Can You Predict the Market?

09/10/00 08:13:54 PM PST

by Dennis D. Peterson

You may not be a rocket scientist, but you'd feel like one if you could see the downturns and upturns in the market, using this form of analysis.

I manage my own 401(k) account. Do you? Maybe you don't. Maybe you think you don't have the time, or it's too mysterious or it's confusing. What would you say if I told you that it's not really that mysterious or confusing, the market goes through predictable patterns, and with just a little training, you could manage your own account?

If you're like me, you have a 401(k) account in which you have money deposited on a regular basis, and you don't pay much attention to it; you have more pressing matters, like trying to find a few spare minutes to read the newspaper, say hi to the wife and kids, feed the cat, and maybe even mow the lawn. That was the old me. The new me makes time to look at the market. What changed?

My impending retirement is what changed. I looked at the biggest cash source I had, my 401(k), and what happened was unnerving. My money, you see, sat in a Standard & Poor's 500 index fund, which suffered a traumatic event in the summer of 1998; the S&P 500 took a significant dip (Figure 1) in late August. Luckily, it had recovered by the time I took notice, but the selloff in the market scared me. Could I have seen the downturn coming so I could have gotten out in time?

PREDICTING THE FUTURE
Now, of course, I know it was possible, and the subsequent upturn was also predictable. The S&P 500 had gone through a double bottom or W formation; numerous texts on technical analysis recognize this as a pattern with a predictable outcome. As can be seen in Figure 1, the left leg of the formation (shown as A) had a sudden falloff. This was followed by what looked like a recovery in the index (B), only to be followed by another falloff (C). By the time the S&P 500 index began to go back up again (D), it would have been hard to believe a recovery was truly in the works until the right leg of the formation (D) reached as high as the recovery (B).

A double bottom is also referred to as a reversal pattern. Even if I hadn't been familiar with how reversal patterns could help me, the downtrend from the peak in mid-July to late August would have alerted me to move at least part of my money to a money market account.

But wait! It gets worse. The decline in late August was so steep that, if I had waited until the S&P 500 was at 1050 to move my money into a money market, I could have saved myself 100 points of downturn because the S&P 500 was headed to 950 or even lower. Is a 10% savings important? It is if it occurs within a two-month period. On average, the market gains 10% per year. Recognizing the double-bottom formation would have told me when I could get back into the market. The key to a double bottom is that the righthand leg needs to go up on increased volume. The second of the two bottoms needs to occur with lowered volume. This confirming volume pattern can be seen in Figure 1 using the ticker symbol of SPY. Traded on the American Stock Exchange, SPY is a scaled-down version of the S&P 500 with an identical stock mix. With a volume confirmation from SPY, the time to get back in would have been around 1000.

FIGURE 1: DOUBLE BOTTOM, OR W FORMATION. The S&P 500 starts to decline in mid-July, and then in late August takes a significant loss to start the double bottom or W formation. SPY volume data mimics the S&P 500, as shown here.

Graphic provided by: BigCharts.com.

THE TREND IS YOUR FRIEND, AND SO ARE RECOGNIZABLE PATTERNS
My approach to managing my 401(k) is technical analysis. Is it rocket science? Not really. It is, however, a take-charge and be proactive method, because you've got a lot to lose. It's a lot better than the stand-on-the-sidelines-and-cross-your-fingers approach. It's even better than letting your broker manage your money because if you have a few million in your account, you'll get some adequate attention. Otherwise, the broker will be busy with larger accounts. For a 401(k), it's generally a do-it-yourself plan.

Where do you start with something as overwhelming as the stock market? Books and publications are the best way to learn, and there are many to choose from. I hope what you're reading now will be a wakeup. The Internet allows access to a lot of data, but nobody is going to draw a trendline for you or point out a price action that looks like a double bottom. You need to look - and draw - for yourself.

Dennis D. Peterson

Market index trading on a daily basis.

Title:	Staff Writer
Company:	Technical Analysis, Inc.
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	Seattle, WA 98116-4499
Phone # for sales:	206 938 0570
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Website:	working-money.com
E-mail address:	dpeterson@traders.com
Traders' Resource Links
Charting the Stock Market: The Wyckoff Method -- Books
Working-Money.com -- Online Trading Services
Traders.com Advantage -- Online Trading Services
Technical Analysis of Stocks & Commodities -- Publications and Newsletters
Working Money, at Working-Money.com -- Publications and Newsletters
Traders.com Advantage -- Publications and Newsletters
Professional Traders Starter Kit -- Software

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