Terrynomics

Near Miss Gaps Imply A Strong Move

2011-10-27T11:24:00.000-04:00

My observations on the movement of the stock market have made me a firm believer in gaps. Today I discovered new information about how gaps convey a market move but first let me summarize the three existing projection methods I use for gaps.

1) Gap Gravity - Gaps want to be filled. They mark points in the stock market where significant buying or selling has occurred, particularly at turning points. I call this gap gravity. A gap will draw the market in. It could take years and years, such as the September 1996 SPY gap which was filled at the nadir of the stock market collapse in March 2009. It was the SPY gap at 106 that helped me determine the direction of the stock market. It is the SPY gap at 133 that is currently acting as "gravity" on the market, drawing it higher.

Note in this chart of the SPY how the gap at 106 began the strong move. When we see a gap form at a reversal there's a good chance it will begin a big move. See how the 133 gap denoted by the blue arrow says the same thing on the way down. This isn't always the case but a gap followed by a strong bar is a very solid indication that the market is moving.

You can see however that as the gaps pile up they exert gravitational force. The top two black arrows were filled within two month's time. The blue arrow was the first gap to the downside.

2) Gap Roadmaps - The location of a gap can help you determine where you are in the trend. We've already noted how a gap at a reversal point can indicate the beginning of a big trend. Gaps also often occur at the ends of minor trends.

Note how gaps begin to appear at the ends of minor trends at the top and bottom of the market. This is a clue that intermediate trend is going to change. The blue arrows at the bottom were accurate in hindsight but they point out one of the big problems with gaps at the ends of trends, which is that you don't know you're at the end of a trend or the middle of a trend. It's a clue but not a sure trading signal.

Gaps that are left behind at the minor trend level can also predict retracements. This occurred recently on the SPY:

The black arrow was a gap that occurred out of a reversal. The market plowed upwards however it was heading towards resistance at the black line. This was horizontal resistance and it also marked a perfect .618 Fibonacci retracement. One had to expect some technical resistance at this point even if one thought the bull rally was still on. The gap provided the key. Note how the retracement bounced off of that gap. This was a wonderful entry point. One has to note of course the leave behind gap denoted by the blue arrow. Does this mark a future roadmap point?

3) Gap Projections. It turns out that the location of gaps frequently can be used to project out the end of a trend. There are two ways that I've seen this work. The first is to use a gap, especially a runaway gap that occurs mid-trend, as the 50% line:

Note how this gap lined up picture perfectly with the 50% line of the minor trend. The trend didn't end there but:

The next gap once again denoted the 50% point to the top. You should notice that in the first picture I computed the distance from the top of the gap while in the second I computed it from the bottom. On the minor trend it doesn't matter much but on the major trend the difference could be several percentage points. My preferred method is to use the point where the .382 and .618 lines align with key market points. You'll notice in both of these pictures that these lines are lining up with DeMark support lines or technical support/resistance lines.

How about our current trend?

Well, the market doesn't have to do anything but that's a pretty tasty alignment. Plus you have a huge breakaway gap that is going to draw the market at the very least to a retracement. Then you have the beginning of the month coming which usually marks a market reversal point. You have tons of technical resistance. Finally note how the .382, .618 and even the 1.382 align beautifully with key support or resistance points. (Note also that this pattern now aligns picture perfectly with the 2008 retracement before the bear collapse). Time will tell but I'll take this trade.

4) Near Misses. Which brings me to my most recent observation which is that a near miss on a gap fill is a significant indicator that the market is heading strongly in the opposite direction. I've seen numerous recent occurrences. The most recent only yesterday:

Note how the gap was almost filled. There's only one possible interpretation, that lots of traders were looking at that gap as a bounce point but they were placing their trades within the gap rather than at the bottom because they didn't want to miss the opportunity to go long.

Next:

At the major trend level this certainly also qualifies as a near miss. The same interpretation can be made that traders had the target range in mind but were thinking about the long side.

This has occurred in other key securities:

Here's TLT, the 20+ year bonds. Note at the arrow how the security was retracing. I had a huge long order in that gap but it never hit! I wasn't the only one thinking about the long side obviously. The gap up two days later was an incredible signal (which I missed). As a fun exercise take a look at the gaps that followed and how they spelled out the roadmap. Did we just have another near miss? Is gap gravity going to draw TLT back up to 122? Does the gap at 110 mark a 50% point to 129?

The Euro is an interesting one:

This is FXE which is the ETF that tracks the EUR/USD currency pair. As one would expect with a security that trades market hours but which tracks a 24 hour security, there are many gaps and they are large. Nevertheless the signals still work and FXE is near miss central. Look at all those black arrows. One fine point I've noticed is that the degree of miss correlates to the strength of the move in the opposite direction. A gap that is partially filled seems to indicate minor trend significance while a gap that is not broken (essentially providing resistance) denotes intermediate or major trend significance. Hard to tell from gaps alone which way the Euro will move next but it seems clear that it will spend time both lower and also higher.

Impaled on the Bear Rally

2011-10-15T21:34:00.002-04:00

This (presumably) bear rally continues to amaze. In an effort to understand it (and determine when it will end) I am going to compare it to two other rallies. The first is the rally on June 26th. Here's a picture of the two:

At this point I want to classify both of these rallies as "relief" rallies. The June rally was so powerful at the time that it completely shook me of my prior assertion that the market had topped and was heading to 106. That shaken belief cost me considerably. The current rally also has me rattled but I am determined not to be shaken of my conviction that this bear correction has not ended.

The similarity in these rallies is striking. Both came directly out of strong bear moves. Both were very steep which is a tip-off to me that they are not sustainable. The June rally was characterized by an incredible leap into thin air at the end with a gap.

The technical points are also remarkable. Note how DeMark has ticked off a 7 count in our current rally (pink arrows). It eventually ticked off an 8 count in the June rally although the 7 count was the high point. Note also how both of these rallies come from DeMark perfected buy setups that called the end of the major bear moves (note to self!). Note how both rallies got new wind when they crossed the 50day moving average (see the big green bars that created, especially in June when that point coincided with the technical resistance line). Note how neither rally (so far) has gotten past the prior high.

To my chagrin both of these rallies fooled me. Yes, fool me twice. The black lines denote my targets which were never reached. Twice I was beholden to the targets and as such was caught flatfooted by the rally. Both times the rally caught me short about halfway through (in June I just held my shorts and shook my head, eventually making money. This time I stopped out and re-entered my shorts between 120 and 122).

The June rally was led by Apple. This October rally actually began the day before Steve Jobs' death and Apple was temporarily held back. The rally's second wind however has once again come on the back of an Apple surge.

Let's check out the 30 minute charts to see if the rallies bear further similarity:

Here I've put the current rally on the left and the June rally on the right and scaled them to approximately match (noting that today's rally is much greater in percentage and point terms). It's a pretty good match up until Friday. Can't really kick myself for going short on Thursday given that pattern. I think it's certainly ominous for the rally to have left off on Friday with a big upswing like that but there's a lot of technical pressure right now so I think one has to be in it.

Gaps:

One thing I actually like about today's stopping point is that it gives us a perfect 38.2% Fibonacci alignment (from open of bottom, excluding the spike) that aligns with the gap and the moving average. This sets up similar action to the June rally where the market quickly slides to that point, finds some support (note the curved pattern) and then briefly rallies back to the level of the top gap. Actually, that spike on the SPY is spurious and there really was an island there that needed to be filled. Check out the DIA:

Today's DIA chart looks just like the SPY, but back in June one would have had much better signals trading the DIA as the gaps basically provided a roadmap for the market action.

Finally let's compare indicators for these two rallies:

Both rallies amazingly had two negative reversals. Frustratingly, the second one marked the top of the June rally but today's rally has logged a higher high. In June RSI shot up to 67 while today's rally is only at 60 (which technically ought to be a bear turning point). Composite is at about the same level (red line) but note how we had the little dip in the June rally which is as yet missing in our current rally. Stochastics turned over in both rallies at the same point. Finally we had downsloped volume in both rallies. Note how the lowest volume in the June rally was the day before the high. My conclusion from this picture is that we are very close but there may be another day or two of upside or possibly a flatter top.

Next I want to compare our current rally with a rally that occurred in 2008 which I've blogged about before. Here is a 20day period chart (essentially a monthly):

I don't mean to imply here that we are heading into a 2008 type crash but I think the picture does indicate that the bottom is not in. The 50 period average (not 50 day average) plays a role in both bounces however in 2008 it was uptrending while today it is downtrending so hard to say if that really is a factor (note how that average called the flash crash!)

In both instances DeMark got to a 5 count. In 2008 it flipped. Let's see if November's is downward.

The RSI is the most striking however. The green line indicates the prior top in both rallies. The blue line indicates the bounce (notably at 40 which is technically still bull territory on the monthly). Then the red line was the end of the bounce in 2008. Today's rally is at that same point although granted a 4 point swing would still put us in that space.

The composite does not provide a good analogy however. We do have a pointed bottom but it is at a higher level and it would be difficult to see those trends match up without further upside. Very interesting to note in 2008 however how the composite "retest" was a good indicator that a bottom was almost in. If you look very, very closely you'll actually see that the composite has actually turned up for the first time at the end of the period that marked the very bottom.

What If I Am Wrong

This is the beginning of the 2010 rally. Steep just like today with gaps. One might have thought that the gap marked the top of the rally but it didn't. Certainly if we see the market begin to make slower, steadier uptrend then we have to consider the possibility that a new bull market has started (or at least an intermediate bull period).

That red line of course is the 200 day moving average and back in 2010 it was almost inevitable that the golden cross was coming. The gap across the 200 was a huge buy signal. Our current rally would need to double itself to get to the same point today although this is exactly what happened in 2008 when the market bounced at a point that corresponded with a gap fill and the 200 day!

Certainly looked like the market was heading back to a golden cross when it hit that "X" spot.

SPY's Last Drop

2011-10-07T20:59:00.000-04:00

I took some pokes at shorting SPY during this rally to no avail. The rally has been confounding me but today finally I'm rewarded with some signs that I have not yet missed the long boat.

Here we can see that a negative reversal was created by today's lower close. This is significant. Note how the previous negative reversal called the last sweeping collapse. The first reversal of the sideways pattern was also prescient. The second reversal was a false signal but given how early it was in the rally it was easily dismissed. The small chart has some even better news:

First the 60 minute SPY chart. Note how we have a lower high on this minor trend. The curvature and top of this rally now looks a lot like all the previous ones. Take a look at how RSI and stochastics have curved over with each wave. Only one of the waves has a secondary hump (higher by one penny).

Now I hate to pull up a 1 minute chart but it's the best information you have when you're looking to place a swing trade 45 minutes before the extended session closes on a Friday night. This one is just fantastic. Here we can see the lower high on the right of the screen which is an undeniable textbook 5 wave. That's 1.5% in about 10 minutes off the index.

