For the past few years since the major stock market drop we saw from 2007 – 2009, I’ve been watching these markets very closely.  The biggest reason is because I’m curious to know whether this bounce we’ve seen in the last few years is something that is going to result in new highs, or are we going to drop, and possibly drop really, really hard from here.

I’m mostly a technical trader and a Fibonacci trader at that.  I do pay attention to the economic news that surrounds us from day today, however, my explanation about why I think the 2011 year close is really important is going to be shown from a technical perspective.

Let’s start out by looking at the smaller picture first (I’d usually say lets look at the bigger one, but I think this way might be better).

If we take a look at the Dow Jones Industrial Average (DJIA), you’ll see that we are currently trading just below the 1.272 Fibonacci extension of the last impulse leg up (6,426 – 11,318) at just under 12,500.  Now, for those of you who are either unfamiliar with Fibonacci extensions,  or are just getting to know them, it should be noted that when markets advance through a structure (in this case when it broke up through 11,318) there’s about a 70% chance it advances to the 1.272 extension (in this case 12,649).  What we also know is that markets tend to either consolidate around these level and either reverse or they consolidate and keep on going (likely to the 1.618 extension which is 14,342).  So far, we have not gotten a full answer, yet.

Dow Jones Industrial Average Monthly Chart

Now here’s where the big picture comes in. If we take a look at the yearly chart of the DJIA, I’m sure you see a slightly different picture. Currently (as noted on the monthly chart) we are hovering in area where the market can make a deciding factor of where it wants to go. What I mean is, if this market decides that it wants to keep going up and we see a break and a close above 13,000, then there is a good chance we’re going to see 14,342.  However, if the market starts to pull back (which we are currently seeing) and continues to pull back down to at least 12,100, we could be in for some hard selling come 2012.  What’s important to understand is what the yearly close looks like matters a lot.  By my analysis, if the Dow trades and closes the year below 12,100, we could be in for some real hard selling.

Down Jones Industrial Average Yearly May 2011

To put this into perspective, I’ve Photoshopped the chart below to show what the Dow would look like if it closed 2011 right around 12,000.  If you’re a technical trader like I am, you’ll clearly notice a a few things.  First, that is one heck of a head and shoulders pattern (80 years in the making), and second, a close like that would be pretty bearish.  I want to be clear, I’m not saying this is going to happen. However, I am watching this level very closely.

Dow Jones Industrial Average Monthly Chart - Photoshopped

If this scenario were to happen and come December 31, 2011, the DJIA closes around 12,100 or lower on the yearly chart, what am I looking for going into 2012?  Well, based on what I’m seeing, I would look for a minimal move down between 9,000 – 10,000.  It’s possible that we even see what many people would call a “double dip” which would be the case if the Dow came all the way back down to about 7,000.  Longer term, it could get real wild if the market breaks that 7,000 area. A scenario in which we could see 5,000.

A lot will be going on in 2012 as well. You have U.S. Presidential Elections, some believe the world will be ending, and I’m sure a lot more.  In either case, this is a critical year for the markets if you ask me; and that’s why where we are now has a huge impact on what this market may do for the next few years.