Technical Reason Why Stocks Will Continue to Rise for Now

by special guest columnist Anthony Jasansky, P. Eng.

One of Sir Isaac Newton’s laws states that for every action there is an equal and opposite reaction. Books have been written, exploring the scientific, literary and political effects of the action and reaction to describe and explain the material universe, the living body, historical events, and psychological behavior. Since investor psychology plays such a crucial role in any market, actions and reactions are an integral part of price changes.

Knowing the law is one thing, but making practical use of it is another. Technical stock market analysts, in the never-ending search for the Holy Grail of their faith, have turned for further help to the works of the 13th century mathematician, Leonardo Fibonacci. Among the tools utilizing the works of the two gentlemen I’ve mentioned is the calculation of the degree of retracement (reaction) to a preceding price change (action).

Over the past two years, the primary “market action,” ending March 2009, took the form of a market drop of historical proportions. Subsequently, since mid-March 2009, the resulting reaction has also been of historical proportions. To put some numbers on the market action and reaction, I have selected the Russell 2000 Index; more specifically, the actively traded ETF that tracks the index very closely (known as IWM).

Advertisement

IWM topped out earlier (July 2007) than the rest of North American indices (October 2007), it declined more (60%) and also rebounded more dramatically from its March 2009 lows (50%). Notably, over the last four weeks, it has also become weaker than the S&P 500.

In terms of the huge price gain alone, the March 9, 2009, to May 7, 2009, reaction could be regarded as a new bull market. However, in terms of its two-month duration, it would go on record as the shortest bull market ever. No matter what one may call the reaction, or how impressive the gains, it has retraced only 33% of the July 2007 to March 2009 bear market. That still falls short of the 38.2%, regarded as a “normal correction,” from a preceding market move, as derived from the Fibonacci number sequence.

Should the recent rally turn out to be more than a correction within a bear market, the next important Fibonacci retracement to watch for is 61.8%. In addition to Fibonacci ratios, analysts also found that retracements of 50% of preceding moves frequently correspond to the level of trend reversals or at least price consolidations. Realistically, the above percentages are to be taken with some margins rather than as precise numbers.

Remarkably, the only North American Index that has already retraced 38.2% of its bear market is the Canadian TSX Composite. For the S&P 500 and the DJIA to reach the same retracement, they must reach approximately 1,022 and 9,495, respectively. That also happens to be the resistance levels that halted the large temporary rebounds in October and November 2008.

The assumption that “money talks” has been put to a critical test during the credit and equity collapse of the last two years. The trillions of dollars spent by governments have yet to revive the economy, though some of the cash helped to charge up the equity markets. It also helped to pacify terrified credit markets. In a remarkable reversal, in the last two months, the U.S. treasuries, a haven during the panic, sold off sharply, while corporate bonds rallied.

Technical Reason Why Stocks Will Continue to Rise for Now
by special guest columnist Anthony Jasansky, P. Eng.

One of Sir Isaac Newton’s laws states that for every action there is an equal and opposite reaction. Books have been written, exploring the scientific, literary and political effects of the action and reaction to describe and explain the material universe, the living body, historical events, and psychological behavior. Since investor psychology plays such a crucial role in any market, actions and reactions are an integral part of price changes.

Knowing the law is one thing, but making practical use of it is another. Technical stock market analysts, in the never-ending search for the Holy Grail of their faith, have turned for further help to the works of the 13th century mathematician, Leonardo Fibonacci. Among the tools utilizing the works of the two gentlemen I’ve mentioned is the calculation of the degree of retracement (reaction) to a preceding price change (action).

Over the past two years, the primary “market action,” ending March 2009, took the form of a market drop of historical proportions. Subsequently, since mid-March 2009, the resulting reaction has also been of historical proportions. To put some numbers on the market action and reaction, I have selected the Russell 2000 Index; more specifically, the actively traded ETF that tracks the index very closely (known as IWM).

IWM topped out earlier (July 2007) than the rest of North American indices (October 2007), it declined more (60%) and also rebounded more dramatically from its March 2009 lows (50%). Notably, over the last four weeks, it has also become weaker than the S&P 500.

In terms of the huge price gain alone, the March 9, 2009, to May 7, 2009, reaction could be regarded as a new bull market. However, in terms of its two-month duration, it would go on record as the shortest bull market ever. No matter what one may call the reaction, or how impressive the gains, it has retraced only 33% of the July 2007 to March 2009 bear market. That still falls short of the 38.2%, regarded as a “normal correction,” from a preceding market move, as derived from the Fibonacci number sequence.

Should the recent rally turn out to be more than a correction within a bear market, the next important Fibonacci retracement to watch for is 61.8%. In addition to Fibonacci ratios, analysts also found that retracements of 50% of preceding moves frequently correspond to the level of trend reversals or at least price consolidations. Realistically, the above percentages are to be taken with some margins rather than as precise numbers.

Remarkably, the only North American Index that has already retraced 38.2% of its bear market is the Canadian TSX Composite. For the S&P 500 and the DJIA to reach the same retracement, they must reach approximately 1,022 and 9,495, respectively. That also happens to be the resistance levels that halted the large temporary rebounds in October and November 2008.

The assumption that “money talks” has been put to a critical test during the credit and equity collapse of the last two years. The trillions of dollars spent by governments have yet to revive the economy, though some of the cash helped to charge up the equity markets. It also helped to pacify terrified credit markets. In a remarkable reversal, in the last two months, the U.S. treasuries, a haven during the panic, sold off sharply, while corporate bonds rallied.