Leading up to that was a very interesting surge. We can see that a triangle formed at the 1 minute level and when the resistance was broken we got a surge from 1 minute momentum traders and stops firing off. Longer timeframe traders (smarter ones than me) were selling into that strength.

Finally inching back further we have a less obvious but still deliciously perfect 5 wave down. I've broken down the waves here and noted how the 4th wave is an obvious 3 wave pattern (it follows all the guidelines including alternation and depth to prior 4th wave). While not quite a "golf club" I'd say this 1 minute chart did everything a golf club pattern does. Compare it with coffee recently:

Note the curving downward pattern and surge back up to a lower level, and then subsequent plummet. I've found this to be one of the most reliable patterns to trade. The toughest part is finding the bottom of the club. The top of the surge is usually easy because momentum slows down long enough to catch it.

Finally I've noted previously that these humps have mostly fallen on a small Kiss of Death. I should have been more patient:

I drew that trend line in yesterday and it certainly gives me some confidence. Note also how the prior technical resistance line (the sloping horizontal) has been providing support. With the exception of this morning's jobs related surge this wave has already been trending down.

The million dollar question however is whether this is a 3 wave or 5 wave. I dare say one could bend this count any way one wants. It has been a weak rally, defined not by buying pressure so much as a lack of selling pressure. Let's zoom out a bit and try to make some sense of Elliott. Here is my original interpretation:

My original interpretation was that we had a truncated 5th wave. This allowed the A/B/C pattern to fit perfectly. It also correctly predicted the lower drop. Things got a little sticky when our last plunge ended too soon. The only way for this interpretation to hold is if the two prior plunges were both "1" waves and that the next drop (assuming it happens Monday) would be a killer 3 wave that would bring us down to 975 and then further by tacking on a 5th wave and possible extension. Frankly this seems too drastic as this stage.

Another possible interpretation:

This secondary interpretation is far more satisfying in terms of fitting a wave count into current market conditions. I arrive at this count by working backwards. Our current wave is a motive wave and thus a C wave. The prior two drops (that otherwise would be extending 1 waves) are actually part of a large, downward sloping, 5/3/5 "B" wave. Then the wave prior to that is an "A" wave. Now previously I had considered this to be motive but I should point out that it has the characteristic choppiness of a retracement wave. It is one of those waves that could be placed either way.

Perhaps the most satisfying piece of this equation is the X wave. The X wave is always a connecting wave between two 3 wave patterns. Characteristically, it is a distinct 3 wave pattern that does not make a higher high or lower low. We can see that our X wave fits this bill.

Where things get messy is interpreting the first A/B/C flat. The C wave to me looks distinctively like a 3 wave although I will grant that one could count it either way if pushed. Then the B wave is the hardest for me to swallow since I think this is clearly a motive wave. However, this wave count eliminates the awkward truncated wave and allows our next motive wave down to end pretty much anywhere.

Finally:

More liberties with motive waves need to be taken but it's possible to interpret this rally as the 1st wave up (in a much much larger corrective pattern granted). This one is really not satisfying to me but I will say that our negative reversal price projection point is higher than our previous low (109). I think by 109 it should be clear whether the wave is motive or corrective which should clarify the picture.

I wanted to revisit the 1937 and 1984 crashes now that our picture has developed a little further:

1937

So 1937 is no longer a great analog. It has a crystal clear A/B/C flat pattern. I can see why Elliott was so excited by his theory. We do have a boatload of negative reversals just like today. We also had positive reversals which were pretty good until they created two fakeouts during the final plunge. The first fakeout would have been particularly nasty. DeMark didn't invent his indicators for another 50 years but you can see that a DeMark perfected on that negative reversal day. Ouch. After being bitten once I'm sure anyone seeing the second would have been more cautious. What 1937 does kind of do however is throw some cold water on the truncated 5th wave theory now that we see what a real 5th wave is supposed to look like.

1984:

Once again 1984 is pretty much a textbook A/B/C flat pattern. One interesting tidbit is that 1984 also has the same little hook that has been bothering me in our current pattern. So this again throws cold water on the truncated 5th theory and adds weight to the other interpretations.

1984 gives us a beautiful 5 wave pattern for the 5th wave an a nice DeMark signal but then it throws a curve ball by making a lower low which I believe is an extension from a small 1st wave prior to the crash. Note the DeMark countdown signaling an end to this market correction. We have no such signals yet although a countdown has reached a 12 count and is likely to signal with a new low.

UUP

I have to admit I was questioning myself on why I hadn't shorted UUP on the composite/RSI divergence that I had blogged about. It just didn't feel right. Now we see it has made a positive reversal that puts it into "gap magnetism" territory. We have 3 gaps before we reach a DeMark resistance point. The dollar could really shoot up there (treasuries by comparison are in "open space" with only bearish reversals right now. I think they'll spike again but probably make a lower high).

Meanwhile, Elliott "determinism" is telling us something about gold:

Note that the sideways action has never made a lower low than the initial drop. Elliott says that there will be a lower low. Odds are that this was a triangle pattern but it's possible for it to extend further. Based on the little straightline plunge hiccup we see in today's action I'd say we're going to see downward action. I think this is going to surprise some technical traders who might be reading this as a triangle pattern (when in fact it's a rectangle).

Using Constance Brown's fib techniques we can plot out some fib support:

We see that 150 provides support. We can also see how the previous support levels have drafted the borders of the current rectangle. The calculated distance (1st wave same length as 5th wave) brings us a little lower, to the DeMark support level. Then there's that gap and the possibility of spikes. I don't think it makes sense to try and catch this falling knife.

I think the most important thing to note however is that gold is making a 5th wave (per the Elliott triangles). This means that the correction is not complete. Gold will rally with a 3 wave and then fall further with another 5th wave. Although it could end up being flat overall, there is the possibility of an extended slide in gold prices. Suffice it to say that gold will not make new highs for some while.

Late Inning Curve Balls

2011-10-05T21:27:00.002-04:00

The market has certainly thrown a curve ball here.

I did feel yesterday that the market would get to 114 but this wave has clearly cut through the 2nd wave of the previous downdraft. So I can only conclude that this downdraft represents a complete 5 wave pattern (same thing threw me with the crash). Perplexing is that we now have a picture perfect 5/3/5 pattern. Unfortunately there's no way to fit this into the bigger picture so I can only say that Elliott has given me the slip.

It's hard to deny that this rally is a motive wave. Darned definition of a motive wave to me and it's a beautiful 5 wave pattern. Given that Elliott has gone foggy however I'll retreat to other tactics. The first thing to note is the technical resistance line at 1150. Recall that 1160 has been the fulcrum point for the sideways correction. It would make sense for that to now become a resistance point.

The second thing to note is the potential for a Kiss of Death pattern on this 1 hour chart. I've noted before how the K.O.D. on the small futures chart has signaled imminent collapse. Note how the futures bottomed out at 1068, lower than the SPY that only made it to 107.43. However, the S&P futures previously bottomed out at 1077 back in August (was it that long ago?). So perhaps the "future" in S&P futures is telling us something about where the market lands next.

Taking a step back at the SPY we can see how there was a pressure release:

We had the negative reversal on the 16th and then with the new bottom and spike we got a bullish divergence. Bullish divergence is tricky. The green line at the right of the screen is a price projection based on that divergence. Divergence price projections are not as reliable as reversal price projections but it is worth considering the possibility that this is now the 2008 style bear rally that takes us into the end of the year. Given that the spike created a 5 wave we must be on the alert for this possibility. Imagine something that looks like this:

Looks pretty darned reasonable right? The key will be whether we get a higher low on the next downdraft and whether that downdraft is motive or a clear corrective pattern. A higher low on something that looks corrective would certainly warrant a heavy long position. A bullish divergence or positive reversal at that point would add further weight.

Meanwhile, as always when the market throws me a bogey I check the components:

MSFT

Microsoft has been helping me a lot with my Elliott analysis. Here we see the motive wave again. The bear case is still in because the previous high had not been penetrated. We can also see a lower low and lower high forming at the end of the day today so the wind is definitely out of the sails.

AAPL

Apple is still making a bear case. This wave has ended in the vicinity of the previous fourth wave (blue line) which is good. It is also carving out a corrective looking pattern. However, on the daily chart:

Apple has a perfected DeMark buy signal on a volume spike and a serious negative reversal. Now that is a lot of support. Overall that would mean the corrective pattern we see in AAPL is an A/B/C with an unorthodox top. The implication is that a stupendous rally in AAPL is coming. Yikes.

ORCL

I'm still holding an ORCL short and I have to say the chart doesn't look particularly bullish. We have a lot of unfulfilled negative reversals. The pattern it is making is very clearly a corrective pattern. Could that corrective pattern continue? Yes. Could ORCL go down, or sideways while AAPL shoots up? Yes. Don't throw the baby in with the bathwater (?).

XLF

The financials are giving us much information but it's worth noting the divergence on the composite index and the stochastics which both measure relatively shorter term momentum than the RSI. There's a tasty gap for the financials to shoot for.

HD

HD has shown strength during this correction. Yesterday it clearly found that same support line. Will it turn around immediately and break support? I'm doubting that. I'm also noticing that stochastics have crossed and that the composite has found support. On the other hand, RSI is about to find resistance so a struggle looks to be on hand. We'll keep our eyes peeled for a small positive reversal or bullish divergence in the coming days.

MO

Altria made a very nice V shape bottom but this chart looks like it's heading to a retest. What I usually have observed with a pattern like this is that the stock makes a fake breakout above the trend line and then heads down further. One can see this on a past JJG chart. Also note how stochastics have crossed and that RSI bounced off of the 60 level.

TLT

The long bond has reached an absurd level, higher than it did during the 2008 crash. We now have numerous bearish divergences as well as a boatload of "gap gravity". A short here would require a pretty generous stop. One might get lucky and catch a lower high in the next few days.

GLD

Gold is giving numerous long signals. First it perfected a DeMark the day of the bottom. Second we have a very serious positive reversal on the back of a string of unfulfilled positive reversals. We have a volume stop on the bounce day. We have large gaps to draw attention back upwards. We have a tiny little bullish divergence at the bottom. Finally we have intermediate support (not shown). It's an easy trade with a tight stop. (Silver looks much the same except it has two negative reversals that indicate it will retest the 28 low. I suspect both gold and silver will create a false downward spike before rallying).

JJC

Copper shows what can happen when DeMark is early! However at this point we have a bullish divergence on the back of a long term positive reversal. We have serious volume today. We have a delicious curve bottom shaping up. Plenty of gaps on the upside. Keep in mind, this isn't a "bull" market it's a possibly bear rally. Plenty of room for a 10-30% retracement when an asset has fallen this far. (The soft commodities are all showing a similar situation).

