# Bearish market components operating in background

Of all the books written on technical analysis and market timing, one of those we have always believed should be included in the Top 10 is J.M. Hurst’s "The Profit Magic of Stock Transaction Timing." First published in 1970, the work has undergone repeated reprints and is still available. Hurst, an aerospace engineer, set out to discover why stock market prices change "in such a baffling manner." Using numerical analysis and computers his goal was to maximize profits.

While the book is a treasure trove of research approaches, two of Hurst’s theories have stuck with us: "half-span moving averages" and "price envelopes." The latter methodology we have modified into what we call "price channels."

Half-span moving averages are simply two moving averages of different lengths that are "moved back" in time. But the two averages are useful in "forward time" when they predict or complete a "crossover," the level at which the two converge at an intersection point. That point usually tends to occur about one half the distance between the high and the low of the move, depending on the cycle. In our analysis we use a "40-bar" moving average moved back 20 bars and a "20-bar" moving average moved back 10-bars, regardless of the cycle the averages are applied to.

Click chart to enlarge

The second Hurst-inspired application, "envelopes" we use with some modifications while calling the offshoot "Price Channels." Hurst’s "envelopes" connected each of the highs and lows in a trend, literally, the objective being to create a series of "envelopes" of various cycle lengths that would "nest" one within another to suggest zones of opportunity. Since the application was a bit more subjective than we like, we have created "price channels" by applying exponential moving averages to the highs for "n" bars and the lows for a similar amount. The chart above has two price channel plots. One is 10 bars long, the other is 50 bars long. We have also modified Hurst’s approach by literally moving the two averages for a given cycle forward by one-half the amount of the average. In other words, the 10-bar is extrapolated five bars forward, the 50 is moved ahead 25 bars. The result of these plots is that a defined "price channel" is created that can be used as a "failsafe" point to enter or exit the market, i.e. "Buy Stop or Sell Stop" levels. The smaller of the two channels works on the minor cycle, the larger on the major.

So why this explanation of research methodology?

Given the tentative nature of current stock market price action, and despite price gains since the July price lows, we remain concerned about the longer-term viability of this market because of the lack of market participation as reflected in our Cumulative Volume data (see dark red line above), deteriorating Momentum (red/green line above), and the potential downside "crossover" of the larger of the two half-span moving averages (see red arrow down and green arrow up at right of price chart above) we explained earlier in this commentary.

First, NCV, or "Cumulative Volume," has been moving higher since the March 2009 price lows, but following the catastrophic deterioration in the indicator during the 2008 bear market, CV remains remarkably weak relative to even its October 2002 level which the indicator has yet to overcome, let alone the October 2007 price highs. Adding to the negative quandary, CV peaked back in late April and that plot point has yet to be surpassed. Underscoring the lack of volume, "pure volume" in the S&P 500 hit a high in October 2008 as the bear market was reaching for its lows. That point still holds.

Then we come to the "half-span moving averages." The falling, heavy black line on the price chart above is the 40 month average moved back 20 bars. The rising, heavy red line is the 20-month average moved back 10 months. Within the next 10 months or so the two moving averages will intersect or give clues that they are destined to cross. That crossover point will, in retrospect, turn out to be close to the midway point of the move from March 2009 to the eventual high of the move since March 2009. In other words, when the crossover is imminent, the positive upmove since those March 2009 lows will be complete.

Other crossover points from the March 2000 through October 2002 bear market are evident along with the advance from 2002 through October 2007. The 2002/2007 bull market had double crossover points because of the 2005 upward-biased "consolidation," but the midway point was still useful, given the symmetry of the trend. And the bear market that lasted from late 2008 through 2009 overshot its downside target, but the principle remains the same: the implied forward movement of the two averages will suggest an end to a current move. When that action occurs in a bull trend, the crossover point minus the distance to the previous lows of the move can then be added onto the projected crossover point to estimate the point of a possible high. The reverse works for a downtrend. Calculate the distance from the high of the move to the crossover point and then subtract that number from the crossover point to create the projected low.

