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Friday, April 13, 2012

Why Do Analogs Work? -- Part 1

Short answer: it's complicated.

I received an excellent question from a reader this morning and found myself pouring a little more into the answer than usual.  Maybe the answer -- which swerves headlong into the issue of whether chart patterns work -- deserves its own post.

The reader suggested that the Fukushima earthquake in Mar 2011 was the cause of the market's decline and, since such a huge event was unlikely to repeat in our timeline, the current analog we're following is unlikely to play out.

While the earthquake obviously helped the market along, SPX started down in February 2011 because: (1) it was very deep into a rising wedge; and, (2) it had completed a huge Crab pattern that started with the April 2010 sell-off; and, (3) it had just completed a H&S pattern.  The following chart clearly shows all three patterns.

Before Fukushima came along...

The apex of the rising wedge (solid, yellow) was around 1380 (the .786 of the huge Gartley Pattern  set up by the 2007-2009 decline.)  SPX had come .886 of the way in time and price towards the apex -- very deep indeed.

From months earlier, the Crab pattern (red, with key points in white) had forecast 1348.89.  We had reached 1344.07 and were already reversing as typically happens.

And, the Head & Shoulders pattern (dashed, white) had already completed.  It targeted 1250, which is exactly where we were 8 sessions later.

But, perhaps the strongest reason had SPX turned tail at 1344 was because it had just tagged a trendline (bold, red dashed) that dates all the way back to 1935.  This TL is actually the midline of a channel that, with very few exceptions, has contained all the major market moves back to the Great Depression.

This midline had been support for SPX since 1991, but became resistance when SPX fell back through in September 2008.

After Fukushima...

The market continued to do what these chart patterns had already predicted.  In fact, six sessions after Fukushima, the market had completely recovered -- reaching the May 1370 high only 29 sessions later. Stay with me, now, because this is where it gets interesting.

On May 2, SPX was on its way to completing that big Gartley pattern.  After 910 points down, and 704 points back up, SPX was a mere 11 points from completing a very well-formed Gartley at 1381.50.  Nothing could stand in its way -- except that annoying midline, again.

Nine weeks and a Bat pattern later, SPX began its 255-pt swan dive -- just as the analog said it would.

With the backstory out of the way, wander on over to Part 2 in which we discuss how the analog predicted last July's crash (and what lies ahead.)



  1. Great analysis, can't wait for the sequel, if you don't mind, can you also relate the analog to now and how it should play out if it were to follow, Too bad I don't play options, or else a 28x increase in my portfolio will be nice, I will settle for a double. Have a nice weekend.

  2. Nice work PW. I do like the way this plays out. Thanks for your work