The Tycoon Report

Here's Why the Odds Favor a Continued Bull Rally ... For Now

Tuesday, January 12, 2010 | Chris Rowe

The market is going higher. 

Odds are, this will continue for a while, or at least through January. 

When we determine what our stock market posture is, we must take all relevant facts into consideration, and we must properly weigh those factors individually -- a process that is also dependent on the current market environment. 

But two very important things happened recently that tell us the market is likely to push ahead for the time being:



The NYSE BPI reversing back up to a column of Xs is a big deal because it shows us that, instead of an external market (the popular indices) moving higher due to a smaller handful of large-cap stocks, the market is now being supported by a newly established trend -- where more and more stocks (of all sizes) are moving to buy signals (breaking through key resistance levels). 

We knew this would likely be the case after seeing the seasonal pattern -- where small-cap stocks rally through December and early January -- occur.

The new uptrend line is important for several reasons, so we'll discuss the significance, how it's created, and we'll apply that to today's market. 

What do Trendlines Tell us?

First, trendlines are at the core of the foundation of technical analysis and should weigh heavily on your stock-market stance. 

Once an uptrend line is violated, analysts start gauging the strength of the market by watching its behavior at key price levels (on the way down).  Those key price points are either at horizontal support levels, or at trendlines that are larger and longer in time frame (than the trendline that was recently violated).

What we saw in the market recently were violations of major trendlines. But instead of the violation being followed by an intermediate-term downtrend (within the major uptrend), which is typical, the market traded horizontally for months after the violations, which is atypical. 

During this time, the market really had no uptrend line to fall back on that was anywhere close to today's levels.

Let's look at what happened. 

How a Trendline Becomes a Trendline

Although marked differently, both charts below are one-year charts of the Russell 3000 (which is the cap-weighted index of the largest 3,000 publicly traded companies in the United States). 

The chart of the Russell 3000 shows basically the same story as most of the major U.S. indices. I'll wrap the story in a brief education for those who aren't familiar with the basic rules of the trendline.

The first one shows the old uptrend line, how it was established and where it was violated. The second one shows the newly established uptrend line that I referenced at the beginning of the article. 

Let's start with the original situation. 

First, let's be sure we understand at what point, in the chart, a trendline actually becomes a trendline. 

You can see, below, that we drew our tentative trendline beginning with the March 2009 low (1) to the following low (2) and then extended it out further. 

After a series of higher highs and higher lows, the market took an intermediate correction (from 550 down to about 510), and then rebounded (2) sharply to the upside, where I shaded in yellow because, after point 2, it was just a tentative trendline.  

It only becomes an official uptrend line once the prior high, or resistance level (red line), is broken again (3).

But you can see in late September/early October, the trendline was violated (red arrow). 

Some bullish hopefuls gave the violation a pass, since it was only a slight violation.  But then you can CLEARLY see the trendline was definitely violated in the second half of October (red shaded circle). 

If the trendline wasn't violated at the red arrow, it was surely violated at the red circle. 

The next step for analysts is to find the next-largest trendline in the much-longer time frame (which actually means going back decades).  That's another story.

Let's look at how we formed the new uptrend line. 



Remember, below is the same-exact chart, marked differently.  It was certainly easier to illustrate my point of when a tentative trendline becomes an official trendline. 

Look below; you can see the red arrow points to a level of resistance that lasted about one week.  I just connected the March 2009 low (1) to the last low that was made before the market broke a new high. 

(Note that I didn't connect to the November low and extend a trendline out because that trendline would eventually have been violated in early December.  So I skipped that in this explanation.) 



So, we have the NYSE BPI and Nasdaq BPI both in columns of Xs (proving that demand is in control), and we have a new official uptrend line in the major averages. 

Why don't I think we will have another violation very soon? 

Because, unlike the rally off of the October low (which occurred while the NYSE BPI and Nasdaq were in a column of Os, proving supply was in control of the majority of stocks in the stock market), this rally is accompanied by the major BPIs being in a column of Xs (showing that the internal market -- the breadth -- is confirming the direction of the major, cap-weighted indices). 

Let's see, how do I close this article now. ...

See You Next Tuesday!



“Profit from the Trend”

Chris Rowe
Chief Investment Officer
The Trend Rider