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| Stage IV
Decline |
How can we recognize a stage IV decline?
Let me review what makes a stage IV decline using the chart of the Disk
Drive Index below. (For additional detail on four-stage analysis, please
see my special report: The
Trading Technique That Will Always Keep You on The Right Side of the
Market.) The chart begins in October 2002 when $DDX bottomed near 50
along with several other technology indices. By March 2003, when the
S&P made its final bottom and launched into a bull market, $DDX was
trading near 75. Note that during this period the index was already
above an upward-sloping 30-week moving average.
As the bull market matured, note first
how $DDX remained above an upward-sloping moving average and second how
it ran parallel for most of this period to the 30-week moving average.
This period represented the stage II (bull market) advance.
In late February 2004, $DDX finally traded below its 30-week moving
average for the first time in almost a year. Almost immediately
afterward, the index broke its uptrend line from the March 2003 low.
This represented the stage III topping process for this index. I date
the end of this stage to April 2004 when $DDX broke support near $115.
$DDX is now clearly in a stage IV
decline. The index remains below its downtrend line, and the downward
sloping 30-week moving average is above share price. Each Intermediate
peak is also below the previous peak--the definition of a downtrend.
Note, however, that even though $DDX is in a stage IV decline, you
cannot short the index or its component stocks willy-nilly. In early
May, again in conjunction with a bottom in the S&P 500, $DDX hit
psychological support at 100, gave a stochastics buy signal and rallied.
The rally brought stochastics back just above 20. As it turns out, that
provided a good shorting opportunity, as the rally peaked and
stochastics eventually gave a sell signal.
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