Stocks & Indexes

By Colin Twiggs
November 11, 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

There is profit-taking across a broad range of markets, perhaps induced by the US mid-term elections and the uncertainty resulting from the political shift. While there may be some weakness, this does not amount to a change in the primary trend which remains positive.

Crude oil is consolidating between $57 and $62/barrel. Whether this will lead to a reversal of the recent down-trend is too early to tell. The dollar continues to weaken, headed for a test of $1.30 against the euro, the high of the last 6 months. Gold continues in a strong up-trend after a bullish, short, mid-week retracement.

Probability of recession in the next four quarters remains at 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 encountered resistance at the October high of 12175, highlighted by higher volume on Thursday [Th]. However, Friday's doji candle signals uncertainty and we could see another attempt at a new high.

Medium Term: A fall below 12000 would signal a test of the first line of primary support at 11650/11700. A close above 12175, on the other hand, would indicate that the target of 12700 (calculated as 11650 + {11650 - 10700}) is still achievable. Divergence on Twiggs Money Flow (21-day) favors the bearish scenario.

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

The Dow Jones Transportation Average respected support at 4600 and appears ready to test resistance at 5000. A break above the May high would signal reversal to a primary up-trend and confirm the existence of a bull market.

Note how closely the index shadows Fedex. Divergences between the two have often preceded a trend reversal in the past.

The Nasdaq Composite Index broke above its April high of 2370, a positive sign for the broader equity market, and the Nasdaq 100 appears about to follow suit. Divergence on Twiggs Money Flow (21-day) warns of a retracement, possibly testing the 100-day moving average.

The S&P 500 is consolidating at the upper trend channel (drawn at 2 standard deviations around a linear regression line).

Medium Term: Divergence on Twiggs Money Flow (21-day) warns of a reversal to test the lower border of the channel.

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

LSE: United Kingdom

The FTSE 100 respected support at 6100, but the marginal new high warns of further weakness.

Medium Term: Twiggs Money Flow (21-day) exhibits a bearish triple divergence, warning of another test of support at 6100. Failure of this level would signal a secondary correction -- more serious because we are only marginally above the April high and a correction would be likely to test primary support at 5500. If, on the other hand, support at 6100 holds, the target of 6700 (calculated as 6100 + {6100 - 5500}) is still achievable.

Long Term: The primary up-trend continues.

Nikkei: Japan

The Nikkei 225 penetrated the lower border of the trend channel (drawn at 2 STD around a linear regression line) and is headed for the 100-day moving average. A clear break below these two lines would be a bear signal.

Medium Term: Twiggs Money Flow (21-day) is also trending lower, a bearish sign. A retracement that respects the moving average (from below) would signal a test of primary support at 14200 -- more bearish because of the failure to reach 17500 and make a new high.

Long Term: The index remains in a primary up-trend.

ASX: Australia

The All Ordinaries retraced for two days before consolidating with an inside day on Friday, strong volume indicating buying support. A rise above Thursday's high would signal the start of another (expected) short-term rally, while a fall below Thursday's low would warn of another short-term down-swing to test the new support level of 5320.

Medium Term: Expect a test of the upper border of the trend channel (channel lines are drawn at 2 standard deviations around a linear regression line). Twiggs Money Flow (21-day) is above zero and trending upwards, signaling long-term accumulation.

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

It is fatal to enter any war without the will to win it.

~ General Douglas MacArthur

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.

For further background, please read About The Trading Diary.