I posed a simple test between Wave Theory and Fractal Finance last night. This is the fourth such test in the past few weeks, and so far fractals are ahead 3-0. Call this the preseason. The test is whether we have begun the dreaded P3 wave down to new lows, or have a sideways market for the next few weeks. The key is whether we break Sp1040 in short order, and stay below, or meander sideways. If we break above 1130, both lose!
The Fractal Finance model looks for Thrusts and Plateaus, and watches for the Bifurcation Point when we thrust out of a plateau (a trading range). We are currently in a small plateau between 1040 and 1067, which is inside a larger plateau between 1040 and 1130 that goes back to May25, the bottom of the action after the Flash Crash. Here is the near term plateau, courtesy Contrarian Advisor:
Tonight's STU is confident the downturn has *finally* started. They are working off a nested 1-2 count since he Aug9 high, which is captured in this next chart from EWP, who says the chart is shouting that the downside is Quite LARGE:
The STU view is that we should not retrace back above the inside wave ii high at sp1065 (es1072 in the overnight futures). The STU is working off some pretty powerful ratios and markers:
- the Hope Rally, a big wave 2, went back 62% of the fall in the Dow off 2007
- the recent summer rally retraced 50% of the drop off the Flash Crash high in April
- the downward trend since has been in a fairly tight channel, an indication of an impulse wave
Wave (iii) should quickly draw prices below the July 1-2 lows at 9614 (Dow) and 1010.91 (S&P)
Could be. Yet volume is not confirming. While we had a 90% down day today, we had anemic volume again. Market Thoughts also worries over the low volume as deconfirming wave (iii) down (see next chart). They also note divergences across several indices, and have a scenario to make it all fit: that we are not in nested 1-2's but in a wave (i) down which should bottom shortly, perhaps below 1040 but above 1010, and then we have a Labor Day Rally. Here is their take on volume:
Curiously, even the normally bullish Carl Futia is now near-term bearish:
If this market is about to rally as I expect we should see strength above the 1050 level early tomorrow. Failing that I think a further drop at least to 1025 and probably to 1010 will be the next development.
I have not mentioned Neely's views much recently, but it is worthy to note that he thinks we are about to rally. His model has us in a B wave since the Flash Crash, which is about to end in time and price, and it should be followed by a C wave rally. This pattern began on Feb5, with the runup into the April high an A wave. He thought this B wave was breaking as a triangle, but it seems to be better counted as a double flat. He is the most bullish of the wave theorists right now. If we break 1130, where both orthodox wave theory and fractal finance would lose, Neely could be considered the winner.
The Fractal Finance near-term view is a sideways move, and this drop is part & parcel of it. Interesting is that a sharp False Break below 1040 followed by a Labor Day Rally would be consistent as well if the drop and bounce is fast. Hence watch whether we continue down on increasing momentum, or slink sideways into Sep, which suggest a run up above the recent plateau into at least the 1074 range if not higher.
Lots of economic news this week, and it is the last week of vacation season. The market is normally somewhat positive into Labor Day, and quiet; but we are seeing fireworks on forex markets due to Japan initiating a new round of stimulus. A sideways move should not surprise, and it may be accompanied with an increase in swings in global markets.