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Room at the Top - Volatility Trends Indicate Market Still Has a Way To Go

Steven Zimberg is the founder of the Societism Institute.  He graduated from Hillsdale College in Economics and Business Administration and is a Certified Financial Planner, Certified Paralegal and Union Electrician.  This article was originally written for Barron's Magazine in 2008, however its interesting to see that we are at the intermediate peak (April-May 2010) as predicted nearly 18 months ago...  (Charts did not upload but are available upon request).

By Steven Zimberg, CFP

October 23, 2008


In the mid eighties, I was fortunate to have an old-time chartist work with me in my investment consulting practice. This was ideal because it was before computers were monitoring stock market indices or other traded securities and helped us considerably with our money management services. His charts included research dating back to the turn of the century. They each gave logical predictions of future market direction. He would always carry his wares guarded in a full length black portfolio.

In one of his charts he called, “The Circle of Volatility”, it characterized a period of time similar to the 1929-1930s when stocks moved much the same way as commodities. Its purpose was to trace classic patterns that, when charted, closely resembled those of some commodities that encountered disaster in the past, like silver during the Hunt debacle.

Spencer showed through his painstaking illustrations and foresight, his prediction of how we again entered this circle in late 1987 (Barron’s July 20, 1987), coinciding with the Great Crash of October 1987. With a law degree from China, he brought methodical patience and devotion to presciently compare the Dow’s pattern in 1987 with that of the “twenties”, which led to the Crash and the Great Depression.

This month’s erratic fluctuations in market prices illustrate similar characteristics that perhaps we are in that circle that occurs ever so infrequently. Unique support that the bull isn’t in immediate danger of wandering into the slaughterhouse, that there is still room at the top. Among the reasons for this: There are some important differences between tops in stock markets and tops in commodities markets.

For one thing, the stock market usually takes a long time to top out. For another, with few exceptions, it tops out in a rounded pattern, followed by a spike that marks the ultimate apex. Commodities, on the other hand usually make spiked tops, inspired by extraordinary news that raises traders’ pulse rates. In addition, unlike commodities futures, stocks are frequently long term holdings, owned by individuals as well as institutions. They are not merely “offsetting positions” or “open interest”, which can be wound up abruptly.

Then, too, all publicly traded companies do not move in sync; their fortunes rise and fall individually, and movement is generally spread over a relatively long period. For stocks, the tipping phase generally is accompanied by good economic news and investor euphoria and complacency. In contrast, the few dozen commodities that are traded almost always top out within a relatively short stretch and, typically amid panic conditions, such as the 14% inflation rate and 21% prime rate that dealt the U.S. a terrible blow in 1980.

To illustrate our point, we had stockcharts.com prepare a point and figure chart, to join our original.


The point and figure method is one of the oldest methods of charting. It shows each consecutive price change of a certain size (for example $1) during each trading day, but includes a notation only if a change of a certain designated magnitude occurs. Obviously, depending on a company’s performance, investor interest and other factors, many such changes can occur in one day, or none may be recorded for weeks at a time. In essence, point and figure charts really are pure measures of price movements.

Point and figure technique condenses multi-year price movements to project upside or downside price targets. Point & Figure charts use rising columns of X's and descending columns of O's to represent these price movements. What an investor sees when looking at a P&F chart is the underlying supply and demand of the security. The columns of X's illustrate demand exceeding supply (rally), and the columns of O's illustrate supply exceeding demand (decline). The numbers and letters are used as monthly indicators, allowing the user to have at least a rough idea of when these price movements occurred aside from the given year markers at the bottom. The numbers 1 - 9 correspond to months January through September, and to save space, A B & C were assigned to October, November, and December respectively.

For example, our work with such charts point to an ultimate target on the low side being where we were last week around 7900 and reaching an initial peak of 11,000 and perhaps an ultimate peak of even 19,000 in the Dow before a bear market truly begins.

The scales have been adjusted to consider the ballooning of the Dow over the past 80 years. The aim here is to put price changes into roughly comparable perspective. Obviously, in percentage terms, a 10 point change in the Industrials means a lot less now, while the Dow is in the 8,000-14000 range than it did when the average was around 375 in 1929.

The 20s chart is based on price moves of five point; the contemporary one based upon 300 point moves. These charts are further refined by the use of the three point reversal technique, which is useful in depicting long term movements in the market. A reversal is simply a significant change, either negative or positive, in the price of a stock or index. Thus, the 20s chart reverses at 15, and the present chart at 900.

The Twenties chart shows that there were many price swings before a top was reached. In fact, 1929 saw more point and figure price swings than were recorded in all the previous 32 years. The chart also shows that, before the calamity hit, a massive top was formed in 1929-30.

For the current market to have a top similar to that of the 1929-30, the Dow would have to would have to spend much more time in a zone characterized by torrid action and violent price swings. The area where this is likely to take place lies in the Circle of Volatility as shown in these two charts.

Even in today’s economic climate with massive government cash infusions to stimulate the world’s credit markets, global real estate ownership percentage values disappearing and foreclosures reminiscent of the past, investors can breathe easy – at least for awhile. Although the Dow appears to have entered this yet to be charted circle of volatility, despite widespread fears, we’re not at the top just yet. Indeed, the market probably has quite a way to go if a scenario like that of 1929-30 is to take place.

Spencer Lowe, you will always be remembered for your special wisdom, devotion, friendship and of course, charting.

 

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