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How to Know When the Stock Market Has Finally PeakedBy Jeff ClarkFriday, November 13, 2009 "We're doomed."
That was the opening line of my speech at the S&A Alliance Conference last Monday.
While the comment may seem downright pessimistic, I was actually one of the most optimistic presenters at the conference. That probably says all you need to know.
At dinner the night before the conference, I was lucky enough to sit down with several of the smartest investing minds I know. Each one of them was cautious, if not downright gloomy on the prospects of the U.S. economy and the stock market. And with good reason...
Stocks are trading at ridiculously high multiples. What little growth there is in the economy is purely the result of the U.S. government spending your future tax dollars today. There's a genuine worldwide concern over the potential collapse of the U.S. dollar. And let's not forget about the 10.2% "official" unemployment rate.
No wonder the conference was shrouded with gloom and doom.
The stock market responded by rallying 250 points that day. It was a proverbial flip of the finger to all of the bears in the room and a reminder of the old saying, "The stock market can remain irrational longer than you can remain liquid."
Pinpointing the exact top in the stock market is an exercise best left to crystal-ball gazers and tea-leaf readers. There is a way, however, for technical analysts to identify a topping process. It's not as good as nailing the exact date the stock market puts in its peak, but it'll get you out close enough to the top and prevent you from giving back all those hard-earned gains.
It's called a fan chart, and it looks like this...
 A fan chart is formed by drawing multiple support and resistance lines from the most recent correction low.
The correction we experienced in July gives us a good starting point. Since then, the market has made a series of higher highs and higher lows. This is typically a bullish pattern. However, the distance between each new high point is getting smaller. And the distance between each "higher low" is smaller as well.
This action creates a "rounding" type of chart pattern – which is typically associated with a topping process.
In the chart above, every time the market broke below one of the fan lines, it formed a higher low and then bounced back up to test the line. The angle of the lines still allowed each bounce to generate a higher high.
That won't be the case if the market breaks below the most recent fan line. If the S&P 500 drops below support at about 1,050, any bounce back up toward the line will create a lower high, and it'll signal the start of a new downtrend for the market.
On the other hand, if the market can bust out above resistance (currently at about 1,110 and rising every day), then forget about the market topping. Stocks will be off to the races through the end of the year.
A break below 1,050, however, may make all those gloomy forecasts at the Alliance Conference come true.
Best regards and good trading,
Jeff Clark
Further Reading:
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