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FRED GOODMAN'S KEY INDICATORS FOR
INVESTMENT SUCCESS
This is based on a report Fred wrote on September 23, 2001, shortly after the markets re-opened following the terrorist attacks of September 11, 2001. I am going to examine the market after Pearl Harbor, in comparison to the market since the terrorist attacks on the World Trade Center and the Pentagon. Back to 1941... The market had been falling for some time, and falling acutely just before the Japanese attack on Pearl Harbor on December 7. This, you will see, is exactly what the market was doing just before 9/11. The immediate response in 1941 was a huge increase in volume and a major shock to the Dow. There were two sharp declines and then a pause for 6 days before the decline resumed in earnest. The important point to be made by this chart is the market action for the next few months was decidedly down, but was followed by a sustained, almost uninterrupted, advance lasting for the next year and a half!
This can be seen more clearly in the enlargement below. There was just one rally, of around 7%, before the April low was made.
Here is the current situation after the terrorist attacks of 9/11. The market had been falling for three months before the attacks. The market response has been sharper than in 1941 and more sustained -- we have suffered six straight declines since the the markets were reopened. The volume has been excessive, just as in 1941, and it is unlikely that we will have a rally until things calm down a bit. This coming Thursday, being a Jewish holiday, is virtually assured to have lower volume -- but hopefully it will not take that long for a pause in the decline.
Here is a side by side comparison of the two events. The vertical line connects the day before each one. In 1941 the first leg down was around 7% and around 10% before the first meaningful rally. We have already sustained a 14.3% drop in the Dow. However, there will be a rally. Many indicators are lining up ready to reverse from extremely over-extended positions. The new highs, as a percent of the new highs plus new lows, is now around 8% for the NASDAQ and 23% for the Dow. When these climb back above 25% you can count on a good solid rally, at least that has been the pattern for the last few years. It would not surprise me to see this happen after the initial bounce. Remember, I am not expecting too much from the very first bounce.
Now let's look at the price/volume charts from 1941. It is of considerable interest academically, but of no interest from a practical point of view, that there was a sell loop on the day after Pearl Harbor. Since the loop was closed the day after and confirmed the day after that, it was not useable -- too late. This time, if you remember, we had several sell loops long before the attack. After the decline in 1941 there was a low-volume "continuation sell loop," as illustrated below. This led to another decline of almost 5% before the only rally before the April low.
That rally was kicked off by an invalid buy loop, one that is destroyed by the removal of a signal day. Please refer back to the chapter on price/volume charting if the "remove on day rule" is unfamiliar to you. The top of the rally saw a clockwise loop completed, as you will see in the next chart.
Unfortunately, the loop was closed by a decline. We can never rely on a buy loop which is completed to the downside, or a sell loop completed to the upside. This was no exception, as you will see in the next chart where a counterclockwise pattern formed that looks like a sell loop, but is not valid due to the "remove one day rule." The day to remove is the second lowest volume point in the chart below. Nevertheless, the market continued down to 92 in April of 1942.
The bottom was reached in the next chart after two invalid buy loops and a sell loop completed to the upside. It would have been easy to miss the bottom based on the price/volume charts alone, but take a look at the activity following the bottom, in the final chart.
Twelve trading days after hitting 92, there were two buy loops. The first was completed to the downside and should have been ignored, but the second one was completed at 98, only 7% above the absolute bottom, with the market headed directly to 142, around 50% above the bottom, over the next year and a half.
Now obviously I have no idea if history will repeat itself. But to bury one's head in the sand is to guarantee that the rally will be missed, while to blithely assume that the bottom has been reached already is also likely to lead to poor results. I feel that it is too early to buy heavily, not only because of the example of 1941, but also because now -- as then -- there are considerable risks of further political and military activities that will likely produce negative market moves. Better to approach this slowly with gradual purchases of stocks or ETFs showing good relative strength, until a few indicators have signaled that the bottom is really likely to be behind us. Fred Goodman, CFP, is a fee-only Certified Financial Planner based in Los Angeles. You can send him your questions and comments via email at Fred@MarketMonograph.com. The charts and commentary represent what Fred is thinking about the market and thinking of doing for his own account and for accounts he manages. There is no guarantee that you will profit from trading as discussed herein. You may lose money and Fred assumes no responsibility for what you do or do not do with this information. 
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