Filling in gaps

For the week ending July 17, the Dow Industrials, the NYSE, and the Nasdaq all made new highs which were confirmed by their volume lines (that is, the volume lines also made new highs). Value Line (which is really an unweighted version of the NYSE) didn't make a new high but its volume line very nearly did and it is leading the index up. The Amex also didn't make a new high but its volume line did.

New confirmed highs were also achieved by the London, Paris, and Frankfurt indexes. Even the Nikkei Dow in Japan is beginning to look better It is, of course, at less than half the level of its ultimate peak (around the 39,000 mark), but nevertheless, the volume line is in better shape than the index. So, the world isn't falling apart, folks. It's still a bull market.

Why is the market backing-off, then? Well, the Bulls (I talked about them in the last issue) recently got up to 54.3%, just under the danger level of 55%. So, out comes Greenspan who says that interest rates might be going up. That should scare them enough to get them to back off. Isn't his timing wonderful? Right on cue.

The Toronto market has been the big laggard. While the Dow has tacked on about 7% since the June low, the TSE has only advanced half as much. However, the volume lines of the four major indexes (TSE 300, 35, 100 and 200) are all close to their previous highs and are stronger than the indexes.

One index I like to watch is the TSE 200 because it tends to leave gaps (spaces) from time to time. In order to see gaps, you have to look at a bar chart. The chart is made up of vertical bars which connect the high and low for each week (day, month) while the close is recorded as a horizontal tick on the right of the bar. An upside gap is created when the low for the current week is above the high for the previous week. A downside gap is created when the high for the current week is below the low for the previous week.

The TSE 200 peaked in October 1997 and began a descent in which it almost retraced its whole upside move from May of that year. However, it left a downside gap in the second week of its decline, very close to its October`-peak. Now, the great thing about gaps is that they tend to get filled in. What does that mean? Well simply, once the index bottoms, it will usually advance to a point which is higher than the level at which the gap was created. The converse is true in the case of upside gaps. That is, the index will usually decline to a point which is lower than the level at which the gap was created.

The 200 bottomed in January of this year and began to climb back up to fill in the October gap. It did so in April and peaked in the third week of that month, just slightly above the gap. On the way up, the index left four upside gaps, one in January, one in February, and two in March. So, I knew that, since gaps tend to get filled in, the odds were pretty good that the index would decline enough to fill all four of them in. Well, by the end of May, the two March gaps had been plugged up. Then the market rallied a bit in June and it now looks like it's going to head south again to take care of the remaining two gaps. That's more than likely the reason for Toronto's poor performance since June-the gaps haven't been filled in yet!

The good news is that, the very next week after the April peak, the indexyou guessed it-left a downside gap, almost right at the top! So, what does that mean? Well, once the January and February gaps have been filled in (that would take the TSE 200 down to about the 380 mark), the odds are pretty good that the index will go right back up to fill in the April gap. The other less likely possibility is that it will go up and fill in the top gap first and then come back down to fill the bottom ones.

The great thing about all this is that the market is telling us in advance what is likely (not inevitable, but likely). If you overlay all the New York and Toronto indexes on the TSE 200, you will see that they all tend to top and then bottom out pretty much at the same time. So, you can use the TSE 200 as a guide for the rest of the market. The 200 is not the only index which leaves gaps. You will occasionally (but not as readily) see them in the 300 and 100 indexes but never in the 35 or New York indexes because of the way they are constructed (that's the subject of another article).

As far as stocks are concerned, I can see no reason to change my position. Stay in the interest-sensitive, consumer staples, and technology sectors and avoid the resource stocks.

PATRICK TAYLOR IS AN INDEPENDENT TECHNICAL ANALYST.

Copyright Canadian Shareowner Magazine Inc. Sep/Oct 1998
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