COW

Beef was early out of the gate, bucking the recent downtrend. Note the power of those positive reversals for price projection! Now we're closing in on a DeMark sell signal and we have a bearish divergence. The trend isn't finished but it's close to turning around. That would make a 5/3/5 for COW and could be an incredible short opportunity.

UUP

Finally, the almighty dollar. Recall that in a previous post I noted that a divergence between composite and RSI often indicates the penultimate top. Well, we now have a higher top and stochastics are once again crossing over. I don't want to rule out yet another top (note the gap within reach) but to me a dollar breakdown looks more imminent than a further run upward.

98 gap fill possibility

2011-10-04T21:21:00.002-04:00

Today Serge Farra posted a somewhat radical bear prognosis on his blog The Stock & ETF Corner. As readers of this blog will know, I've been predicting a SPY gap fill at 106 for many months. I've always believed that the market would dip slightly lower, most likely to 102 and change. So I was at first skeptical of Serge's analysis but on further analysis he may be on to something.

Here's an overview of the SPY. Note the itsy bitsy gap at 98.07 which is around where Serge calls his bottom. I'm a big believer in gap magnetism, especially on the SPY. As a stopping point this is a good place as there is a boatload of support (Mega support) just below that point. Of course to get to that level the market would have to push through a ton of technical support created by the 2010 correction, the infamous 106 gap and then a boatload of prior support as evidenced by the DeMark support lines.

Let's zoom in to the daily action though and point out how Elliott Wave is giving us a hint that Serge may be correct:

Here's a closeup of the S&P futures which, until today, were giving an extraordinarily satisfying Elliott count. The momentum in this latest downdraft is clearly a 3rd wave and this validated the prior count including the little a/b/c corrective pattern that I thought was a dead giveaway. What this picture has always been hinting at however is a low well below 106 based on the size of the 1st wave.

One cardinal rule of Elliott Wave is that the 4th wave cannot penetrate the 2nd wave. Today's rally penetrated well into the 2nd wave of the overall trend which means that this could not be the end of the 3rd wave. What I believe it could be is the end of a 3rd wave sub-wave, the pink (iii) wave in the upper picture. Note how we had two "i" waves, an extending wave. That provides two more opportunities for this wave to extend.

It's always hairy to try and project extensions in a high momentum market but today's rally forces us to consider that this 3rd wave is not complete. The picture above provides a possible course of action that would explain further downside that doesn't create a bottom. The green and brown projected lines pair up with the green and brown "i" waves. This creates a 3rd wave that is long enough to allow an appropriately sized 4th wave retracement. I think this part is critical. The 3rd wave must be long enough to make room and currently it is not. In order for it to be long enough it must at a minimum get to 106 but probably lower. The bounce at that point is likely to be a fakeout.

What is particularly compelling is that the 102 and change area makes arithmetic sense again. In this example the 3rd wave is 1.618 times the size of the 1st wave. Next we assume a 4th wave bounce that meets resistance at today's market bottom. Finally, a 5th wave that is the same size as our 1st wave gets us right in the 97 gap area.

Next consider the amount of overall zig zag that this chart would end up having. We would essentially have tremendous support/resistance from 98 all the way up to 123. That would set the stage for an extended sideways market which makes sense given where we are in the historical context.

What If This is Wrong

The first thing that gives me pause is that I got caught blindsided by a similar analysis that was overly bullish at the market top. That analysis (and associated fear/hesitation) stalled my short entry into the market and cost me a lot of money:

That miscalculation cost me 5% profits. Totally ridiculous considering that the market had done every single thing I had predicted up to that point. I should have been massively short and allowed myself to stop out if I was wrong instead of hesitating. Luckily I snapped out of my haze quickly enough to still make a nice profit (missed the boat but dove into the water). So, is SPY 97 an overly bearish prognosis that flies in the face of months of analysis and will cause me to miss the bull boat?

Secondly there is the look. 97 is nice because it would create an overall 5/3/5 pattern with the 5 legs approximately the same number of points (25 v 23). However from a percentage basis 100 would be closer (18%) and given the steepness of the initial drop in the 5/3/5 my expectation is for the final 5 to be smaller overall. When one looks at historical crashes one just doesn't see a pattern like the drop to 97. One usually sees one of two things. Either, (a) the market bounces before going into a mega bear market (such as 2008) or it finds support with a second leg that is about 2/3 the size of the first leg. That would put us back in the 102 area. It just "looks" right that way, and for Elliott wave counters that is a huge part of the puzzle.

Finally there is timing. SPY 97 would require the market to descend well into November if not December. These are historically bullish months and given the length of this bear market I'm expecting bear fatigue to settle in at some point. Who is going to short the market past the 102 mark (below Dow 10000)? Currently I don't think there is enough bear sentiment to accomplish this (note bear sentiment levels are extremely high right now, so what I mean is there's not enough additional bear sentiment). The market needs a recharge before it can dive down that low and Elliott doesn't provide an obvious mechanism to do that without first allowing the market to surge back into the 120s or even 130s.

Summary

So what I can say with a reasonably high degree of certainty is that the 106 gap fill will not be the bottom. This is hardly news. I believe very strongly that there will be a bounce between 101-106 and that this will require daily monitoring of the wave patterns. What I still think is a likely possibility is that the market will then linger in this area as Elliott carves out either triangles or a flat pattern. Either one is a tip off that the next wave will be the final 5th wave. I believe that this will result in a slightly lower bottom that will essentially look like a re-test. In the scheme of things, 102 and 97 are not that far apart. What is more relevant is the daily wave patterns. Look for this market collapse to end in a subdued manner (with all the energy taken out) rather than a spike.

I also think that RSI will be providing plenty of signals at that point. The dollar and treasuries will likely have already turned around and some bellwether stocks will be rallying inexplicably.

My own personal trading strategy this time around is slightly different. Rather than trading the index I will be trading a basket of securities that have shown strength during this decline and that have hit technical support. This should provide some insulation against a premature long entry and also some extra juice if a bull rally ensues.

2008 v 2011

2011-09-29T21:02:00.004-04:00

I continue to be fascinated with the comparison between the 2008 and 2011 crash. Tonight I decided to compare the indicators for the two markets at the same point using my software www.thetradingrange.com.

2008

This is 2008 2 days before the 1st of the month. The green arrow indicates where this market went (just filling that gap before falling into a mega crash). The first thing that is evident is the incredible amount of pressure in the RSI. First there were several long term negative reversals which correctly predicted a re-test bottom (and look at the purple line that dips down below the chart. That negative reversal was a hint of what was to come). Then after the negative reversals played out we got several layers of bullish divergence. That was a lot of pressure pushing down and then suddenly released.

We did get one more negative reversal which did not play out. The fact that it did not play out was a critical piece of information.

Stochastics were the real sucker punch. That chart appears to be curling over and stochastics have crossed at the 80 mark. That to me looks like a market that is running down but it was a fake out. We got a stop the next day and then it gapped up on April 1st.

2011

Our current market looks similar on the chart but there are some striking differences in the indicators. The first is the relative lack of information in the RSI. There is not a lot of pressure in the RSI. It is "loose". The one bullish divergence was fulfilled. The one negative reversal was also fulfilled.

Stochastics are what I think of as "coiling". They are butting up against resistance. When they do finally reach the support level I think we will have a rocket on our hands. That said, they are crossing over now so perhaps like 2008 we get a fakeout?

If we zoom in on 2008 though we see something very interesting that is missing today:

In 2008 we had a "golf club" characterized by a rounding bottom and several repulsed attempts to break a horizontal resistance line. We even got a higher low and higher high - very different from today. (I probably would have shorted the golf club at 138 and gotten creamed!)

Zooming in on the futures I might have an Elliott explanation:

This is the 5 minute futures for this week's action. The run-up does not look like a motive wave. It is impossible to make a "5 count" out of it. Generally this is a tip off that it is a corrective wave although I will say that I have seen some large motive waves begin like this.

On yesterday's descent we have two clearly motive waves (green) and again a clearly corrective wave (red). Notice how the small corrective wave looks a lot like our larger (presumably) corrective wave.

Now let's attempt to assign some wave counts:

This looks suspiciously to me like the beginnings of a large 3rd wave. It is extending right from the get go. What I like about this interpretation is that the "a" and "b" waves are crystal clear 3 wave patterns. The "c" wave is what confused me this afternoon, which is what "c" waves do. They are WTF waves.

Let's zoom out and take a look at the implication:

This continues to fit with yesterday's interpretation.

I see two ways that this current C wave can play out.

Scenario 1

In this scenario, today's late market action was the 1st wave in the C wave. This would imply a pretty serious rally tomorrow. Since the B wave is unorthodox (below the end of the prior motive wave) it does imply that the C wave would be equally extended in the other direction (Constance Brown's "springboard" metaphor). The yellow line of course marks where this interpretation is wrong and needs to go back to the drawing board.

Scenario 2

Scenario 2 is pretty straightforward. Basically we ain't heading back. There is room for a very small 5th wave of the "C" wave (the dashed line) but anything more than that and it's either scenario 1 or else a confounding corrective wave that requires new interpretation with more mental muscle. Note how the dashed line ends at what would be a technical resistance point.

Finally, I think the recent gold top serves as something of an analog to what is happening here:

We often see this same descending motive wave pattern preceding steep drops (we also saw it on the S&P in July at the 30 minute level). Gold and the S&P here are not perfect analogs. Gold would require a wonky Elliott explanation however the pattern is extremely similar.

What if I'm wrong

If the market goes higher then a wonky Elliott Wave count like the following would be necessary:

One can make Elliott bend to your will if need be and as I mentioned, I have seen this kind of weird pattern turn into a motive wave, or at least become the first motive part of a 5/3/5 corrective pattern.

Trading this one is tough as it requires a momentum trade that might easily be stopped out on a retracement.

Kiss me, Kiss me, Kiss me

2011-09-29T01:30:00.001-04:00

Serge Farra commented today in his blog (The ETF Corner) that it has been difficult to make money during this correction. Having been flustered by the oscillations myself I have to agree. However in an effort to improve my analysis here is a 20/20 hindsight chart on how to have made money:

Part of the issue is finding the right timescale. This is a 30 minute S&P futures chart and it demonstrates some very interesting material. The three humps all demonstrate Serge's trademark pattern the "Kiss of Death". Late to the party but perhaps we'll get one more?

One thing I have been in tune with is the timing of oscillations. This timing actually goes back to 2010. The 1st of the month has been an indication of where the market is heading. Note the 1st arrow on this chart began the crash (that was the day the debt deal was signed and the market staged a fake out morning rally). The 1st of September (second arrow) marked an amazing short entry. Now the 1st of October is coming up. What will happen?

