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Technical Analysts Are Running for the Hills… But Don’t Follow Them

It’s Friday… so that means we take a break from our regular articles and plunge into the world of charts instead.

Once again, I’ve selected a couple of compelling graphics that put the week’s investment news into perspective.

This time, we have a dose of technical analysis and (gasp) bear markets. Here goes…

Wall Street Shakes its Magic 8-Ball

As if America’s near-death experience over increasing the debt ceiling wasn’t enough, we’ve also had to endure a terrible stock market for almost two weeks.

In fact, on Wednesday, the Dow was poised to extend its losing streak to nine consecutive days. The last time that happened? Way back in February 1978, when another Democratic president was contending with a period of anemic economic growth.

However, the bulls mustered up enough momentum to eke out a 30-point gain by the end of the day and the losing streak was snapped at eight days. Alas, the market reverted right back to form yesterday, though, with massive losses.

So is this bull market still intact? Not according to the foremost technical analysts…

Head and Shoulders… Knees and Toes

“The technical line in the sand is 1,250 on the S&P 500.”

So said Bank of America’s (NYSE: BAC) Mary Ann Bartels on Tuesday. She’s ranked third among analysts who study price charts in Institutional Investor’s 2010 survey, so we should listen to her, right?

Well, look out! Because the S&P 500 did indeed dip below that level this week.

However, I don’t recommend you put too much stock in Bartels’ line in the sand. Why?

Because technical analysis is a crock! Okay, that might be a bit harsh. It’s more accurate to say that technical analysis is… well, largely inaccurate.

That’s not just my opinion. A 2010 study from Massey University in New Zealand states: “Over 5,000 popular technical trading rules are not consistently profitable in the 49 country indices that comprise the Morgan Stanley Capital Index… [the] rules do not add value beyond what may be expected by chance when used in isolation.”

So does the latest out of Bespoke Investment Group. As the firm wrote in a recent research note: “There have been quite a few head-and-shoulders and reverse head-and-shoulders calls for the market in recent years and… most haven’t worked out as planned.”

Hmm… so much for Investopedia’s assertion that the head-and-shoulders pattern is “one of the most reliable trend-reversal patterns.” Maybe the “knees-and-toes” pattern is more accurate?

In all seriousness, if you’re really concerned about a bear market, there’s only one definition and two numbers you need to worry about…

Why These Two Numbers Are Crucial

The official definition of a new bear market is a 20% decline that was preceded by a 20%-plus rally.

Well, a 20% decline from the May highs would put the S&P 500 index at 1,097 and the DOW at 10,342. And we’re not there yet, folks.

So relax and mind your trailing stops. If and when the indexes drop below these levels, it’s time to start adjusting our strategy. That is, making more aggressive moves to sell short fundamentally flawed stocks.

That’s all for this week. But before you sign off, do me a favor: I’d love to know what you think about our work at Wall Street Daily. So get involved by sending us an email to feedback@wallstreetdaily.com or by leaving a comment on our website.

Thanks and enjoy the weekend!

Ahead of the tape,

Louis Basenese