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Cramer: Breakout or breakdown, chart patterns tell the story

Friday, 12 Jul 2013 | 6:16 PM ET
Can the averages keep on roaring?
Friday, 12 Jul 2013 | 6:15 PM ET
Mad Money host Jim Cramer digs into the S&P 500 using the methodology of Carolyn Boroden of FibonacciQueen.com's.

(Click for video linked to a searchable transcript of this Mad Money segment)

With the market sitting at or near all-time highs, should you sell or buy more?

In other words, can the averages keep on roaring, or have we reached a level where stocks are overextended and due to get pummeled?

"This is the kind of issue where it really pays to check your emotions at the door and think about things empirically," Cramer said. That is, it's easy to get swept up in the euphoria of the advance but euphoria is rarely a friend to investors.

Whenever pros such as Jim Cramer need to take emotion completely out of the equation they turn to technical analysis to see what chart patterns suggest.

And for the following analysis Cramer turned to Carolyn Boroden of FibonacciQueen.com.

Boroden is an advocate of charting so-called Fibonacci levels, a method of analysis based on a series of ratios discovered by the medieval Italian mathematician, Leonardo Fibonacci.

According to Fibonacci analysis, the way bull markets typically works is that you'll have a pullback that stops when it retraces a key percentage of a previous move higher—these key percentages all come from so-called Fibonacci ratios: 23.6%, 38.2%, 50%, 61.8%, and 100%.

Fibonacci analysis also suggests that in a bull market, once a decline ends, the stock market will gain more than 100% of the prior swing.

Temnly | E+ | Getty Images

According to Boroden, after the swing lower, the current market has been advancing 127.2%.

Confused? In other words, in a bull market after a decline has ended, the overall stock market recaptures losses and then some.

Now, here are the key levels.

Boroden's target is 1,721—that would be a 127.2% reversal of the recent sell-off.

(If you're still with us, her next target is for the S&P 500 to go to 1765; that's a 161.8% extension of the previous swing, another key Fibonacci level.)

And looking at a longer time horizon, Boroden thinks there's every reason to believe the S&P could climb to 1,823. That's because when you look at the down-swing from the 2007 peak to the generational lows in 2009, the rally over the last few years has only recently erased 100% of that move lower.

Again, Boroden says typically gains are 127.2% of the previous pullback. In this case, that would take the S&P all the way up to 1,823.

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It's worth noting that other chart watchers aren't so bullish.

Carley Garner, the co-founder of DeCarley Trading thinks that the market will probably get short-term toppy sooner rather than later, because stocks typically have a rough time making progress over the summer.

She says it's possible we could see a repeat of what happened in the spring and summer of 2011, when the market ran up to make new highs then failed. That said, even Garner believes that, after a rocky summer, the stock market will come back to make a nice year-end run.

Although Jim Cramer is a fundamental investor, he thinks the technical analysis warrants attention.

"Even though I'm not a chart guy, I'm bullish and it appears the charts are on the side of the bulls," Cramer said. "However, I agree with Garner that a time-out could happen when we get into the thick of earnings next week."

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