Now note the intermediate resistance line (big red line). Yesterday's rally hit this ceiling square on the head. Today marker a "lower high" which is in itself a bearish thing and has created another steeper minor trend resistance line. Now note the green line. This marks a former resistance line turning into support. Finally note the amount of horizontal resistance at 1180 and support at 1140. Frankly, I first noticed this way back in that first rally when I stopped out at 1160 in both directions. I knew from there that 1160 was the "mode" of this corrective pattern and that we would be oscillating over that point. Never knew it would last this long!

What this boils down to though is that the market is likely to get turbulent inbetween all this support and resistance. Darned market is coiled like a snake. My bet is that The first of October will again send the market south (and that a lot of this last rally was quarter end positioning). Somewhere around that pink arrow is where it will top out. It could spike above that line (as it did on the 13th) but it won't get far as 1200-1220 has demonstrated solid resistance.

Elliott Wave

It's always a task trying to fit Elliott Wave into the S&P, especially as the futures chart and actual index can often look dramatically different. This picture is my best effort. It continues with my unorthodox "truncated" 5 wave which is the only way I can make any sense of the pattern.

In my previous post I did a pretty good job at forecasting waves "1" and "a" on the right of this picture. Here's the flashback:

(Why I didn't go long at 111 is beyond me. I'm a better analyst than trader). I was surprised by today's sudden downturn although there's plenty of room left in the interpretation. We can either trace out a small a,b,c flat pattern as indicated by the blue line; or C can extend for two days in a hell of a rally for a 5/3/5 pattern (the dashed line).

What is critical is the pink horizontal line. If the market gets past this then my interpretation is dead wrong and most likely signifies that a bull rally is on.

Mindsets

Lately I've been focusing on trying to understand who is driving the market. John Hayden in his book RSI: The Complete Guide made two observations that stuck with me. The first is that at any point there is a certain group of traders controlling the market. I made the observation in a recent blog post that I thought technical traders were controlling this market. A quick perusal of Serge's blog comments would demonstrate that majority rule was indeed in effect.

The second observation is more subtle. As traders we're taught that a market goes up when there are more buyers than sellers and vice versa. Hayden makes the interesting observation that the opposite can happen. That when buyers retreat from a market that the sellers have no-one to sell to. A trending market requires buyers and sellers (how else can one explain the high volume during market panics?) At that point the market can stagnate or even reverse itself. He claims that this is part of what drives retracements.

So given this information we need to understand at any point in time (a) who is buying and selling and (b) what are their mindsets.

Serge compared this market correction with 2008 and I felt it was a reasonable analogy but this evening I got to thinking about it and I think it falls short in the "mindset" analysis. The general mindset in 2008 was that the market was "fine". Recall that this was the "nobody could predict this" financial crisis. The initial 2008 drop was considered by many to be a correction and a buying opportunity. It was of course a fake-out, but it was this ongoing general bullishness that powered the first bear rally (which I think we'll get but not as soon as now).

Today we don't have that mindset. The general perspective is that we are in a recession. The 2009-2010 market rallies were a surprise and still suspect in the minds of both professional traders and much of the general population. There is so much talk of recession right now that the expectation is a market that is going to be lower.

Who is buying? The buyers are those who missed out on the 2010 rally. The main suspect I've identified are value fund managers who are buying based on what they believe are juicy forward P/E ratios. You can read about them every week in Barrons. Combined I believe that they have enough unallocated cash to keep the market in the 10,000 range. I believe an enormous amount of buying pressure would come in at 10,000.

The net result of the general economic expectations but good corporate numbers equates to exactly what we're seeing; a middling market. In my previous posts I've demonstrated how this part of the stock market cycle generally sees the market retreat to the mode (50% retracement) and then effectively go sideways for a year to three years. I believe we're seeing this in action. Granted, there is a lot of dead space to fill between 12,000 and 13,000 and I believe we'll see the market spend considerable time there but I don't think we'll be back in that range before the market tests the support level in the low 10,000s as I believe is the expectation of much of the trading community.

And If I'm Wrong

There is the possibility that the market will reverse overnight. If we gap down tomorrow then the market could fall very rapidly to the 106 level. This would make a very good momentum play as I doubt we'd get a gap fill at this stage of the game.

Dollar Nearing It's Pinnacle

2011-09-23T10:32:00.000-04:00

The dollar has skyrocketed with the recent market action (crash 2.0). My thesis remains that the market will bounce around the 1060 mark (10100 Dow). Looking at things from the reverse angle I see evidence that the dollar is topping. Let's review the pinnacle pattern starting with silver:

I've talked about this pattern before. We get a divergence between the RSI (blue indicator) and the composite RSI (red indicator). We also see stochastics top out after a brief dip. What is notable here is that this divergence marks the penultimate peak. There is often a final rally to a new high but note how the indicators are now moving in the opposite direction.

Gold:

I remarked on this in a previous blog post. Unfortunately I was caught off guard by the amount of time that elapsed between the peaks. Yet the pattern held.

S&P:

Again we see this pattern and this time the timeframe between penultimate peak and pinnacle is much longer. I believe the length of time between these points is related to how long the previous run-up took place. In the case of silver we had a very quick parabolic run-up and so the peaks were close together. For the S&P this run took place over 2 years and so the peaks were two months apart.

Francenstein:

Here we see the same pattern but notice how we didn't get a second pinnacle. I believe this was due to the Swiss intervention. They killed the monster with a heavy handed threat. You can see what would have been a bull market into a secondary peak truncated on the 1st of the month.

Dollar:

Fast forward to today and we see the same pattern on the dollar. This run-up has been exceedingly fast and so one would expect to see a pinnacle next week. This completely jives with my theory that the market will bottom next week and begin a rebound on the 1st of the month. The caveat here being that we want to see the composite index look like it did for silver: dropping as the dollar makes new highs.

It's worth noting that we do not see this pattern on treasuries. Quite possibly this means the bull market in treasuries will take longer to stamp out. This makes sense when you consider that the run-up in treasuries has taken place over 2 months as opposed to a one month run-up for the dollar. There are of course no guarantees that the pattern will show up, but when we do see the pattern it makes for a high probability short.

SPY Fibonacci Magic

2011-09-22T22:01:00.000-04:00

You just have to love when the Fibonacci ratios trace out a "grid" for the market:

Very often a runaway gap will mark the 50% line for a strong drop or crash (for extra credit take a look at the gap in 1987. Imagine how much money you could have made with that information.) So I used my fibonacci projection technique and came up with this amazing picture. Today's gap is enormous. It's the third very large gap we've had in this correction. The other two were filled with retracements. Maybe this one will be too, in which case this analysis becomes less potent. For the time being I'll assume this gap will remain unfilled.

If we run a hypothetical Fibonacci retracement we can line up the .618 and .5 lines at the top and bottom of the gap almost to the penny! Further beauty can be found when one notices that the .382 of this projection lines up with the bottom of the crash (less the spike. Close examination will show that the day before and day after the spike showed support at that exact level). Finally that same level corresponds with the 2010 runaway gap (more extra credit. Project a Fibonacci from the 07/01/10 bottom with .50 landing at that runaway gap. Ta Da! You could have called that wave to the penny. This magic trick also works on the 12/01/10 gap to call the top of the market!)

Where does our projection land? 104.85. This is about a buck lower than the bottom of the 106 gap that we've long expected to get filled. It is a few pennies lower than the support bottom prior to that gap (less spikes).

This trick also worked nicely in the 1937 market which I've pointed out as an analog for today's market:

The blue arrow denotes the 50% gap in the final leg of that market crash which I believe is analogous to today's market action. It was not quite as startling a gap but then that crash was working on a much longer time scale and much larger price scale than today's market (keep in mind that I believe that today's market has a clock that wants a directional reversal on the 1st of the month. So we're essentially in a hurry up offense.)

The black arrows denote all the places where these Fibonacci lines were respected both prior to and after the projected retracement was actually made. Four points of respect prior to the projection would have given tremendous confidence I believe to sticking a short. The projection falls a few pennies lower than the actual low so as always one should be exiting trades before the projected price!

These marks continued to be respected after the bottom was made. This may be a possible roadmap for our own market. It's interesting to note that these lines continued to be respected considerably into the future:

These lines continued to be respected right up until the bombing of Pearl Harbor. The bottom of the "V" is 04/29/42. (If you look closely (click on chart) you'll see a gap that lies right on the 50% mark from the day before Pearl Harbor to the bottom of the "V"!). The 1938-1942 market was a hell of a market. That's a 45% climb from the 1938 bottom to the top just 6 months later. Then it's a 45% drop from the top down to the bottom of the "V" in 1942. That cliff dive in 1940 was a 25% drop in 9 days. Only 1929 and 1987 were steeper.

1984 v 2011

2011-09-20T21:58:00.000-04:00

Though not quite as striking as the 1937 v 2011 analog in regard to shape, the 1984 correction matches many pivot points with today's crash. Note that 1937 and 1984 both end with the same result, a final run down after three camel humps.

1937:

1984:

2011:

Note that 1984 does not contain a distinct "golf club" from point C to point D but it was close. Unlike 1937, 1984 contains two humps before the crash although G was higher than E - the opposite of the 2011 crash.

What is notable about 1984 is the bottom of the crash. It contains 3 distinct humps just like 1937 and today but the second hump is a 3-wave (points 4,5,6) just like today. The rally from 7 to 8 is also "jagged" just like today.

The 1984 correction is more to scale with our current market, dropping 14% in the crash versus 18% for our own crash. Note also that point 4 is about the same distance from point D in both 1984 and 2011.

I think it's notable that 1937 and 1984 continued on with the same pattern as well: two humps and then a strong rally into a sideways market. Their courses diverged a few months later when 1937 plunged to retest the bottom while 1984 rallied into a phenomenal bull market.

1937 v 2011

2011-09-20T17:46:00.000-04:00

I just discovered a rather remarkable analog for today's market with the 1937 market.

1937:

Today:

The thing that struck me immediately was that 1937 had 3 bounces off of the crash, none of which landed lower than the low point of the crash. This is exactly like today and differs from almost all other crashes.

The second thing that struck me is that 1937, like today's crash, began with a "golf club" correction.

Next I noticed that the crash in 1937 stopped at a horizontal resistance point just like today's crash. Finally, the bottom ended up at about the same technical point as the point I've been predicting for so many months: SPY 106.

There are differences to be sure. 1937 did not have an unorthodox B wave top following the "V" dip. The trends up, while similar, are not exact. Finally the scales are very different. Take a look at the numbers on the 1937 graph and you'll see that the oscillations in the 1,2,3 lumps are as large as our entire "crash". Truly a terrifying market!

