Nasdaq Forecast 2006

Nasdaq Forecast 2006


The Trader's U E-Letter: Issue # 180

Wednesday, March 22, 2006

Nasdaq Forecast 2006: Actions To Take When the Market Gives Us Multiple Signals at the Same Time

by D.R. Barton, Jr., Chairman, Trader's U

There are some clear signals in this world that should cause us all to sit up and pay attention:

  • If you're walking in the woods of North America on a warm day and hear a sudden persistent rattle in the leaves, you had best be on guard against venomous snakes.
  • If you see lightning in the distant sky and hear the roar of thunder, you know that you should find an umbrella or roof to stand under.
  • If October is approaching and you're a Chicago Cubs baseball fan, you need to be prepared for eminent collapse and disappointment.

Yesterday, the Nasdaq market gave us a clear warning signal. Let's take a look what it was saying and what we should do in response, including actions to take from our Nasdaq forecast for 2006.

The Perfect Reversal on Nasdaq?

The chart for the Nasdaq Composite Index gave us a clear technical reversal signal yesterday. And it wasn't a run-of-the-mill reversal; this one has lots of supporting components. But before we discuss those, let's take a look at the plain chart. Please study it before scrolling down to the next one - I thought it best to have everyone take a hard look at it before I described the technical indicators that I see. So, see what makes sense to you about this chart.

The Nasdaq Composite Index: technical reverse signals

Okay, let's take a look at yesterday (Tuesday) in particular (that is the next-to-last bar on the right side of the chart). On that day, the market made a new high (just barely) and then spent the rest of the day rejecting the notion of climbing higher, and finished near its lows of the day. This type of bar is known as a key reversal bar (also known as a one-day reversal).

But a quick look at this bar shows a couple of other important factors:

  • This was an outside day on Nasdaq (meaning the high and low of the day were outside of the previous day's high and low);
  • The close was below the low of the previous day; and
  • The range of the bar was much greater then the normal daily range.

These factors all strengthen the signal. But we're not done yet! There's more going on than just the reversal day. Take a look at the following chart:

Nasdaq Forecast 2006: strong momentum divergence on the chart

As you can see from the chart, in addition to the reversal day, we have a really clear double top and a strong momentum divergence (as indicated by the MACD indicator at the bottom of the chart).

All of these things coming together may not forecast the apocalypse, but they should attract our attention.

There are fundamental issues that we could consider here:

  • Google and Apple Computer, the two darlings of the recent mini-bull market, are struggling and pulling back
  • Microsoft hurt the computer sector with its announcement of delays in its new operating system rollout.

But none of these were direct causes for yesterday's reversal, so only moderate weight can be given to the fundamental outlook.

One note from the other side of the coin: Some analysts would note that reversal days have called 100 of the last 10 tops… Meaning that reversal bars in isolation happen much more frequently than actual reversals. But with our other technical indications, our case for a reversal here is much stronger than an isolated bar.

Forecasting the Nasdaq in 2006 with a Sensible Action Plan

It's not time to panic (yet). Let's look at some reasonable actions traders and investors can take when the market gives clear signs of potential turning points:

  • If you are long technology stocks: Re-evaluate stop loss points and get ready to take action if the market continues to fall. Don't jump out just based on this analysis, but make sure you don't give back significant profits or take significant losses here.
  • If you are considering a long position: Now is not the time to enter! The sensible action plan would be to wait for the market to pull back and enter at a much better price, or enter only after Nasdaq and the markets make a new closing high (at least 10 points above Tuesday's high).
  • If you are thinking of going short the market: Check your time frame and profit targets. With a good signal like this one, a short position can be entered with a tight stop just above the market highs. But remember that the market has been in an extended uptrend and that taking partial profits at an intermediate target level is a useful idea.

Turning points are always tough to identify. But we can take sensible actions when the market gives us multiple signals at the same time, like we're seeing now.

Today's Trader's U Tips & Tricks

  • I found a good article on the "purist's view" of reversal bars. Visit this site for a brief look at key reversal bars.

Great trading,

D.R.

The Chart of the Week

Google (Nasdaq: GOOG) is at a key decision point. There is an unfilled gap from back in October that has been providing support for the past couple of weeks. If this support is broken (and that's a good probability play), look for a rapid 10% drop to test the $300 level.

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