Prechter May have Nailed This One

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.

Summary:

• 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.

Comments

[DG]

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).

It's not just the arithmetic size that matters, it's the percentage retracement of wave 1 at each Degree. On that measure, the second wave-2 is actually larger than the first.

Again, I think there is an error in the logic here.

I also find myself not completely convinced by Neely's count from the April high. That said, my count and his count could continue to be quite similar, behavior-wise, for the immediate future.

http://img830.imageshack.us/img830/44/spxdailyjuly4.png

[Smiddywesson]

EWT works great, and I incorporate it into my position trading. It also influences my shorter time frame trading. BUT EWT relies upon human sentiment being reflected in the markets, and there is a difference between human sentiment and price action, particularly during a once in a century meltdown during which the fed, the treasury, all the big banks, and the media are doing everything in their power to influence the markets and the access of market participants to information.

We can kid ourselves the EWT is some sort of metaphysical force that always reflects human sentiment, and therefore, is always fractal, working on any time frame no matter how much volatility and manipulation is resident in a market, or we can be realists. EWT is a tool. It's a damn good tool. But when the markets are manipulated, or when they are in their death throes, you would be well advised not to rely upon the shorter time frame interpretations where the theory, even in the best of times, is still in its infancy.

Prechter has made me a lot of money, but I can't blame him where the tool he offers is ill suited to the task. Use EWT to position trade. Maybe use it for some swing trades. But if you think EWT is going to predict the day to day weather in a hurricane, you are just a brainwashed cultist.

[Not to imply anyone here is a cultist, I mean in general that the tool becomes less useful as volatility and manipulation increase on shorter time frames. All three variables are currently at max values, so beware of following the old rules and use common sense]

Smiddy

[molecool]

I don't think the Euro really matters that much right now - watch the AUD/JPY.

[Dsquare]

The wave down to 1041 shouldn't be counted as an impulse as wave "4" retraced almost all of wave "3". Makes more sense this was a flat to 1041 from the 1200 area off the high. Then an x wave and another a-b-c. This wave up to 1100 should be a d wave, the question is can it recover and break the b-b line (usually d waves of triangles do). If this is all a b wave like Neely thinks then we should finish with an ending neutral triangle with c the largest leg. So the current move down is e or still part of d. If the SPX started a new wave down from the 1200 area (and not a b wave like Neely thinks), perhaps a flat-x-expanding triangle combination could develop before the counter-trend move begins.

[Ken]

Has Neely turned bullish yet?

[Hank Wernicki]

Yes the market is a fractal and we go a nice one today !

Hank

[Panic is for Losers]

I seriously doubt the market is a fractal. But it's moot, because we'll never know.

I would hold a basket of good companies for the long run. If you've got more than a 10 year horizon, 50% stocks, 30% bonds, 20% cash.

[adg]

sell your stocks, it is going to crash!

[Dsquare]

Ken, I don't know. I don't subscribe.

[MHD]

Yelnick..... I've always found EWI view of the economy and the big picture very interesting, even though I do not use Ewaves for trading. What is their current take on the almost sure thing QE #2?
And do they think once QE2 is announced that it would cancel their wave 3?

[twitter.com/DrBubb]

I reckon that the Elliott Bulls like Carl F. and Tony C. are wrong. This cannot be a bull market - the volume is running in a downwards direction.

I took several hours today to summarise the views of many Bearish forecasters, be they E-wavers, cyclical analysts, or astrologers. You can find it here: http://tinyurl.com/crash2010

[twitter.com/DrBubb]

MHD, I don't see how we can have a QE2 program this side of the election UNLESS the stock market crashes first. The first one did not deliver, and was very unpopular amongst those Americans who vote AND PAY TAX, and the taxpayers are likely to be voting against the tax and spenders.

However, if we do get a crash, then people may panic and be desperate enough to support another program.

In short, if you are expecting QE2 to save the market from a crash you are likely to be disappointed IMHO.

[Account Deleted]

Head and shoulders formation of apple inc
http://niftychartsandpatterns.blogspot.com/2010/07/apple-inc-head-and-shoulders-pattern.html

[yelnick]

Panic for Losers, recent analysis of the market pretty well confirms it is a fractal structure from a chaotic nonlinear system. The randomness of the Random Walk and Efficient Market Hypotheses would not have the underlying self-similarity of the market, which means it is not random but obeys some underlying order. This is a huge insight since it means the market is not a series of independent events like rolling dice but has memory - the past effects the future.

[yelnick]

Ken, is NEely bullish? Term needs to be defined by which time frame."
- Neely thinks we are in a corrective wave so in a yearly frame is bearish
- He does not think we break the Mar09 lows, so in a decadal frame is bullish
- He thinks the current move should reverse up and may make new highs, but may simply come close to recent highs. In a monthly frame he is neutral.

[yelnick]

MHD, I have not seen any interesting comment on QE2. Prechter maintains his view that the Fed cannot prevent deflation. You may have previously seen an excerpt form his Conquer the Crash book on this in my blog. If you join Club EWI (click here) you can see a bunch of recent articles on related topics, but not on QE2 in any depth. Here are some:

signs point to deflation

Fed not in control

Understanding the Fed (35 page ebook)

Conquer the Crash: 8 free chapters

Can the Fed Stop Deflation?

The Most Important Investment Report You'll Read in 2010

[yelnick]

Dr Bubb - great summary! thanks for sharing.