Truncated 5th Wave Interpretation of S&P

2011-09-17T22:08:00.000-04:00

Here's a current chart of the SPY (S&P 500 ETF) for discussion:

The chart is very troublesome from an Elliott Wave perspective. Let's break down into what I believe are corrective and motive waves:

It doesn't take a lot of interpretation to come up with this. Wave 1 we've discussed earlier. It could have been counted either way but in retrospect can only be motive. Wave 2 is quite clearly a 3 wave. Wave 3 is obviously a motive wave. Wave 4 can't be anything other than corrective, even if the internals are a tough count. Wave 5 appears to be motive. I generally recognize the golf club or "reverse J" shape to be motive. Wave 6 is obviously a 3 count. Wave 7 turned out to be a 3 count which really surprised and baffled me. Now wave 8 I originally believed to be a corrective wave but it looks motive at this point.

The trouble is that there's no good Elliott Wave pattern to match this. The only thing that would make sense is triangles like such:

There are many problems with this interpretation though. The first is that B and E don't look like corrective waves. One would need to take some liberty with that interpretation. Another problem is the width of the corrective pattern. It just looks too long given the quickness of wave 3. It's all out of proportion. The final problem is that it looks as if wave E is about to curl over. Triangles are usually flat, expanding or contracting. While there is certainly room for some imperfection in the real world one has to question whether this could really be an expanding triangle if the E wave doesn't get all the way up to the 126 range.

So it was while I was looking at the chart for Microsoft that I realized that there is another interpretation:

MSFT is a very different chart but still lends itself to a clean Elliott interpretation. The key thing to notice is that wave 5 dips lower than wave 3. Let's compare head to head:

Essentially MSFT, while initially dipping lower has weathered the correction much better than the broad market (as has the entire Nasdaq composite in fact). What I believe is salient however is that we might want to consider that the SPY has in fact completed a 5 wave but that the fifth wave was truncated:

Aside from the truncation this is an incredibly satisfying wave pattern. First the motive waves all line up where they should be. Secondly the A, B, C pattern is a run of the mill "flat" that is slightly contracting. The bottom of the C wave is slightly above the bottom of the A wave. As that would imply, the top of the C wave is slightly below the top of the A wave.

The implication would be that we are soon to begin another 5 wave down. Here's a possible scenario:

Note how wave 1 and 2 of what is a motive wave would really look like more of an extended sideways correction. I have to stick with a bounce off of 106 as the end of wave 3 although that wouldn't give us much of a wave 4 and 5. There are no guidelines in a 5/3/5 as to how long the ending 5th wave should be. Our original 5 wave is about 24 points from the top to the bottom of the truncated 5th wave. Assuming the same magnitude drop from our current point of 122 would get us around 100 or so.

From there I believe that this is just part of a much larger corrective pattern that will play out for months but might play out for as long as a year or two. The historical record certainly shows extended sideways markets for long periods at this point in the cycle.

The biggest problem I have with this interpretation is from looking at the S&P futures charts which are 24 hour continuous (except weekends). As I've noted previously in this blog, the futures often give cleaner Elliott patterns than the SPY:

The most troubling thing is that the futures dipped as low as 107.7 in the after hours of the final day of the crash. A truncated 5th wave then is really truncated. The interpretation looks a little fishy from this angle. Yet the same interpretive problems remain regarding motive waves and the very clear 3 wave patterns for A and B.

I believe that the behavior in this corrective pattern can almost entirely be chalked up to technical traders:

Almost everyone has had a say in this correction! The main question is when larger forces enter the market to push it in one direction or another. Right now I think things look very good for a short. Stochastics are still running so we may have another few days to the upside but this current wave is curling over and as you can see from the chart has been choppy rather than a straight shot (compare it to the rally on the far top left of this chart to see what I believe is the difference between a one sided rally and one that is being fought all the way up). I don't think technical traders are yet willing to capitulate a market running lower than 110, and so we'll get our 2nd wave bounce at that point, but if this next move down appears to be motive then I think it will add weight to my interpretation.

Treasury Golf Club in the Making

2011-09-07T22:55:00.000-04:00

It's early to say for sure but I'm watching for a potential golf club pattern in treasuries. Here's a chart of TLT (20yr treasury ETF) flipped upside down using the "flip" feature of my charting software:

Notice the curvature of the top of the pattern. The bottom is still extending with spikes. I would watch for something like this to form:

I can't say for sure how many spikes we'd get. I have two here but it could only be one. The thing to watch for is the top to flatten out and form a resistance line (support upside down). On the downside a flat pattern is ideal although it's not unusual for the last dip to be extra low. If the pattern holds, then TLT should shoot off (down) according to the pattern. This would not be unexpected given that I believe the market will stage a significant rally soon (after touching 106 I'm still believing).

Market Crash Redux

2011-09-06T21:18:00.000-04:00

The market action continues to trace out a rhyming couplet with the flash crash correction:

Today's gap gives us the first measurement point using my gap projection technique. If we extrapolate today's gap as a future .618 retracement then the projected bottom is 116.40. This falls within the gap fill area of our expected bounce point.

Lending weight to the analysis is the fact that this projection technique worked correctly during the flash crash correction. The market action is very similar between these two corrections. Today the market rebounded in a single day. During the flash crash correction the same thing happened but it took two days to map out the same pattern. The gap that was created however accurately predicted the bottom. We should only be so lucky as to get an opening gap tomorrow at 112.96!

I wouldn't count on an exact to-the-penny projection, or a perfect gap fill, or the market stopping on a dime. Like the flash crash correction bottom, I would look for momentum to slow and create a curving bottom. Stochastics are at about the same place now that they were back in the flash crash correction at this point so that also gives us some indication that it will be time for a long position. RSI and composite also tested support back then. If do so again this would bring the market down into the 104 range.

I also wouldn't necessarily count on this being the beginning of another bull market like the one that emerged from the flash crash correction. It's quite possible that bump #3 leads to a deeper low (whereas in 2010 it was a .618 retracement). Market action should alert us when the time comes.

Coffee and Golf Clubs

2011-08-28T12:57:00.000-04:00

I've been following coffee for a while, accurately predicting the moves, and once again not making any money because I haven't been trading. Regardless, I think coffee is still offering up compelling risk rewards:

Here is the chart for coffee futures off of the all time high. It is a series of what I call "golf club" patterns because they look like a golf club. The pattern is characterized by a rounding off at the bottom after a steep drop and then a few failed rallies that market out a resistance line. The club usually ends in a rally. That rally usually ends in a steep drop.

Here we can see club #1 comes out of the initial drop from the high. This was a hard one to play because the rally was not as steep as one might have expected. Nevertheless a purchase at the rounded bottom offered a compelling risk/reward.

Next coffee carved out another larger club. Point #2 would have been difficult to call but again the rounding off would have been a signal to give the trade a shot.

Next coffee made another club, #3. This is a club within a club. It offered a nice trade when it rounded off but it offered a stellar trade when it dropped a little bit further and found support at the .618 retracement for the previous intermediate rally.

Now that rally looks to be coming to an end. Notice how the curve is tapering off right at the resistance lines. The primary resistance line I believe is the red line that marks the top of the gap (that drop off was in the A.M. session). Currently the rally is stopped at the .618 for the retracement itself. Given market conditions I'm expecting this curve to taper off for the next couple of days and then drop off steeply. It's a good trade now. Possibly an even better trade in two days although one can never count on the market waiting for you!

The gap at the bottom of the previous rally again ought to have been a tipoff to buy. Regardless, it now marks a target. Given the length of the rally though I wouldn't be surprised if it finds some support on the way back at #3 golf club's red line.

Coffee can be traded through the ETF JO although it is sometimes difficult to short. Also compelling (not shown):

Stochastics on JO have topped.
Composite has topped.
RSI is a day or two from resistance.
DeMark sell signal perfected and still counting.

The other soft commodities (Cocoa, Sugar, Cotton) are in a similar state and offering compelling risk/reward on the short side, although a few more days might provide an even better opportunity.

Selling Volatility

2011-08-28T12:17:00.000-04:00

Today I was reading in Barron's about an interesting idea. The idea is for skittish buyers to use options to hedge their bets. It's an interesting strategy. Let's take a look at how it might play out given my current price projection targets. Here's the SPY chart as a reminder:

I have a very strong belief that the market will hit 106. I think the actual bottom is likely to be between 106 and 102. As indicated in previous blog posts I think the most likely scenario at that point would be a retracement back up to 120 (about where it is now) and then a fall back to the same area for a retest. I believe there is a smaller chance that the market would fall back further to the 90 area. I believe there is little to no chance that the market would get all the way back to the 2009 lows.

The option strategy is to sell a put at the price that you would be willing to buy. So given our probabilities, I'd be willing to buy at 106. I'd be very willing at 102. I'd bet the farm at 90.

The upside to the option strategy is:
1) You earn the time premium while waiting for the stock to fall to where you think it is going
2) You get a consolation prize (the option proceeds) if you're wrong and the market never gets where you're going
3) You get a bonus (the option proceeds) if the market falls to where you think it's going, but it doesn't get there before expiration

The downside risk is:
1) If the market falls further than you're expecting then you're locked into the target price. For instance, say you had a 106 put but the stock fell to 102. Now you're worried it might fall to 90! You're options then are:
a) Buy back the option and pay a very steep penalty because the price has gone way up from volatility
b) Short the stock and risk getting whipsawed
c) Suck it up and own the stock for the long term
2) Not so much of a risk but an opportunity risk is that the stock falls very close to the strike price but doesn't quite make it. Then if you want to buy the stock you'd have to double your capital commitment, at least until the option expired.

So basically, this is a tradeoff of many upsides with high probability moderate return vs. one downside but it's a doozy. Let's see how the numbers actually work out. Here are the latest quotes on options for the three price points I've identified:

SPY Sep 30th @ $90 .37-.45 (down 25% on Friday)
SPY Sep 30th @ $102 1.10 - 1.09 (down 32% on Friday)
SPY Sep 30th @ $106 1.57-1.67 (down 15% on Friday)

The first thing to notice is that this would have been a much better strategy if we'd done it Thursday when the market was down! Oh well. You could wait and buy it when the market is down again...if you're sure the market is heading down. Note that now you're gambling with upside #2, the consolation prize.

Let's take the conservative approach and assume that we sold at the bid:

$90 = $9000 capital earning $37 over 30 days: 5% annualized return
$102 = $10200 capital earning $110 over 30 days: 13% annualized return
$106 = $10600 capital earning $157 over 30 days: 18% annualized return

Well, since I'd be wiling to bet the farm at $90 then selling those options ends up being a nice alternative to keeping the money in cash. If the market does come down to 102-106 then these options (or the October equivalents) will get very expensive and offer an even better yield. Pyramiding a position in this option is a nice strategy if one is holding cash in reserve for a potential bargain basement day. This is basically like getting a 5% yield on a one month CD! (Note that this doesn't include commissions. The price for a single contract trade at Interactive Brokers would be $1 so the price is negligible. The same cannot be said for some other brokerages).