Given the downward bias of the longer of the two half-span averages and the poor showing in Cumulative Volume and Momentum relative to statistical resistance points, we continue to wonder if the rally over the past 19 months could prove to be nothing but a retracement within the context of a longer-term bear market that was initiated in October 2007. Underscoring that suggestion is the fact that our Most Actives Advance/Decline Line (MAAD) continues to hint at the lack of broad market participation by the so-called "Smart Money" players. While the market has rallied strongly since early 2009, MAAD continues to resist on the upside and has only recovered about one quarter of its losses since the 2007 highs.

Finally, while the current bias of the stock market has a net positive longer-term price bias, last week’s selling notwithstanding, we continue to note the lack of positive confirmation by a variety of market "internals." When we add in the half-span moving averages with the larger of the two on the major cycle still dropping, the burden of proof remains with the bullish camp. Simply put, since that longer-term half-span average will be cancelling out higher numbers put in place months ago, the prices following the October 2007 highs, nothing but renewed strength on increasing volume will erase our current concerns since implied "crossover" levels could loom sooner than later.

Weekly MAAD statistics peaked the week ending November 5 by posting plots consistent with action in the major market indexes. After topping out back on October 12, however, Daily MAAD cumulative data have continued to deteriorate. In fact, the daily series declined last week to levels not seen since the end of July. And this weakness occurred after Daily MAAD failed to confirm broad market strength on November 5.

While we suggested in last week’s commentary that the daily failure could be erased, given the bias of market prices several days ago, the fact that the smaller and more sensitive indicator has continued to deteriorate, is a suggestion that Smart Money continues to exit this market despite higher prices

While we will continue to defer to the overall positive effect of higher bids so long as they last, we must also continue to note that the underpinnings of this market, especially as reflected in MAAD, leave a lot to be desired.

Click charts to enlarge

McCurtain Call/Put Dollar Value Flow Line (CPFL)

CPFL data on both the Daily and Weekly cycles hit new highs last week relative to the late April peaks to suggest that options players continue to think the broad market will move higher. And well it may be once the short-term retrenchment is over. But as we noted in our discussion of MAAD along with deteriorating Momentum and Cumulative Volume, while prices can still be spurred upward, lacking concerted selling, there will come a point when it will take more than a supposition of higher prices to maintain the bull move.

Options players via CPFL have a good historical record of being on the right side of the trade during the "body" of the market move. They have, however, tended to get skittish before major market highs. We suspect this market move will prove to be consistent with that history on the larger cycle.

Click charts to enlarge

Conclusion

The S and P 500 Index lost 33.00 points, or 2.6%, last week with the Dow Jones Industrial Average dropping 251.50, or 2.1%, to 11192.58. The short-term uptrend that began in both bellwethers in July is now under threat while the next larger Intermediate-term Cycle and Major Cycles remain viable. If the lesser trend does turn negative, the S and P must hold above 1114 this coming week with the Dow will be required to stay above 10545 to keep the Intermediate Cycle in both positive.

Despite the longer-term fears we outlined in our commentary above and lacking any further evidence, we must presume that any weakness which might develop at this time should occur within the context of a larger cycle positive on both the Intermediate and Major trends.

We should add, however, that the more short-term up and down activity develops with without notable strength on the larger cycles, the greater the odds that those longer-term half span moving averages will move toward a resolution point that will NOT favor the bullish camp.

