NOTE: Please look for the interview with Jay Kaeppel in the November 2009 issue of "Technical Analysis of Stocks and Commodities" magazine on newsstands now.

As the old marketing slogan goes, "inquiring minds want to know." Or to put it into more timely and topical terms, "where will the stock market go from here?" That is the question on investors' minds these days. In recent months investors of all stripes have been lulled into a sense of semi-comatose calm as the stock market marched relentlessly higher. After the battering that many individuals took during the November 2007-February 2009 decline, a state of semi-comatose calm actually felt pretty darn good. Of course, that is the problem with the stock market. Just when everything starts to feel "comfortable" - blambo - right between the eyes, if you know what I mean.

At least that's how it is for those who did not experience the other end of the spectrum, that being the bitter pill of selling at the bottom. Ironically, these people have being praying for a pullback ever since, yet now are not sure if they should get back in. For there is a sense of relieved calm that comes with "making the pain stop," even as the market turns tail and runs to the upside, leaving one standing there trying to figure out just exactly what's happened. Good for the psyche in a weird way, but sadly not so good for the trading account balance.

It seems somewhat odd that in an area of endeavor that swings endlessly from one extreme to the other, the majority of investors still focus on seeking some kind of "comfort level." As if such a thing was possible. Investing in the stock market can lead you to become very wealthy, or it can lead you to become very poor, or it can lead you to someplace in between. But regardless of where your fortunes ultimately lay, the one thing it can do beyond all else is to cause you to experience great angst at times. The present time is one of those times. For as I mentioned, the dreamy little 60% run that the market enjoyed between March and October came to at least a temporary, but nevertheless, very abrupt halt during the last week of October. And now everyone is asking the question, "where to from here?" Is this just a routine pullback in a longer-term uptrend and should one simply hold on and/or use it as a buying opportunity? Or has the next down leg of a longer-term bear market just begun? I will throw in my own analysis at the end of the article.

BEYOND PREDICTIONS

As the market sold off and investors awoke from their stupor, market pundits everywhere (myself included) came out like Puxatawney Phil on Ground Hog Day, each spouting their "prediction" of what the future holds. I scoured the Web this past weekend to see what the general thinking was and here is what I found: rising longer-term moving averages, flat to declining shorter-term moving averages, rising regression channels since early 2009, declining regression channels from late 2007, Gann Fans, Fibonacci retracements, Elliott Waves, standard deviation bands and a variety of trend lines veering off in virtually every conceivable direction.

I have "helpfully" assembled a number of these findings into Figure 1:

Figure 1 - The Dow Jones Industrials Average with a few "helpful" indicators

While I am an ardent believer in technical analysis I couldn't help but to notice that this all pretty much proves once again the validity of:

Jay's Trading Maxim #532 (which states definitively that): If you draw enough lines on a bar chart, price will eventually hit one of them.

SO WHAT DOES IT ALL MEAN?

So is all of this analysis just a waste of time? No, that's not actually the point I am trying to make. The point is that in the end, some people will use certain indicators and methods and some people will use others. And ultimately that is okay since that is what makes the markets "go 'round." If we all agreed that some certain event always meant "buy" and another always meant "sell," then when we actually went to sell there would be no one there to sell to. So while I may at times poke fun at me and my technical analysis brethren, in reality things are just the way they should be. Which all raises the bigger question, which leads us directly to, well"

THE BIGGER QUESTION

So while the question on most people's mind is "where will the stock market go from here," the bigger and more important question that needs to be asked and answered is "what's your plan?"

A person looking for someone to tell them what the stock market is going to do will typically either:

a) Listen to the person with the most persuasive argument, or;
b) Listen to the person with the opinion most like their own.

But what if that person is wrong? This is exactly why "a plan" is of critical importance. So if I ask "what is your plan" and your first reaction to that question is "huh?", then my friend, we need to talk. For a person who answers the first question ("where is the market going next?") without first answering the second ("what is your plan?") is in danger of ending up as one of those poor souls who reacts a little too much and a little too late to every twist and turn in the market. And that is an unhappy place to be.

So what is your plan? For example, are you a "long-term investor?" At present, a "long-term investor" is loosely defined as an individual who:

1. Became conditioned over a multiple year period to believe that "the stock market always goes up," and;
2. Rode the 2007-2009 decline all the way to the very bottom and;
3. Has breathed a heavy sigh of relief in recent months as the market rallied and;
4. Just wants things to "get back to normal."