The $102 - $106 levels offer better annualized returns but one needs equivalently greater conviction that the price level will hold and a good strategy to manage whipsaw risk. Here I don't think the premium is worth the risk if one really wants to buy the stock. There's no guarantee that the option holder will put the stock to you and so you need twice the capital. You could easily miss $600 worth of upside appreciation while stuck holding a $100 option through to expiration.

So in conclusion, I don't think the Barron's strategy is a good one for nervous buyers because of the complication involved in managing the expiration dates. However, I do think that selling the deep puts is a very good strategy for earning a yield on idle cash that would be deployed if the market reached that level. Given that volatility is very high, there's no guarantee that the $90 options (even for future months) will get more expensive.

Given our very strong belief that 90 would mark a bottom and tremendous buying opportunity. One might even consider a ladder of puts out to October, November, December. Heck for super idle cash one might consider:

SPY Dec @$74 .61-.68: 3.3% annualized yield

These are 30 year yields for 3 months with the downside risk being a complete market catastrophe. If a retest of the 2009 lows doesn't market a buying opportunity then what would? Again, if volatility remains high and the market does sink down to 106 in the next week or two then this yield might even spike. What an opportunity for idle cash that would be.

Beginning of Month Tells

2011-08-27T23:08:00.000-04:00

I've noticed that the trading day on the 1st day of the month on SPY (S&P 500 ETF) has been very informative at least since the flash crash. Consider the following chart. Click on the image to see it more clearly:

It starts off with a word of caution because the first significant beginning of month tell is a fakeout. It looks like a bullish gap but it goes nowhere and that small rally fades. What an incredible signal however. Look closely at that rally off of the bottom. It started with a very strong white bar. Then there were gaps at the ends of the first and last peak. The market is ready to take off.

What we will soon observe however is that a gap at the top of a rally is often an indication that the rally is coming to an end.

Next we have the terrific bull market that came out of the flash crash. Note three waves begin with gaps on the first of the month. Now, I don't know what could be a stronger buy signal. If you ever see this formula then buy: gap up on the first of the month after a retracement.

(Note the gap that begins the second wave. See how the previous wave ended with a hammer, almost a gap.)

At the top of this market we start to see the tide changing. Now we're getting red bars on the first of the month. The market climbs higher but the warning bells are in.

Before the crash however we get another fakeout, an big white bar that was caused by technical traders covering stops over a technical point. This is a false rally ending in a dramatic island candle. Once again, a gap at the top of the rally indicates it is about to end.

Finally we got the big red bar on what should have been an up day, the day the debt deal was reached.

What can we expect on September 1st (this coming Thursday)? I don't know. Not every month has a significant day on the 1st. Tracking back before the flash crash this pattern doesn't hold up. I think a reasonable explanation is that this activity is caused by institutional trading. Perhaps fund managers but certainly traders with a long term focus. They seem to be a prescient lot.

My best guess right now is that the market edges it's way back to the 1200 range. Perhaps on Thursday then we see a red bar.

The alternative scenario is that the market dips back to 1100 and we get a white bar. This would be uncomfortable since I believe the market is heading further south but by my own logic (especially if there were a gap up) then this should be a buy signal. I believe in this case it would warrant a limited long position.

I believe the indicators and chart pattern are giving good evidence that the market will retest 1200 before dropping back:

It's been my observation that crashes follow similar patterns. Note the flash crash correction on the left of the screen. After the flash crash we got what is referred to as an "automatic bounce" as indicated by the orange circle. This is generally attributed to short covering and bargain hunters. Likewise in our most recent crash we got the automatic bounce.

If the dip after the automatic bounce does not make a deeper low then it is often followed by a secondary bounce which leads to the ultimate low. This is indicated by the pink circle. I believe that is where we are right now.

The reason I believe we're heading up to 1200 rather than making a lower high is because of the indicators. Note the stochastics are "running". Rarely do stochastics turn around midstream when they look like this. Possibly they could turn around at the green line as they did right after the flash crash but given the current market momentum and recent news (Buffet investment in BAC and strength from Bernanke's speech) I believe it's reasonable to project the market edging up a bit.

Finally, RSI often retraces back to 50 after a crash before the bear market continues. We saw this in the flash crash correction and I believe we're seeing it again. We're only at 42 so there's still room for the bulls to edge the market up a bit. We are seeing divergence on the composite and RSI indicators so caution is still the word. Let's look at the small chart for the S&P:

The market's bounce off of the lower diagonal support line is clear evidence that technical traders are behind this latest rally. Possibly the market stalls at the red diagonal resistance line but I believe that the technical traders are more likely gunning for the 1200 horizontal line in the hopes that this will turn into a bullish triangle. I believe their hopes will be dashed at that level.

More SPY Fractals

2011-08-23T21:14:00.000-04:00

Today's rebound caught me off guard. I wasn't expecting such a rally. The chart is interesting enough to warrant a mid-week blog post. Here's a chart of recent action on the S&P futures:

After getting whipsawed last week during the initial bounce I spotted a high probability trade on Wednesday when the S&P finally climbed up to 1206 (I had initially predicted the retracement would get here but was impatient and started trading when it only got to 1700). The white curve on the left was flattening out which meant that we would get some downward action and I was hoping for the final wave.

Next day indeed was down. That steep motive wave (orange arrow) resulted in an enormous gap at market open. The pattern played out with a 5th wave. Then we got a little triangle, the pink arrow that says "fooled me". I was expecting that to be the end of the retracement and for the market to continue downward. Instead it rocketed upward. How far will it go?

The first thing I should have noticed was that this wave was flattening out. "Higher lows" as they say offered plenty of opportunities to take a nifty profit. The pattern here is what I call the "golf club". The golf club usually has a few bounces up to a horizontal support line. The thing about the golf club is that it usually ends with a sharp climb upward which is exactly what we got. Here are some other golf clubs:

S&P

Coffee

My observation about the golf club rally is that it is ephemeral. It usually doesn't reach the previous high and portends a steep fall.

My problem was that I was too busy counting waves and wanting them to be perfect. Right now I believe I've seen this happen before:

On the right is the current S&P on a 30 minute scale. On the left is a 5 minute chart from the 11th. I made a horrendous trading error going short in-between the purple and blue circles that day expecting the motive wave to extend. Should have recognized that today but at least I wasn't day trading!

So what happened to the left chart?

This rally eventually retraced .618 of the prior decline. It then bounced a second time and completed a .5 retrace. Finally it bottomed with a big "V". Most interestingly, the length of the green lines is exactly the same.

Let's extrapolate on the current chart:

As you can see from this chart, the S&P futures are already curling over. They hit the .5 retracement today. If that is the top then 1065 is the projected bottom based on the motive waves being the same length. If it manages to climb up tomorrow to the .618 retracement (1170) then 1074 is the target. 1074 would essentially be a retest of the previous 1077 lows. 1065 would actually be our target. Since this would be a 3rd wave we'd still expect some sideways action and a slightly lower low around 1040.

I suspect that we won't see the .618 retracement. The market pretty much returned right to the bottom edge of the big gap. It didn't seem to have enough juice to bridge that gap. Not surprising really.

I suspect tomorrow the market will open down. If the market attempts an opening gap fill then really I think that's an incredible gift to those who want to take a high probability short. More likely the market just tanks and most of us are left watching!

Finding A Bottom

2011-08-22T14:39:00.000-04:00

Right now I believe the only salient question for market analysis is: where is the bottom? Here is a chart of the current S&P:

There are two gaps on the S&P index. The first is at 1089 (green) and the second is at 909 (purple). Historically at this point in the market cycle the market will drop in the area of the blue circle. That is, it generally retraces the amount of the previous major wave which ends up at about the mid-point of the prior market crash (2008). Still, that's a pretty big circle so we're going to have to break out some price projection techniques to try and narrow things down. The biggest question for me is whether the purple gap is a possible target or a bogey.

Historical Context

Let's review the historical context. First 1977:

1977 ended up being more of a correction than a crash, and so the actual corrective pattern is not an exact match. Regardless, the green and purple arrows match up almost identically. We can see that the actual bottom for 1977 ended up right at the first "higher low" from the previous rally. This would correspond to about 1050 on our own market and would neatly fill the infamous SPY 106 gap:

Let's now take a look at 1949 which is the other historical prototype for this market:

Here indeed we had a stupendous crash which nevertheless ended up in about the same location relative to the gap (technically not a gap but a "thin area"). In 1949 however there was no obvious purple gap as the market was rather zig zaggy with plenty of coverage.

Crash Patterns

The 1977 bear market is not a good analog for our current crash. At this point I'd like to take a closer look at 1949 as well as a few other crashes that bear a similar imprint to our current crash. Let's zoom in on 1949 and compare it to today:

To me, the trademark feature of the 1949 crash is the volatility at the bottom. As you can see from this picture, the volatility at the bottom is somewhat symmetrical with the "stairway" pattern that led to the crash. Our own market had a single step and as such I would expect at least one false rally (aka short term trading opportunity). The wild cards in our own market are the two blue "X" marks. The first X is from a higher point and thus we might expect it to produce another lower point. Indeed I think that's a possibility but it's important to note that these two X's were not part of the stairway pattern. As such I believe they may play out into a larger correction. But first let's take a look at two other crashes that bear a similarity to our current crash. First 1962:

Here I'm comparing the 1962 crash on a daily chart with the S&P futures on a 30 minute chart. The S&P futures dipped much further in the after hours of August 8th, all the way to 107.7. Often the S&P futures provides a much clearer wave pattern than the index or ETF. The similarities between these charts are striking. They include a single step into the crash, a curved crash and a retracement back to the 50% mark of the crash. Even the wave pattern leading into the retracement looks similar.

There are some subtle differences though. If we look withing the crash curve we can see that 1962 had a well defined 3rd and 5th wave. In our current crash, the 5th wave appears the longest. This is a warning sign that the previous wave count is not complete.

Secondly, the wave patterns in the retracement are opposite of each other in these crashes. 1962 started motive while today's retracement started as a zig zag. Next 1962 had a 3 wave while today's crash had a curved motive wave. Finally, on the way down, 1962 had a clear step pattern while today's crash was a motive slide up to today.

As such, I believe the 1962 pattern is analogous in that they both "retest" the bottom, however 1962's retest was part of a larger motive wave upward and thus did not actually make bottom while today's retest (I believe) is finishing out the prior crash wave and thus should make a new bottom. Still, the analogy demonstrates that we need to be on the lookout for the possibility that we will not get a new bottom, and more probably I think, that if we do get a new bottom it will not be much lower than 1077! Again the infamous SPY 106 gap looks like a good end point.

Finally let's look at 2002 versus today:

Amazing right? Once again we see nearly the exact same pattern. It is worth noting however that this 2002 "crash" was actually the end phase of the dot.com crash. So 1962 was on the way up; 2002 was on the way down; and today is essentially sideways. The lesson here is that the same supply/demand patterns show up regardless of the major trend.

