This is an update of my post of 22 February 2011. The second half of this post also contains new material related to an Active Trader (April 2011) article and will be stored in the new folder “Ongoing MIDAS Research” along with Bob English’s chart.

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A.Coles, 17 March 2011

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Summary and update

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The purpose of my Feb 22 post was to warn readers that an important price/time inflection was clearly visible on a number of European and US stock indices and hence to warn of a possible top.

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Prices were rallying hard on Feb 22 when the post was made. Since then, however, the major indices have broken both the 20 day and 40 day moving averages as well as the September 2010 intermedediate degree trendline (ie, 6 weeks to 9 months), indicating that a correction of at least this magnitude is now underway.

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However, on Tuesday of this week the DAX also ominously broke its March 2009 primary degree trendline. Since this trendline originates at the subprime low, this is now of considerable significance and points to the correction being possibly of primary degree proportion (ie, 9 months to two years). However, since a correction of this degree is highly unlikely so soon after a major market bottom in March 2009, the real possibility that must be considered now is that the market is beginning the putative wave C which, according to conventional Elliott Wave theory, has long been predicted on the basis of the relatively clear wavecount on a number of international indices, including China’s Shanghai index. My next post will cover this large topic.

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It’s clear in any case that this was indeed a major inflection point in light of the data that were confirming big related intermarket moves last week. The Reuters Jefferies CRB index was down 2.9 percent over the week, its largest fall since last November, and copper and iron ore were also down 8.6 percent and 6.2 percent respectively. I’ll return to these data too in the next post in relation to some recent MIDAS work on the Baltic Dry Index, which had been warning of the implications of China’s troubles for some time. The flipside of these large moves was haven movement in US Treasuries, gold, and the US dollar.

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The inflection point in price and time

Before saying more about the implications of these major technical breaks on the indices, I’ll quickly recap on why this major inflection point stood out so much on February 22.

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The price aspect of the inflection point was identified by several indicators.First, price was about to test the major downside trendline on Bob English’s long-term detrended MIDAS curve on the DJIA (www.precisioncapmgt.com), which he drew attention to in a privately circulated email. Courtesy of Bob I’m posting the chart here as Chart 1.

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Chart 1

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Second, there was a clear  five wave Elliott Wave impulse completing from the July 2010 bottom accompanied by a very significant negative divergence on the weekly MACD histogram. I posted this chart in my February 22 post and readers can see it here .

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The time aspect of the inflection was identified by the Long Term Delta. For readers not familiar with Delta time analysis, it’s an extremely accurate, almost clock-like, fractal system discovered by the Chicago commodities trader Jim Sloman and then adopted by Welles Wilder, who discreetly publicized it to the fund-management community before later writing a book. It’s vastly superior to standard cycle analysis. The Long Term Delta (LTD), one of several fractal time levels the system identifies, is roughly equivalent to the intermediate-term trend. My solution to the LTD on the S&P 500 was signalling the start of a new cycle barring an inversion. It’s clear now that an inversion did not occur. I can therefore update the LTD by stating that the next LTD pivot is due between early May and mid-June. See Chart 2.

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Chart 2

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It’s not possible to be more precise than this due to the small amount of variance in the system. Readers note: I’m not claiming that a major bottom will be in place between these dates, merely that this is the next significant time juncture on the LTD and that it will affect the market by at least three to four weeks.

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As for price targets, it’s possible right now to launch a bottomfinder on the DAX (as on many other indices) because the displaced move is parabolic. However, I suspect that this will only forecast to the current end of this parabolic move, which I doubt will coincide with the time period forecast by the LTD. The DAX futures are currently being supported at the 6,400 area, because this related to the swing highs created during the March-July 2010 correction. However, this support area won’t last long and I suspect that S1 is a more realistic target. See Chart 3 below. However, note that S1 on the VIX has already been taken out (see below). This might be forewarning of what’s to come with regard to the S1 subprime curve on the indexes.