[Panic is for Losers]

Yes, the market isn't random. And it's NOT a fractal. It is basically a log curve growing at 2-3% per year. There is some randomness to it, however that causes deviations from that curve.

If you had heeded my stocks 50%, bonds 30%, cash 20% this morning you would be doing quite nicely today. Live long enough and follow that advice and you'll be megarich.

[Wave Rust]

the turnip is at hand.

a turnip in hand is worth two in the bush.

buy it?

wave rust

[Wave Rust]

wave counts tend toward randomness

buy now
sell aug 24-26

big down to christmas ,,,, reeelllly big

wave rust

[Mamma Boom Boom]

>The most important question is, "Do we form a consolidated bottom, or is it a 'V' bottom?" ......

Posted by: Mamma Boom Boom | Friday, July 16, 2010 at 11:18 AM<

I think that has been answered.

[da bear]

I pointed out what EWI pointed out before they did.
Down trend? yeah, I pointed that out. I said that the Corrective 2 COULD BE OVER.
same as them. so do I get points for this?

they should still count the last rise from 9,600 to 10,400 as wave e of 2. That would conform with their alternate count from their previous EW Financial Forecast.

Can't wait for the next EWFF.

da bear

[da bear]

Is Proverbs 7:22 warning us to stay out of stocks this Thursday (7/22)?
You be the judge!

da bear

[Wave Rust]

Dr Bubb,

wouldn't want all them dudes in my canoe, leaning over the left side whilst i was the only one trying to keep the canoe upright.

bad economy = good stuff for stocks

bad for stocks = somebody finds all those saved jobs

wave rust

[yelnick]

da bear - Proverbs 7-22: "all at once he followed her, like a bull (ox in those days) going to the slaughter, like a sheep (ram) hobbling into captivity". The siren call from Mother Market can lead us on the road to perdition. The rest of it also fits: "... and not knowing he is drawn like a fool to the bonds". Good double entendre there!

[da bear]

yelnick,

the King James version says, "He goeth after her straightway, as an ox goeth to the slaughter, or as a fool to the correction of the stocks;"

da bear

P.S. Funny, because I think I know who that chick is. lol

[yelnick]

da bear, I like some of the other translations, especially when the bring it up to modern idioms and use 'like a sheep to the slaughter"

[upstart]

How many times are we going to go up and down and all around DOW 10,000?

[David]

I am not a trader but it appears to me that bonds ignored the rally off the July lows.

I have noticed that through all the girations on teh stock market up and down the bond market has been trying to tell us something is terribly wrong with the economy.

As someone who has been in bonds since 2006 I can tell you that even I am amazed that they can find debt buyers at yields this low. It looks like Japan in the 1990's.

I was actually hoping to be forced out of my bonds and into stocks. I almost did back in May. But the notion of an economic recovery never seamed too real to me.

Thanks to Yelnick, Denninger and a few others I can get my news from reliable sources.

[adg]

well after hours ibm panic, tomorrow crash day

[da bear]

yelnick,

you have quoted from the PPT Bible. You know, the real version tells you to stay out of stocks. The PPT version tells you to stay away from bonds (Treasuries) and implies that there is no danger in buying stocks on dips. lol

da bear

[Daniel Goulding]

"Yes, the market isn't random. And it's NOT a fractal. It is basically a log curve growing at 2-3% per year."

Maybe someone with a strong interest in mathematics can correct me, but does not a log curve imply chaos/complexity ergo fractals?

As far as I know a system can either be close-ended (deterministic) or opened ended (either self-oraganising or random). The scenario you point out doesnot fall into one of the three. The market is self organising and hence a fractal beast.

Again if anyone out there has some interest in mathematics and can see a flaw in my reasoning please point it out since apart from W, I am also interested in tyhe pursuit of knowledge.

Taz

[yelnick]

Daniel, the market could be a fractal with an underlying trendline that reflects the growth over the long term of earnings. I think everyone would agree that weather/climate is a chaotic nonlinear system whose measurements are fractals, and the closest fit to the last 150 years of global temperature is that there is a 0.6C degree/century trendline and within it we have a 60-year oscillation due to the oceans, the so-called PDO in the Pacific. The 60-yr cycle has a +0.6C to -0.6C range, and the combination can make people think the world is heating up much faster than it is when we are in the up cycle, which goes 1.2C from the bottom to the next peak in 30 years, plus the 100 year trend adds another 0.2C, for a 1.4C swing. When it drops over the next 30 years, it falls 1.2C less the 0.2C trendline, or 1C. Within that dominant set of trends, the annual fluctuation is chaotic and fractal.

[yelnick]

da bear, ROTL!!

The budget should be balanced, the Treasury should be refilled,  
public debt should be reduced, the arrogance of officialdom should be  
tempered and controlled, and  the assistance to foreign lands should be 
curtailed lest Rome become bankrupt. People must again learn to work, 
instead of living on public assistance.     
 -   Cicero, 55 BC

[-Anikitos]

-------------
Yes, the market isn't random. And it's NOT a fractal. It is basically a log curve growing at 2-3% per year. There is some randomness to it, however that causes deviations from that curve.

If you had heeded my stocks 50%, bonds 30%, cash 20% this morning you would be doing quite nicely today. Live long enough and follow that advice and you'll be megarich.
-------------

Yes, but even most complicated fractals can be flattened to appear flat. Everything in the Universe of ours is a fractal, atoms, flowers, frogs, humans, and I bet human actions are a fractal too when looking at population as a whole.