The big difference between 1962 and 2002 however is that the "retest" actually made a new bottom as I am expecting for our own market. Note the blue lines next to the curve and how 2002, like today, finished the curve with the longest drop. This is the indication that a new bottom will occur after the retracement. I believe the pink circles mark the analogous points although our current retracement does point towards a deeper "retest" than occurred in 2002. We'll explore this further in the article.

Worth noting is what happened in 2002 after the bottom was finally reached. This I believe is a likely scenario for our own market. What looks like a secondary retracement is actually the motive wave from the 1962 market, along with the retest that doesn't quite touch bottom. This creates the symmetry with the aforementioned "X" marks that occurred in our own market back in May.

Oh look, the market is plummeting as I write this...

Fibonacci

After first analyzing historical context and wave morphology I usually turn to Fibonacci levels to attempt to identify likely points of support:

Not surprisingly, we had a major Fibonacci confluence zone at 1098 which is where the market bottomed out (although the futures did go further) and just a hair lower than the first major gap. More difficult is predicting exactly where the next wave will stop as we have levels at 1060, 1040 and 1016 which correspond with clear landmarks on the chart. We also have the doomsday fib, last line of support, at 936 which is a hair above the 900 gap.

Possibly these three levels are an indication that we will see the volatility that would be synonymous with the 1949 crash. Or possibly they mark the stop and retest from the 2002 market. It is difficult to say, and dangerous to make an assumption at this point. What these levels do however is set a good exit point for shorts (1060) and tell us that it is time to focus in when the market gets to these points.

Let's use some other price projection techniques.

Gap Extrapolation

I am probably not the only person to use this technique but I've never read about anyone using it so I'll claim invention. Gap extrapolation is based on the observation that gaps eventually get filled. So when we see a gap created we know that, eventually, the market will come back to refill that gap. Since we also know that market retracements tend towards Fibonacci ratios we can therefore project out, or extrapolate, a bottom (or top) based on how far we expect the retracement to occur.

So in this picture I've drawn hypothetical Fibonacci retracements from the 3 possible price projection points we came up with out of standard Fibonacci theory. The gap is difficult to see on this SPY chart because of an after hours block order so I've added a black bar so that you can see the gap (it is a stupendously wide gap). Note also the black support/resistance line.

The bar that most likely fills the gap on a 2002 style bounce would be the middle black bar. 119.42 is a 50% retracement from 1040. The green line, 1016, has the 50% retracement landing in the middle of the gap which is also meaningful. Often very large gaps only get partially filled.

A 38.2% retracement is only possible from the 1060 position. If this occurs then the implication is that the bear market will be ongoing and that the next stop may indeed be the 900 mark. If the market only makes a 50% retracement then some sideways action would be expected, and given the historical context I'm putting a higher probability on this and so 1040-1016 seems more likely now.

Wave Ratios

Waves are always difficult to identify but we have some landmarks we can use based on the S&P futures chart. The best landmark is retracements. A 4th wave retracement typically ends at the previous 4th wave's vicinity. As such, I believe these lines indicate the wave count. Since our wave 3 (long white line) is much longer than wave 1, there is no rule that indicates how long our current wave 5 should be. However, guidelines are that the wave 5 will either be the length of wave 1 (which it cannot be, because it was such a steep retracement) or it will be .618 times the length of wave 3. That would put the bottom at 1063. So once again, we're in the ballpark.

The most troubling thing about the current wave however is how steep it has already been. We only see one clear motive wave which took us from 1206 to 1118. We still need room for two more motive waves! One possibility is that wave 3 is the same length as wave 1 (88 points). From 1147 down this would have wave 3 bottoming at 1060. Since our wave 2 is flat we would expect wave 4 to retrace back to 1093. Then wave 5 would likely be .618 X 88 which would create a bottom at 1038.

This is really the least explosive type of wave. The most explosive wave would have wave 3 ending at 1004 and wave 5 ending at 987. I do think the prior scenario is a good one though as a lot of people will be going long at 1060 and that 1040 will look like a minor retest. We'll know more of course once we see this 3rd wave play out.

Disturbances

There are three things that disturb me currently.

1) The S&P gap at 900

This gap adds uncertainty. Given the macroeconomic conditions it is not out of the question to see the S&P at 900 (Dow at 9000). I don't think anyone would be surprised or shocked.

2) The most recent gap

This is a chart of DIA which tracks the Dow rather than the S&P. I use it because it doesn't have the spurious block/algorithmic trades that fog up the S&P chart:

You'll have to click on this to get a bigger picture to see all the gaps but even from this distance you can see the size of the most recent gap (6). Only the breakaway gap from the 2008 crash (1) rivals it in size. Basically, on Friday the Dow Jones opened 280 points lower than it had closed. That's an incredible loss of confidence without any trading activity. Such gaps are usually reserved for extreme market crashes like 2008. The length of wave 1 (as discussed in the previous section) was suitably long given the gap but I'm concerned that it is an indication of extreme bearishness that might be an omen for a lower end point.

It's worth looking at how gaps provide a roadmap for the market. The bear gaps are indicated by black numbers and the bullish gaps by green letters. One important lesson is to always trade in the direction of the gap. This is especially the case for breakaway gaps that occur at the end of a turning point. One could have gone long at point A or point B and experienced incredible profits, even weathering out the flash crash. Likewise, in our current market, points 5 and 6 are clear indications to go short. Runaway gaps (gaps that occur in the middle of a trend such as points 1, 3, 4) are more difficult to read. Often we'll see a gap at the end of a trend and won't know in retrospect whether it is runaway or not.

For my money, I believe that gap 6 is most closely related to gap 2. It's just that the size of the gap gives me pause.

3) Elliot Theory

Elliot Theory tells us that at this stage we should be seeing a 3 wave correction, not a 5 wave. The crash pattern however is almost certainly painting out a 5 wave. I think wave reading at the major trend level is difficult if not dangerously misleading. I prefer the historical context but let's analyze the possibilities. The first possibility is that this crash does indeed end the 3 wave by either of these possible counts:

The blue count might be the "obvious" count seen from a distance. We know from close up observation however that this is probably not correct. The white count has the little step counted as wave 1. This is all out of proportion and so seems unlikely as well.

Given that this current wave is a 5, we should be expecting a zig zag 5/3/5 pattern. That might look something like this:

If we're going to get to the 900 range, then the zig zag is how we're likely to get there. Note that the middle wave (3) should be easy to identify as a non-motive wave and give us plenty of warning if this is going to happen.

A zig-zag however is indicative of a market that is in a hurry to correct in order that it can proceed upward. This doesn't really match the current economic conditions which look to play out over a longer time period. I've trained myself to recognize however that usually when a wave pattern is unclear that it means that the pattern being played out is much larger than expected. Given the historical context, we should expect this bear/sideways market to take much longer than a few weeks to play out! So perhaps we're looking at something more like this:

While it is difficult to come up with a satisfying wave count for this scenario, I believe nevertheless that it is the most likely. It matches the historical context (1978 being a false rally). It also provides the most time for the market to play out the economic conditions. A possible QE3 coming out of the Jackson Hole meetings might provide the context for such a false rally.

This pattern also leaves room for another rally and retracement as wave 1 of the next big boom. Such a pattern occurred in the 1979-1982 market.

Timing

Note the lines in this chart:

The S&P is on a clock of sorts. Throughout the previous corrective period the dips occurred in the middle of each month. During the flash crash correction the peaks occurred in the middle of the month. Likewise, we now observe that this previous peak occurred in the middle of the month.

Generally speaking, the opposite turning points occur at the beginning of the month or thereabouts. Unfortunately these are not quite as regular as the peaks and valleys but given the current pattern and timelines I believe we can expect a bottom around the end of this month. Coincidentally, this corresponds with the timing of the Jackson Hole meetings. It's hard to imagine, given the current market state, the S&P clock, the retracement projections, etc that the results of Jackson Hole wouldn't provide a buying opportunity. Whether the effect lasts or not is harder to say. I believe however that we will be able to watch for ongoing wave patterns based on this same clock.

Most importantly, note the two black lines denoted by points "A" and "B". These were both points that I call "truncated markets". In both instances the market looked like it was going to take off but instead immediately slipped into a steep correction. I believe the cyclical timing is the key to catching these. Those were on the bull side. Now I believe it would be the opposite. Watch out for a steep dip (wave 5) towards the end of the month that is in reality the beginning of a bounce.

Other Related Assets

First let's look at the dollar:

The market requires a falling dollar in order to rise. Currently, the market will fall if the dollar rises. It is also likely to fall if the dollar stands still or wiggles around. Thus, we've had a market crash during what is essentially a sideways movement of the dollar. As everyone knows, the market has been on life support and without a falling dollar it is doomed.

It does look though like the dollar is falling. the white arrows point to clearly motive waves. The trend for the dollar has turned down. Now, on the minor trend level it does look set to climb a few notches before this overall trend continues. The green lines are enough to get the market down to the 1060 level I believe.

Now let's look at the long bond:

It's been a hell of a ride for 30 year treasuries. The yield spread recently dipped below 2%. The ride is not over yet. We are clearly making out a sideways pattern. This is very high probability for a 4th wave which means treasuries have another notch up. Wave counts can always extend but I believe we're seeing the 5th of a 5th here which should be followed by a correction back at least as far as the arrow shows if not further. Overall, treasuries are in the territory that they were in at the height of the financial crisis. It's all out of proportion with what is actually going on in the equity markets so I wouldn't be at all surprised to see a significant retracement.

Gold

As noted in my previous blog piece, gold has recently gone parabolic. This never ends well. However, like treasuries it appears as if the wave pattern is not played out yet. I'm estimating 1930 as the top. Gold should at least fall back to 1750 but most likely to 1500. Unfortunately, very few are ever willing to see at the top of a parabola. Greed takes over.

Market Survey

This blog post has taken much longer than I had anticipated but I can't finish without a quick market survey.

I'll start with Corning because a good friend of mine trades it and it got a mention in Barron's this week. I'm concerned though. Here's a weekly chart:

This is big picture but note the pattern. A rocky climb over an extended period and then a steep drop off. The last climb has the tell tale ragged action of a B wave. The implication is that this current motive wave downward is not finished. I think the long term support line is indicative of a bounce point around 11 for this stock. Note the thin cover in the 12.50 area which will probably serve as an intermediate stop. My expectation is that it bounces around this point back up to 16-17 and then comes down to finish the 5th wave (as indicated on the chart). If GLW has any implication for the broad market it is that we will indeed see lower lows after a retracement.

We've looked at Microsoft before but let's look again:

So many people are long Microsoft as it is a core component of most indexes and most mutual funds. Microsoft is a darling because of the cash on the books and market position. For those in the technology know however, we know that Microsoft is a sinking ship. The technicals seem to confirm this. Once again on the weekly chart note how MSFT appears to be making a B line for the thin spot which is the equivalent of S&P 900. The wave count is a decent read. Most damning are the stochastics which indicate that MSFT has quite a bit further to fall before it gets a bounce. Long term it probably eventually winds it's way back up into the 30s, after all so many people own it that it will take a lot of misses, and a lot of spent cash before it comes down. Decades perhaps. Still, I wouldn't be long in the near term.

