History repeats itself in the Dow Jones

published 22 August 2014

Today is the day Fed watchers have been waiting for with bated breath Janet Yellen, the US Federal Reserve chairman, is scheduled to utter words at 3pm UK time that they believe will put another rocket under stock markets. By the time you read this, the words will probably be out there for all to digest.

Naturally, the key question they want answered is this: what is the Fed's intention regarding the Fed Funds short-term interest rates, which have been on the floor since the ZIRP policy started.

Of one thing I am sure: Yellen's statements will be couched in the usual mumbo-jumbo that Fed chairmen are known for.

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I have news for the Fed-watchers: interest rates are set by Mr Market, not Ms Yellen and pals. What Yellen says will have little bearing on the path interest rates will take, except possibly in the very near-term as emotions run high for a few hours.

Actually, I am hoping for a bullish/dovish' statement (along with every investor and their dog), but for the contrary reason that it would set up the possibility for a buy the rumour, sell the news' event. It would cap off a most remarkable rally off the 8 August low a rally I alluded to in my last post on the Dow of 15 August.

Proof that history does sometimes repeat

The big decline of the previous week was starting to turn around from a precise hit on the Fibonacci 50% level. The market was possibly starting a rebound rally then.

I noted the possible similarity between the position of the market then and that in February, when the market staged a hefty rally and went on to make new highs.

And that is precisely what has transpired a repeat of history. Here is the updated chart:

The 'buy the dip' crowd were aggressively out in force, as they have been since 2009 and pushed stocks back up. This was a vivid demonstration that history does sometimes repeat.

The market offers an excellent trade setup

Momentum is already back up at levels where previous tops were made. Although it is possible that the rally could continue its relentless climb from here, the odds are swiftly diminishing for this outcome.

I have noted that when the Fed had previously made a much-anticipated announcement, the initial reaction was generally bullish. But within a short period, the market made a major top and a substantial decline ensued big enough for a very profitable short trade.

I wonder if a similar setup will present this time?

Are we getting close to the top?

This index has been the strongest of all US indexes as speculation has concentrated on tech shares. The faith investors/gamblers are putting in the ability of projected new developments in tech and biotech (and social media) to produce years and years of above-average dividend growth is astonishing it is a veritable mania.

Here is the last wave up in the Nasdaq from the April low:

There is a clear impulsive five-wave pattern with a long and strong wave 3. The August rally is my wave 5 (and has had no down day in 11 trading days) and now momentum is practically off the scale.

The universal expectation that the Fed will keep supporting shares has reached fever pitch. The belief is that the Fed will not allow a sell-off in shares, as that is the main arena for wealth-creation that they support. We shall see whether or not the Fed has such amazing powers when the next sell-off gets under way.

The interesting feature of the chart is that at the current 4,052 level, wave 5 = 1.618 times wave 1, which is a common wave relationship. Also, the market has met my upper tramline a region of considerable resistance.

If my Elliott wave count is correct, the top cannot be far away.

John is is a British-born lapsed PhD physicist, who previously worked for Nasa on the Mars exploration team. He is a former commodity trading advisor with the US Commodities Futures Trading Commission, and worked in a boutique futures house in California in the 1980s.

He was a partner in one of the first futures newsletter advisory services, based in Washington DC, specialising in pork bellies and currencies. John is primarily a chart-reading trader, having cut his trading teeth in the days before PCs.

As well as his work in the financial world, he has launched, run and sold several 'real' businesses producing 'real' products.