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Weekend Stock Market Analysis

(1/8/11)

For those that follow the Relative Strength Index (RSI) 1900 significant Market Bottoms have occurred under certain conditions involving the RSI.   The chart below is a plot of an 18 Period Monthly RSI which is smoothed by a simple 5 Month Moving Average.    Notice when the smoothed RSI has dropped below the 35 level and then risen back above it (points A) major bottoms have occurred on "5" different occasions (points B) with the most recent one in the Spring of 2009.  Furthermore all of these major bottoms were followed by sharp oversold rallies exceeding 75% over a relatively short period of time.

Meanwhile a breakdown of the past 4 occurrences will now be shown with the first one way back in the early 1900's.   In this case the Dow dropped 46% from its 1901 high before bottoming in late 1903.  This was then followed by a 143% rally over the next 2 years which peaked in late 1905.   After rallying 143% the Dow then sold off over the next two years and lost 45% of its value before bottoming in late 1907 near its 78.6% Retrace calculated from the late 1903 low to the late 1905 peak..   

Meanwhile the next RSI occurrence happened in 1915 as the Dow lost 47% of its value from late 1909 through late 1914.   This was then followed by a 98% rally over the next 2 years which peaked in late 1916.    Meanwhile after rallying 98% the Dow then went through a sharp 40% correction over the next year as it found support once again at its 78.6% Retracement Level calculated from the late 1914 low to the late 1916 high.

The next RSI occurrence was in 1932 after the big market crash from the late 1929 peak as the Dow lost 89% of its value before bottoming in July of 1932.   This was then followed by a sharp rally over the next 4 years as the Dow gained 380% before peaking in early 1937.   Meanwhile after topping in early 1937 the Dow then went through a choppy correction over the next 5 years in which it lost 53% of its value.   Also notice it found support twice near its 61.8% Retracement Level (points C) calculated from the July 1932 low to early 1937 high.  

Another RSI Signal occurred in the mid 1970's as the Dow lost 47% of its value from early 1973 through early 1975 which was then followed by a sharp 80% rally over the next 18 months which took the shape of an "ABC" affair.   This was then followed by a 28% correction over the next 18 months as the Dow found support near its 61.8% Retracement Level calculated from the early 1975 low to the late 1976 high.   Furthermore as I have pointed out in the past after the 1976 top the Dow traded in a choppy trading range for the next 7 years before finally breaking out in 1983 as it continued to hold support at or above its 61.8% Retracement Level (red line).

Meanwhile the most recent RSI Signal occurred in the Spring of 2009 as the Dow lost 54% of its value over a 17 month period which has been followed by a sharp 77% rally over the past 22 months.  So far this pattern looks very similar to the mid 1970's pattern and is exhibiting an "ABC" affair as well from the March 2009 low.   If the Dow is nearing a top and eventually retraces 61.8% like occurred in the mid 1970's then a drop back to around the 8500 level is certainly  not impossible in the long run.   Also a 61.8% retrace back to the 8500 level would correspond to a 28% correction which is what occurred in the mid 1970's as shown above. 

To sum things up what this research shows is that the move from the March 2009 low is nothing unusual as there have been previous occurrences in the past after the market has become extremely oversold and the smoothed 18 Period RSI has dropped below the 35 level.   Also after each impressive oversold rally the Dow eventually retraced anywhere from 61.8% to 78.6% of the previous upward move as it corrected from 28% to 53%.   Meanwhile as shown above the current pattern most resembles the one from the mid 1970s which would mean an extended consolidation period would develop over the next several years with support coming in at the 61.8% Retracement Level.       

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