times.

My approach is to assign probabilities to each possible outcome. Assigning actual percentages would imply a degree of precision which, most of the time, is unachievable. Terms used are more general: "this is a strong signal"; "this is likely"; "expect this to follow"; "this is less likely to occur"; "this is unlikely"; and so on. Bear in mind that there are times, especially when the market is in equilibrium, when we may face several scenarios with fairly even probabilities.

Analysis is also separated into three time frames: short, medium and long-term. While one time frame may be clear, another could be uncertain. Obviously, we have the greatest chance of success when all three time frames are clear.

The market is a dynamic system. I often compare trading to a military operation, not because of its' oppositional nature, but because of the complexity, the continual uncertainty created by conflicting intelligence and the element of chance that can disrupt even the best made plans. Prepare thoroughly, but allow for the unexpected. The formula is simple: trade when probabilities are in your favor; apply proper risk (money) management; and you will succeed.

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