Monday, May 16, 2005

Three Peaks and Domed House in the Dow

For the past year I have been following the evolution of one of George Lindsay's Three Peaks and a Domed House formations in the Dow. In my 2003 and 2004 stock market forecasts I wrote that I expected such a formation to develop during the anticipated 2003-2005 bull market and in my 2005 forecast I identified such a formation in the Dow and analyzed its implications in more detail.

(Those of you who want to learn more about George Lindsay's approach to market forecasting should call Investor's Intelligence at (914) 632 - 0422 (New York state in the USA) and ask for a copy of "Selected Articles by the late George Lindsay".)

Once a Three Peaks and Domed House formation has been identified in its early stages it has great forecasting value because the market follows pretty much the same pattern time after time with minor variations. If the formation is a "major" one in Lindsay's terminology it usually lasts two years from start to finish thus giving it added forecasting value. Lindsay once estimated that the stock market in the US has historically spent about 60% of the time tracing out Three Peaks and Dome House formations.

The main characteristic of the market when a 3P-DH is developing is that the averages spend most of the time in trading ranges. Only occasionally will definite trends up or down develop and these typically last only a few weeks. This has been exactly the behavior of the Dow and S&P over the past 14 months.

The first chart you see above this post is the ideal model of a major, Three Peaks and Domed House Formation. The three peaks are labeled 3,5 and 7, while the top of the domed house is labeled 23. In a major formation peak 7 typically occurs six to ten months after peak 3. Moreover, point 23 typically occurs an average of seven months and ten days after point 14. For a more detailed discussion of the variations upon this theme one encounters check out Lindsay's original article in the booklet from Investor's Intelligence cited earlier in this post.

In my view the Dow Industrials have developed not one but two Three Peaks and Domed House formations during the past year.

The first one I discussed in my 2005 Stock Market Forecast. In that forecast I said that the three peaks were February, June and September of 2004. But since I now think this formation is only a minor formation I have relabeled the three peaks as the points 3,5 and 7 in black numerals you see in the second chart above. In this interpretation these three peaks are only separated by four months, thus making the formation a minor one. This minor formation probably ended at the April 2005 low.

There is also a major three peaks developing currently. It is labeled by the red numerals in the chart. I think that we saw point 14 on May 13. If so we can add seven months ten days to that date and estimate that point 23 will occur on December 23 of this year. I like this projection because it fits in more neatly with the implications of the other Lindsay methods which were discussed in my 2005 forecast.

So we conclude that the next seven months should be very bullish ones for the Dow.

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