Thursday, January 24, 2008

Early Warning Signs

Anyone who follows the stock markets is currently wondering... What will the stock market do over the next few months or years? Fortunately, there is a relatively simple way to get a feel for what is likely to come next. This method does not require one to guess anything about profits, dividends, interest rates, government intervention and so on.

Here's how it works.

Over long periods of time stock markets move in trends. After a number of years the long-term trend changes. A simple way to detect if the trend may be changing is to use a simple trend line. For a Bull Market the trend line moves upward. It is a line connecting all of the major low points. For a Bear Market the trend line moves downward. For the Bear Market it is a line connecting all the highs. The trend line works for market indexes and for many stocks.

We can think of the trend line and the market action relative to the line as a "trip wire" or early warning system. The market cannot change from one long-term trend to the opposite long-term trend without breaking through the trend line that has been "in force" for a number of years. This is a simple undeniable fact. This analysis is scientific because it can be repeated and verified by others. For longer time periods there is always only one long-term trend line. Any market history chart will show this to be true.

At this point in time we wonder.. Are the stock markets just in a relatively short-lived and shallow correction, or have the stock markets begun a much deeper longer-term Bear Market? Before the next large Bear Market can begin, the Bull Market trend must be penetrated on the downside. The long-term trend must start to change.

These two graphs show that the US and Canadian Stock Markets have both broken below the long-term Bull Market trend lines. These trend lines have not been violated for the last 5 years. In general, longer time period trend lines are more important that shorter time period trend lines.

At the very least, the recent breaks through the 5 year Bull Market trend lines should be viewed as an early warning of a larger (deeper) Bear Market starting. If so, it is only in the early stages.


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