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Chart 3

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Additional MIDAS tools recently applied to the uptrend between March 2009 and the recent February 2011 top

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I flagged this post as containing new MIDAS work insofar as I have been following this uptrend with several additional MIDAS indicators that don’t contain the VWAP formula upon which MIDAS curves are based. For interested readers, I have an article appearing on this topic in the April edition of Active Trader. The material came too late for the book.

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MIDAS volatility curves on the VIX

First, if we look at Chart 4 below we’ll see three MIDAS volatility curves on the VIX. The VIX is one of the most widely quoted indicators in the popular financial press but it’s hard to understand why technicians haven’t used the volatility data to create more accurate signals. One obvious thing to do would be to run a momentum formula through it to get consistent signals that can measure trends of various durations depending on the lookback period, much like Larry Williams did with the Stochastic to create the COT Index from COT Report data. In any case, creating MIDAS curves from VIX data is one way of creating novel support and resistance fear/complacency signals from the VIX.

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Chart 4

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As we can see if we look at the blue arrow and the large red one on the right, a MIDAS curve has been resisting pullbacks in falling complacency all the way up this uptrend since September 2010 and even before it, since the blue arrow below the large red one highlights that it was possible to launch the MIDAS resistance curve on the VIX in late May, a good month before the S&P 500 bottomed. Indeed, with some porosity the VIX even resisted the volatility (“fear”) associated with this bottom.

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Moving to the far right of the chart, we see that the pullbacks in the recent uptrend since September have been timed extremely well by the VIX MIDAS curves, as they resist pullbacks in ongoing complacency. However, the current February-March decline was resisted on the VIX initially by three MIDAS resistance curves, two coming all the way back from the March 2009 subprime bottom. Again, the fact that this major resistance area in downwards complacency has been taken out has to be taken very seriously.

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Importantly, I notice that the same price-based curves on the S&P 500 are a long way from being tested. Does the breaking of the VIX curves from the same subprime 2009 bottom imply an early warning that the price-based curves will also fail to hold price? Only time will tell. In any case, early warnings of price moves on MIDAS curves plotted on time series other than price would be yet another new use of MIDAS curves. I’ll watch this chart with interest. In due course, I’ll also start plotting MIDAS support curves on the new volatility uptrend on the VIX. See Chart 5.

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Chart 5

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MIDAS Momentum Curves on the MACD

Another chart of interest in relation to the recent Febuary-March top is Chart 6. This chart is also of interest in so far as it’s another example of MIDAS curves being applied to new time series and thus of not containing the VWAP content. The use of the MIDAS curves on the MACD is restricted to times when the MACD opens out and starts trending. It doesn’t always do this, since it will often oscillate fairly rapidly back and forth like a bounded oscillator. See Chart 6.

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Chart 6

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In Chart 6 we see the MACD in relation to the S&P 500. For the purpose of this blog entry, our interest is in the momentum MIDAS curve launched from point (3) on the right. Notice that, like the VIX MIDAS curves, it too was launched a month or so before the actual price low, thus supporting it definitively when it did come. In Chapter 16 of the book I worked with On Balance Volume as the independent time series and called this phenomenon the Dipper Setup, meaning that in divergences you can launch MIDAS curves from time series tops or bottoms to catch the actual price highs or lows rspectively. For decades traders have celebrated the power of divergences to warn of the ends of trends, but have grown weary of trying to time them. This particular application of MIDAS curves is a genuine solution to this intractable problem.

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In any case, the blue arrows reveal how powerfully the MIDAS momentum curve has supported the September intermediate uptrend. However, it too has now been tested successfully in this February-March downtrend, and this too must be regarded as another indication of some significance, since we now have breaks in price, momentum, and volatility. This indeed was an important price/time inflection point.

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MIDAS Curves on Economic Datasets: the Baltic Dry Index

I’ll write a separate post on this.

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