Prechter's trading service, the Short Term update (STU), had been holding firm on the nested 1-2 wave structure. I discussed several market scenarios earlier this week in the latest Big Tease post: the new bull, the expanded flat correction into August, and the nested 1-2. The outside limit of the nested 1-2 was Sp1100, the point at which the inside wave 2 was no more than the outside wave 2. (If the inside waves get bigger than the outside, this is likely not a nested 1-2). Mother Market hit that level several times and could not break through. The fade off it for the past two days is fairly large, and brings us back to the level of the Flash Crash: Sp1065.
Tonight's STU discusses the odds of the dreaded wave iii of 3 down having started. The weekly decline was broad-based, and in general an increase of volume indicates the direction of trend, in this case down. SlopeofHope had noted an EWI pattern of an 8-9-day rhythm of market turns, reprinting the following chart from EWI. These sorts of patterns come and go, but this worked this week to peg the change of trend down. The topping this week was "ragged" according to the STU, so now we might now see this 9-day pattern fade away, and have a general down trend without a turn back up in the next 9-day window (the turn of the month the week after next).
The STU discusses some of the alternate wave counts of its readers (as reflected in blogs such as this), and added this very gracious commentary, which I hope they do not mind me repeating:
A lot of readers were absolutely certain that the market's main indexes were headed above the June 21 highs, and even higher into August. Leaning against the prevailing sentiment can be difficult at times, but it is something that a wave practitioner gets used to quickly. That certainly does not guarantee one's success, but it helps to recognize emotional extremes when forecasting an impending trend change. And in fairness, there are still alternate potentials, albeit waning, that allow for a market recovery that carries above 10,600 (1132 in the S&P) prior to the start of the next big down phase of the bear market. The odds however, continue to favor the wave count that we've consistently showed over the past month or so in these pages.
If we do head south, we should at least get to the Sp860 level (Dow8200), which probably seems beyond belief to most investors right now. Along the way we will have sharp and deep reversals - this one went beyond the normal 50-62% to come back 74% (S&P) to 81% (Dow), bracketing the outside retrace level of 78%. You can see similar deep retracements in the period after 2000, and in the sickening slide after the 50% Hope Rally in 1930.
We are in a channel downward which points to a much deeper drop. AllAboutTrends had a nice crisp commentary about the market staying within a downward channel on Friday, and the market acted to their prediction. Mike Paulenoff concurs, finding the dominant downtrend intact after the S&P failed to hurdle the upper channel resistance:
The other indicator to watch is the Dollar Index. The USD has corrected about 50% of the rise from DX74 last December to DX89 on Jun7. It fell sharply yesterday and bounced today. The Euro got back to $1.30 and the AUD to 89c before falling today. A turn back up should coincide with the wave 3 drop. If we see a USD drop and Euro rise on Sunday evening/overnight, we might also see a snap-back stock rally Monday/Tuesday. Both moves should be short-lived.
While the odds of the big drop have increased, the downturn in the last two trading days does not yet confirm it. One of the alternative scenarios is the BIg Tease, which has the market in a large ABC flat wave 2 since the end of the Flash Crash movement down, rather than a nested 1-2 i-ii structure. You can read more about it in Mother Market is a Big Tease. We would be in the C wave of the Big Tease, and it would break as a five-wave move. This drop would be a wave 4 of C. Wave 4's normally correct 38-50% of the prior wave 3, which went from just below Sp1020 to just below 1100, or a little over 80 pts. We remain in a normal corrective range. Wave 4's can go farther, and it would take a breach of the range of wave 2 (ie. breaking below the top of wave 1) to confirm that something else is going on. Take a look at this chart from Carl Futia of several days ago:
Carl puts boxes around waves 2 and 4. (This is the e-mini chart, so slightly different than the cash S&P chart.) The top of the first box is the end of wave 1, around es1040, which works to Sp1042. The second box is wave 4, which in the two days after he posted this has broken below the bottom of the box, invalidating Carl's bullish prediction at that time (the red line). It would take a run below the 1040 level to break the Big Tease count.
Carl has a bullish bent, and even if we break the 1040 level, there still remains a bullish count. I have previously dissected Carl's simplistic count, and think the bullish structure is different. One of the problems with calling the Hope Rally since March 2009 a new impulse wave is the awful internals - overlapping waves and lack of smaller degree impulsive structures. Even this Big Tease C-wave is very ugly and difficult to call impulsive. Take a look at this chart of the S&P (courtesy EWTrends) and eyeball the sloppy overlapping structure and the odd look of waves 1-2 (blue) relative to the rest of the pattern:
Now, sometimes it is better not to see the sausage factory, and a smoothed version of this like Carl's e-mini chart above shows the pattern more clearly. Nonetheless, given the lack of impulsive waves, a second alternative is gaining in odds along with the dreaded iii of 3 down: Neely's triangle count. The simplistic bullish count sees five waves up in the Hope Rally, with two major corrections before April 2010: the run to Jun11 (wave 1), the drop into July9 (wave 2); the long run into Jan 2010 (wave 3) and the drop to Feb5 (wave 4); and the final run into Apr26 (wave 5). Given the sloppy overlapping character of the so-called impulse waves (1-3-5), especially 3, Neely instead counts the whole pattern as a double correction where wave 2 is part of a triangle off Nov 2008 and 4 is an X wave. (Neely's view also works if you view the Hope Rally as a triple corrective pattern with two X waves connecting three corrective structures.) He finds us still in a corrective pattern, and counts it as an ABC flat where the A wave ran from Feb5-Apr26 and the B wave is still on. Given this is a flat, and wave B has already gone lower than the start of A (the 1011 bottom several weeks ago is lower than the Feb5 level of 1044), the C wave may not go to new highs but truncate below the Apr26 level of 1220.
The important thing right now is the B wave. It seems to be breaking as a triangle, where what EWI counts as a 1-2 followed by a i-ii, a four wave pattern so far, Neely counts as legs abcd of a five-wave triangle. We would be in leg d, and the correction the last two days may just reflect a middle wave B of a three-wave leg d. Unlike the wave 4 of the Big Tease C wave, Neely's leg d could breach the 1040 level and still be on. Usually, however, a minor B wave in an ABC zigzag (which is what leg d appears to be) does not go back more than 50-62%, which means a break of 1044, the 62% level, would stress his count.
- watch the USD/Euro overnight/next few days for a major USD bounce
- watch for a break of 1040-1045
A failure of both indicates the market is still in its Big Tease.
PS - the potential reversal in the USD to back up is a much bigger play than shorting the S&P! It may be the inordinate focus on the stock market is simply missing bigger opportunities elsewhere.