« The Secret to The Stock Market for the Rest of 2008 »

Various theories - both fundamental and technical - are floating around the investor class, regarding what the markets will do over the remainder of 2008.

The fundamental crowd typically says something akin to "as goes the housing market, so goes the stock market". That is both evasive as well as missing the point, in our point of view. We could list a number of reasons why that view or any other economy-based view is of absolutely no use to the investor with a timeframe of anything less than several years (even perhaps a decade or longer) but the foremost of them is the fact that the stock market leads the economy by 6-9 months. In a scenario like the present, the markets could drop a further 50% or rally 50-75% in 6-9 months.

Accordingly, a shorter-term view is imperative if one is a trader/investor with a horizon of anything less than 3-4 years. One needs to try and envision the path of the markets over each 4-6 week period and then plan his/her allocation strategies based upon the potential paths over that period.

We've done our research and are absolutely convinced that the action over the next 4 to 6 weeks depends largely upon the answers to the three questions listed on the chart below.

 

As you can see, we've given price action only secondary consideration (notice the low opacity of the candlesticks) on the chart of the S&P-500, above. The Bollinger Bands, the 20-day Moving Average (in the upper pane) and the Bollinger Band Width (in the lower pane), have been given primary importance.

That is as a result of our unequivocal belief that the character of the Bollinger Bands will provide the most useful clues as to the levels at which the most widely followed market index in the world will be trading at over the next four to six weeks.

As mentioned on the chart, we believe that traders have to seek answers to the three primary questions presented on the chart, on an ongoing basis over the next few weeks and based on the answers to those questions, expect prices to trade as low as the 650-700 range, as high as the 1050-1100 range, or sideways within the 840-1010 range.

Before we get into the reasoning behind why we believe that the Bollinger Bands hold the key to the markets for the remainder of the year (a 6-week period starting today), let's provide you with a brief insight into why the aforementioned targets/ranges come to prominence...

We need to actually take a closer look at price action over the past 6-week period in order to see the significance of those levels. The most easily noticable pattern of the past 6 weeks is the descending triangle pattern within which prices have traded over that period. Notice the three lows - in early-Oct, late-Oct, and a couple of days ago, respectively - each of which took place at roughly the same level (840-850) and the two highs - in mid-Oct and very early-Nov, respectively - the second of which (1010) took place at a lower level than the first (1045) that form a textbook descending triangle over the preceding six-week period.

The height of that pattern is approximately 200 points. Projecting that "height" downwards from any breaking of support at 840 (and thereby a confirmation of the descending triangle), we get a target of 650 or 700, depending upon which particular technical measurement technique is used. That is where the bearish target range of 650-700 comes from.

On the other hand, if prices continue to find support at 840-850, the index will try to make its way to the falling resistance line that is the upper boundary of the descending triangle. If prices are then able to break that trendline, the descending triangle will be defunct and there will be a chance that the index will go on and fill-in the "thinly-trade zone" between 1050-1100, but only if the Bollinger Bands permit (more on this later). As you can see on the chart, the index sliced through that level like a warm knife through butter on the way down, back in late-Sept/early-Oct. That is where a bullish target range of 1050-1100 comes from.

Now, having taken a look at the potential bearish and bullish extremes to which the markets can travel over the ensuing 4-6 week period, let's look at what the Bollinger Bands are saying is the most likely scenario as of the present...

The Bollinger Bands are flat at present. If the Bollinger Bands continue to stay flat over the ensuing period, we're likely to see a range-bound market. That is a basic tenet of Bollinger Band theory, of course.

The lower Bollinger Band currently lies at approximately 840. The Upper Band lies at approx. 1010. That is where the neutral market range of 840-1010 comes from. Under "normal" circumstances, that range is expected to prevail.

So, the obvious question now must be, "what will instigate any deviance from 'normal' circumstances?"

The answer is simple... Will the Bollinger Bands remain flat or will they start to expand at some point? (Let's leave aside the possibility that the Bands might actually contract over the ensuing period, because any such occurrence is likely to ensure range-bound action within the aforementioned "normal" circumstances anyway.)

Why does it matter whether the Bollinger Bands stay flat or expand? In a nutshell, Bollinger Band theory states that expanding Bollinger Bands point to a trending environment and flat Bollinger Bands point to a range-bound environment.

Having laid the ground work, we now leave you with the three primary questions we believe traders need to ask at each juncture over the ensuing 4-6 week period:

(1) Is the lower Bollinger Band falling?

(2) Is the upper Bollinger Band rising?

(3) Are the Bollinger Bands flat?

Once the answers to those questions have been arrived at, the trader might find the following information provides a useful "cheat sheet", if you will, of what the likely market outcome will be, given the answers to each of the questions (and to secondary questions, as listed below, that may arise in each case):

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(1) Is the lower Bollinger Band falling?

       If yes, is price below 20dMA?

       If price is below 20dMA, 4-week* target is 650-700

       If price is above 20dMA, refer to (2)

(2) Is the upper Bollinger Band rising?

      If yes, is price above 20dMA?

      If price is above 20dMA, 4-week* target is 1050-1100

      If price is below 20dMA (and lower Bollinger Band is falling), 4-week* target is 650-700

(3) Are the Bollinger Bands flat?

     If yes, the 4-week* target range is 840-1010

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We'll be updating the chart and will provide relevant comments on a regular basis over the coming weeks, so please visit our blog every day to check out the latest update.

Also, if you are not already aware, please note that FREE ACCESS TO MEMBERSHIP SERVICES for 10 days only has been made available from Nov. 12 - Nov. 21. So please check out the Stock Market Commentary, Stock Picks, Options Picks and Model Portfolio sections of the Members Area. We invite you to peruse of the features that are regularly available to members-only and we hope that what you see convinces you to consider signing up for an ongoing membership to our site.

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