If this describes you personally, then the next relevant question is "have we learned nothing in the past 24 months?" Hopefully we've learned that investing in the stock market is much like taking a ship on the ocean. Simply trusting the wind and the current to get you where you want to go is generally a poor strategy. A rudder and at least a light hand on the tiller offers far greater odds. So it is too in the stock market. If you have some idea where it is you wan to go, and if you are willing to "take control of the ship," at certain critical junctures - even if you end up temporarily off course - you are far more likely to "make port."

SUMMARY

So one more question: "what would cause you to sell?" In other words - well, come to think of it, that is a fairly straightforward question as is. Some people will tell you the market is oversold and ready to rally higher; others will whisper in your ear that we are on the cusp of another serious down leg. Someone will ultimately be right and someone will ultimately be wrong. Same as it ever was. But none of that really matters.

What you must determine is:

1. "What will you do to defend your wealth and when" if the market starts to break.
2. "What will you do to maximize your wealth if the uptrend resumes in earnest?"

If you do not already have definitive answers to these questions, then it's time to stop browsing the Web and get to work.

MY OWN SHORT AND SWEET ANALYSIS

For the record, I don't have a crystal ball. I used to have one but sadly it took me longer than it should have to figure out that it wasn't actually working. Hey, live and learn, right? In any event, for what it is worth, here is my take on the stock market:

1) The major trend is presently "up." This is evidenced in Figure 2 by the fact that the 50-day moving average for the Dow is above its 200-day moving average. As I wrote about in an article titled "Going With the Flow," dated September 24, 2009, this simple crossover method has done a good job over the years of keeping investors on the right side of the major trend. The important caveat here is that there is no prediction built into this information. It simply tells us what the trend is right now.

Figure 2 - DJX with 50-day and 200-day moving averages (bearish cross in January 2008; bullish cross in July 2009)

2) Also buttressing the desire to give the bullish case the benefit of the doubt is the fact that we are now into the November to May portion of the "Sell in May and Go Away" cycle theory. As first uncovered by Yale Hirsch and as I wrote about in detail in Seasonal Stock Market Trends, over the long run, this period has far outperformed the May through October period in terms of overall stock market returns. See Figure 3.

Figure 3 - Growth of $1,000 invested in Dow November into May (blue line) versus May through October (red line) since 1949

During the past two years the Dow has declined between November 1st and early May of the following year. Nevertheless, for the record, since 10/31/1949:

• $1,000 invested in the Dow only between the close on October 31st and the close of the third trading day of the following May, grew to $61,118 (or +6,012%).
• $1,000 invested in the Dow only between the close of the third trading day of May through the end of October each year, declined to $845 (or -15.5%).

So I would not write of "November-to-May" just yet.

3) Lastly, a number of useful indicators are flashing "oversold" signals of late. Most notable among these are the widely followed McClellan Oscillator and the VIX Index (see the VIX in Figure 4).

Figure 4 - Spikes above 80 by the 3-day RSI of the VIX Index (bottom clip) often signal bottoms for the S&P 500 (top clip)

So for now investors can give the bullish case the benefit of the doubt. As always however, there are some cautionary items to keep an eye on. Market breadth (i.e., advances versus declines and new highs versus new lows) have weakened quite a bit. Typically, when breadth breaks down it takes a period of time before a major uptrend once again exerts itself. So a bit of patience may be required here.

If the Dow and other major averages pop back quickly to previous highs accompanied by light volume and without confirmation from the A/D line and an improvement in the new high/new low ratio - and if relative strength, stochastic, MACD and On-Balance Volume indicators fail to confirm by moving higher - that rally will likely fail and be followed by more "backing and filling."

Ultimately, the primary determinant of the next major move in the stock market will be the state of the economy. However, remember that the stock market leads the economy and not vice versa. And getting a handle on the future of the economy is tougher than ever these days. Anyone who is pro-Obama will tell you that the economy is getting better, anyone who is anti-Obama will tell you it is getting worse (can't we all just get along?). The only thing I know for sure is that in the history of U.S. economics, a heavy-handed government has almost invariably served as a deterrent to economic growth. Just something to keep in mind.

In sum, I continue to ride the major trend but am keeping a close eye on the exits. But, hey, that's just me.

What's your plan?

Jay Kaeppel
Staff Writer and Author of Seasonal Stock Market Trends
Optionetics.com ~ Your Options Education Site

Questions for Jay? Please visit "Ask the Traders" through the discussion board on the Optionetics.com home page.

NOTES:

Jay's latest book, Seasonal Stock Market Trends: The Definitive Guide to Calendar-Based Stock Market Investing, was ranked among the Top 10 Investment Books for 2009 by the venerable The Stock Trader's Almanac 2010. For more info, please click here.

Please look for the interview with Jay Kaeppel in the upcoming November 2009 issue of "Technical Analysis of Stocks and Commodities" magazine.