We wish all our readers peace and goodwill over the Christmas season
and prosperity in the year ahead.

Bearish Divergences Continue

By Colin Twiggs
December 16, 2006 12.00 a.m. ET (4:00 p.m. AET)

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.
This will be the last newsletter for the year. The service will resume on January 9th.

The Big Picture

The Dow and SP500 have recovered, but continue to show bearish divergences on Twiggs Money Flow, warning of a seconadry correction/consolidation ahead.

January light crude, is rallied to $63.43/barrel, but the base above $55 is not yet solidly established (it could just be a bear market rally). The euro is headed for a test of $1.30 against the dollar, but as long as it respects this level the up-trend against the dollar is intact. Gold retreated to $614.60, but as long as it holds near $615.00 the secondary rally is also intact.

Probability of recession in the next four quarters remains at 44 per cent according to the Wright model. A rise above 50% would be cause for concern.

USA: Dow, Nasdaq and S&P500

The Dow Industrial Average broke through resistance at 12350 after a bullish narrow consolidation above 12250. Triple-witching hour on Friday accounts for the heavy volume, but the weak close at [F] warns of distribution; do not discount a retracement before the index rises above Fiday's high.

dow jones industrial average short-term

Medium Term: The recent false break below the trend channel of the last 5 months (drawn at 2 standard deviations around a linear regression line) has reversed and I have redrawn the channel to include the recent break. The index now appears headed for a test of the upper border of the trend channel. The bearish divergence on Twiggs Money Flow (21-day) warns that the index may be nearing a secondary correction. A close below 12100 would confirm.

Long Term: The Dow continues in a primary up-trend, with initial support at 11600/11650 and primary support at 10700.

dow jones industrial average long-term

The Dow Jones Transportation Average continues its retracement to test intermediate support at 4600. Failure of support would indicate a test of the primary support level at 4150. Respect of 4600, on the other hand, would mean another test of resistance at 5000. Breakout above 5000 would confirm the existence of a bull market.

dow jones transport average

The Nasdaq Composite formed a bullish ascending triangle, but so far has respected resistance at the upper border of 2470. A short retracement, or consolidation, above 2420 would signal that an upward breakout is likely. The break below the lower border of the secondary trend channel indicates that the up-swing is losing momentum, but more serious is the bearish divergence on Twiggs Money Flow, warning of a secondary correction.

The index remains in a primary up-trend with initial support at 2350/2370 and primary support at 2000.

nasdaq composite

The S&P 500 secondary rally continues, but Friday's weak close indicates increased resistance.

sp 500

Medium Term: The rally has broken out above the long-term trend channel, warning that the long-term trend is accelerating. A change in the long-term trend will only be confirmed if the next secondary correction ends well clear of the lower border of the trend channel (e.g. near the center line). Bearish divergence on Twiggs Money Flow (21-day), however, warns of strong distribution and an approaching secondary correction (or consolidation). Watch for a break below the 5-month secondary trend channel which would warn of a retracement.

Long Term: The S&P 500 continues in a primary up-trend, with initial support at 1320 and primary support at 1220.

LSE: United Kingdom

The FTSE 100 is testing resistance at 6260. A short retracement or narrow consolidation below this level would be a bullish sign, indicating that a breakout is imminent.

Medium Term: The target for a breakout would be 6500 (6260 + [6260 - 6020]). Failure to break through resistance would signal another test of support at 6000. Twiggs Money Flow (21-day) is not yet bullish, but has recovered most of its recent losses.

Long Term: The primary up-trend continues, with initial support at 6000/6100 and primary support at 5500.

ftse 100

Nikkei: Japan

The Nikkei 225 recovered strongly, with accumulation signaled by Twiggs Money Flow (21-day) consolidating above the zero line at [B+].

Medium Term: The trend channel may have to be re-drawn after the recent downward breakout, so a test of the upper trend channel is fairly ambitious, but expect a test of the April 2006 high of 17500. Reversal below 16800, on the other hand, would signal trend weakness.

Long Term: The index continues in a primary up-trend with support at 14200 and resistance at 17500.

nikkei 225

ASX: Australia

After considerable resistance on Tuesday [T] and Wednesday the All Ordinaries broke out with a strong blue candle on Thursday, completing the ascending triangle. Friday [F] signals further selling, with a narrow range and large volume warning of strong opposition to the up-swing. This is an evening star candlestick pattern, warning us to expect a retracement if there is a close below mid-way on Thursday's blue candle. Otherwise a consolidation is the stronger possibility, while a new high would signal continuation of the up-swing.

all ords short-term

Medium Term: Reversal below 5460/5450 would indicate trend weakness, but trend continuation is more likely. The index appears headed for a test of the upper border of the trend channel (channel lines drawn at 2 standard deviations around a linear regression line), currently at 5770. Bearish divergence on Twiggs Money Flow (21-day) warns that the index may be nearing a (secondary) reversal or large consolidation.

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

all ords long-term

I learned this, at least, by my experiment;
that if one advances confidently in the direction of his dreams,
and endeavors to live the life which he has imagined,
he will meet with a success unexpected in common hours.

~ Henry David Thoreau: Walden

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.