MAAD data for past 30 Weeks* CPFL data for past 30 Weeks

 Date NYSE Adv NYSE Dec Date OEX Call \$Volume OEX Put \$Volume 4-16-10 11 9 4-16-10 684317 282231 4-23-10 15 5 4-23-10 1049228 141637 4-30-10 2 18 4-30-10 139488 363448 5-7-10 3 17 5-7-10 929902 2329559 5-14-10 14 6 5-14-10 263151 730414 5-21-10 5 15 5-21-10 1172844 1654053 5-28-10 10 10 5-28-10 477797 584893 6-4-10 5 15 6-4-10 265339 515370 6-11-10 12 8 6-11-10 263791 544655 6-18-10 11 9 6-18-10 357965 119532 6-25-10 5 15 6-25-10 91068 599114 7-2-10 4 16 7-2-10 1034509 771231 7-9-10 18 2 7-9-10 635690 110808 7-16-10 9 11 7-16-10 171633 445073 7-23-10 16 4 7-23-10 322870 174663 7-30-10 15 5 7-30-10 199970 217368 8-6-10 15 5 8-6-10 271701 115037 8-13-10 3 16 8-13-10 132060 409972 8-20-10 8 12 8-20-10 176830 488032 8-27-10 6 14 8-27-10 207995 222943 9-3-10 17 3 9-3-10 488323 102016 9-10-10 12 7 9-10-10 287697 82863 9-17-10 15 5 9-17-10 289703 112410 9-24-10 12 8 9-24-10 209124 100570 10-1-10 9 11 10-1-10 145020 121894 10-8-10 14 6 10-8-10 394156 98483 10-15-10 10 10 10-15-10 476975 115923 10-22-10 11 9 10-22-10 2575024 116468 10-29-10 10 10 10-29-10 376133 120924 11-5-10 13 7 11-5-10 547056 71345 11-12-10 5 15 11-12-10 203906 305387

*Note: All data is for week ending on Friday even though ending date may be a holiday.
Unchanged issues in MAAD calculations are not counted.

MAAD data for past 30 days* CPFL data for past 30 Days

 Date NYSE Adv NYSE Dec Date OEX Call \$Volume OEX Put \$Volume 9-30-10 8 12 9-30-10 28029 12528 10-1-10 18 2 10-1-10 17478 6476 10-4-10 7 13 10-4-10 25223 8818 10-5-10 19 1 10-5-10 78970 27351 10-6-10 9 11 10-6-10 33902 9810 10-7-10 7 13 10-7-10 92598 4234 10-8-10 12 8 10-8-10 102074 12642 10-11-10 10 10 10-11-10 108223 18879 10-12-10 15 4 10-12-10 22624 16689 10-13-10 9 11 10-13-10 106471 12181 10-14-10 8 12 10-14-10 31758 8467 10-15-10 2 17 10-15-10 263380 37882 10-18-10 9 11 10-18-10 74440 22047 10-19-10 6 13 10-19-10 244564 76604 10-20-10 12 8 10-20-10 35040 32917 10-21-10 7 13 10-21-10 33737 31632 10-22-10 8 10 10-22-10 20998 20664 10-25-10 11 9 10-25-10 17826 36728 10-26-10 11 8 10-26-10 18462 22227 10-27-10 10 9 10-27-10 39486 23322 10-28-10 8 11 10-28-10 187396 20725 10-29-10 8 11 10-29-10 19943 32281 11-1-10 10 8 11-1-10 32748 43173 11-2-10 8 11 11-2-10 53000 26682 11-3-10 12 7 11-3-10 51603 27749 11-4-10 14 6 11-4-10 178789 37602 11-5-10 10 10 11-5-10 170900 27121 11-8-10 12 8 11-8-10 68863 17326 11-9-10 5 15 11-9-10 169694 45289 11-10-10 11 9 11-10-10 42694 33514 11-11-10 8 12 11-11-10 37089 30380 11-12-10 4 15 11-12-10 30639 94150

*Note: Unchanged issues are not counted.

Robert McCurtain is a technical analyst, market timer and private investor based in New York City. If you would like to read more about how the CPFL is constructed, read a Futures article on the concept. This will take you to the MAAD article. Robert can be reached at traderbob@nyc.rr.com.