Apple also looks alarming on a weekly chart:

Note how deep the stochastics are running. Note the divergence between composite and RSI (green and red lines pointing different directions). Finally the Elliott Wave count looks like it wants AAPL in the red circle before we get a kick back upwards for a 5th wave.

Home Depot on the other hand looks strong:

Stochastics bottomed already and now are making bullish divergence, as is the composite and RSI. Meanwhile, HD hasn't come back to retest the lows like the rest of the market. I suspect the worst is past for HD, although it will still probably duck back below 30.

Proctor and Gamble also looks relatively strong:

Can't say I like the broadening top, and the X marks the point where one would definitely want to bale on this property, but in the meantime stochastics look good, it is holding up better than the broad market and we have good divergence on the indicators.

Con Ed certainly has weathered the storm:

Looks like it has further to climb although it might just go flat if the general market rebounds. Brewing bearish divergence on the RSI although still early to tell.

Caterpillar I think tells the tale for what happens to the market:

Here on the daily chart we see a Fibonacci confluence zone that predicts a bounce. We also see brewing bullish divergence on the composite. However, the gap marked "eventual" coincides with a .618 retracement line and there's not a lot of support above that line. So I think CAT bounces at 75 but then eventually winds it's way down to 66.

Judging from the market survey I think going long at 1016-1060 is likely to be a temporary position as there is just too much evidence that the market will fall back further.

What we do know from a long term perspective however is that the gaps at 1190 and 1330 provide eventual upside targets. A long position taken in the 1016-1060 range is likely going to have to weather some downside paper loss but should eventually yield a nice profit. We should be on the lookout for a breakaway gap to the upside as a sign to go long with a large position, otherwise a modest position I believe is most warranted for playing the likely retracement off of a 1060 bounce.

After The Smoke Settles Is There More Smoke?

2011-08-12T23:13:00.000-04:00

The predicted market correction has come to pass. While I was buffeted a bit by a slippery market, I am glad that the prediction came through at approximately the time I most expected. I feel my analysis techniques have been validated and I have learned a great deal about market tops which will serve useful in future years.

I have to admit to being surprised by the correction taking the form of a crash. I had expected a more drawn out correction. Readers of my blog will recall that 1946 and 1977 are analogs to today's market in the general cycle. The economic conditions are similar to 1977 as was the time scale of the prior bull market, and so I expected a correction on a similar time scale: months to a year. Instead we got a crash, which is what happened in 1946.

My original thesis was that the market would fill the SPY gap at 106 (S&P 1060, Dow 10,100) and then bounce around for a few years but not dip lower, or much lower. Now I'm questioning that thesis.

Where are we now:

This is a chart of SPY (S&P ETF). Currently the chart is making out a pattern that I'd like to call The Saxaphone (looks like a baritone sax!). It is actually typical for a crash to take a breather around this point before resuming. My expectation is that the market will resume downward to 106. Fibonacci extension from this point gets us in the 104-107 range. A .618 fraction of the 3rd wave gets us in that range as well (S&P futures dipped to 107.7 which I consider to be the true bottom of the previous wave).

There is incredible support at the 106 range so I fully expect the market to bounce there. But how far?

Troubling Signs

There are a few things that are troubling me. The first is the Nasdaq:

This is a chart for QQQ, the Nasdaq ETF. Now, my analysis says that this corrrection should be of the major trend level. Does this look deep enough to you? See how the S&P has gone much much deeper already. Are we to believe that this is the limit of what will be erased from the Nasdaq. Are tech stocks really not going to correct significantly?

The Nasdaq made a broadening top according to technical trading and as such the measured distance would be 47.07 and would hit this red line:

which is about as far as the S&P has already gotten. So for this to happen, the Nasdaq would have to fall much further than the S&P during this next wave down. Or, the S&P will fall further than we're expecting... A grain of salt, the measured distance is a guideline, an expectation, it can be more or less. More often deeper than shallower.

As goes Apple so goes the market. Let's take a look:

Well, Apple has a pretty fantastic long term trend line. The first pink circle is about where I was shorting Apple during the last correction. Idiotic. The danger in day trading is losing site of what is actually happening. One glance at a long term chart would have saved me money that day. Here and now, it looks as if that trend line will hold again. EW theory would want Apple to come down to the range of the first pink circle but I wouldn't count on it. So, Apple looks good and this certainly is a major part of what keeps the QQQ above water.

Microsoft is a major component of the Dow and Nasdaq. How does it look?

Microsoft doesn't look so good. It's kind of a dream chart from both a technical perspective and Elliott perspective. The wave between the green lines on the left is a textbook 5 wave motive. EW tells us with absolute certainty then that Microsoft is heading down. The A, B and C waves are again incredibly clear. Next week's plunge should take MSFT down below 24 which will be very bad news.

From a technical perspective we have a symmetrical triangle about to be broken. We also have a decent head and shoulders pattern, and one would expect a return to the next line as I've drawn out. Short MSFT and long AAPL? Who would have guessed... But for the broad indexes this is definite trouble.

More damning are the stochastics on the MSFT weekly chart:

That's what I call "running stochastics" and it is about the highest probability trade I have. Now it is possible for stochastics to bounce in the middle but it's rare and given the market conditions, EW, and technicals, I'd say this is confirmation that MSFT is going much lower.

Let's look at a bank!

We don't see this stuff too often. Only during market panics. Bank of America has a breakaway gap and now a bear flag. Notice how the top of the flag is flat. That's serious resistance. The measured distance on the flag pole gets BAC down to 4.63 although a runaway gap could see it go much further. But then we are near the bottom of where BAC was at the bottom of the financial crisis. I would call that a retest and possibly a long.

Home Depot

HD looks like it will weather the storm. The big black circle shows a choppy climb which provides major support in the range of the black bar. This is like a bullet going from air to water and so the collapse should slow. What I do see is a potential head and shoulders working itself out over the next year. Weekly stochastics (not shown) also look very good for a HD bounce.

IBM has had an incredible run:

This bird's feathers are going to be clipped in the next few days though. Note that stochastics are running. We do have support a little above the bottom. All this should bring IBM to the green line. From an EW perspective this would be again textbook as the 2nd wave was flat and the 4th wave would be deep. It would set up a 5th wave for IBM but then once again, EW says that in a few months time we would be right back here.

Oracle

ORCL has been an incredibly well behaved stock. I think the gap will be filled imminently. Then back up for either a "Kiss of Death" (a la Serge Farra) at the diagonal black line, or to complete a H&S at the horizontal black line.

How about a retailer?

This is Aeropostale and it demonstrates the general state of retail. Coming up on support so I'd expect a bounce. I see a kind of pseudo head and shoulders forming, and from an EW perspective a 5th wave.

Caterpillar

They go up, they go down. Very thin support for Caterpillar but I think it will hold for a while. EW could go either way but I think the attached is the more likely story. The gap at 32 is ominous.

Finally GE on a monthly chart

Probably doesn't require much explaining. Check out the stochastics. Remember this is monthly so that could be years downhill for GE, although in the short run it looks like we're bounce for a head and shoulders pattern. Too bad there isn't an inverse GE ETF! That would be a long time to hold a short but it would be the gift that keeps on giving.

So to conclude our stock analysis I think it does look like we'll get a decent bounce at the expected area. I think Nasdaq may dip further, my theory being that most of the crappy stocks in the broad market have already had their asses kicked. Aeropostale as an example. RIMM is another:

Looking only at this stock, you'd never know the market crashed during the period encapsulated in by the green oval. RIMM was a harbinger of the crash but just doesn't have that much further to fall. Darned thing is close to selling at book value. Maybe that "Microsoft buys RIMM" lottery ticket will be worth picking up again in a few days.

The other thing that's been bothering me is the dollar:

The dollar never made a new low as I had expected it to. The market crashed on what has really been a very minor bear flag with a lot of volatility. I believe that this is a correction in a motive wave that should then take us lower. But how low? I don't know but EW again implies that the dollar would then retrace back up which could provoke another crash, or continued bear market at the very least. Certainly this is in line with what the technicals look like in the individual stock analysis.

Finally, what about the commodities?

Here's sugar on a weekly basis:

It certainly came down, and if the crash plays out next week then I would expect it to hit the .618 retracement which would definitely be bearish but then it hasn't come down nearly as far as we might have expected. Stochastics I think again tell the story although on a weekly chart, with stochastics at the top there could be quite a bit of upside left (daily stochastics point the other direction). Certainly a "lower high" from sugar would be an incredible short. (Ah, if only I'd shorted. I had calculated 108 as the top but it only made it to 106 and so I never got the trade off).

Good news coming to the pumps I think:

Oil has been knocked back hard. I suspect it will climb back to the blue diagonal and then fall back again. Hard to say where it goes long term but I can't say that oil must fall any further than it has.

Recognize this pattern?

This is JJG, an ETF that tracks the price of corn and wheat. But to me it looks a hell of a lot like UUP turned upside down. I've trained my eye to look for curvature and this looks like prices are heading down and will retrace a good portion of that prior wave. If this really is the inverse of UUP then that would mean that any stock market rally would be brief, if we expect the curvature to hold up. Thin evidence I admit.

This is COW, an ETF that tracks beef. This is the 30 minute chart:

Pretty slippery to try to make a wave count out of this but this is my stab. Then if we zoom out:

Suddenly COW makes sense again. We had a clear downward 5 wave coming into this retracement. I had expected the retracement to be swift and was surprised to see it carve out a 5 wave up. Now I recognize (I think?) that the retracement is belabored and can go much higher. If it gets as far as the top of my green line then it's coming down. You would have thought commodities would have come down hard with the market crash but they didn't (oil being the exception). So that event is yet to play out. COW could bounce into another 3 wave up to play this thing out over months or even years, or it could come down deep. EW can't tell us.

No it's not the stock market, it's copper:

Perhaps the worst offender of the "commodities haven't crashed yet" dilemma. Note how copper diverged at the top from the stock market. That should have been a tip off huh?

We call this shape a parabola:

Check out the stochastics on this monthly chart of gold. Wouldn't take much to send it back to 144, or 120, or 100. Did you see gold flinch last week? I did:

There's a flinch in the last bit of parabola. But watch out shorts! Where's the 5th wave? Yikes, what will a gold spike look like next week if the market tanks again as I suspect?

Temporary as it will be though. Note the divergence between composite and RSI. Where have we seen this before?

Yup, silver. Extra credit try to match up the red divergence with the prior gold chart...

Anywhere else?

Yup, Swiss Franc. (Will it bounce off of the return line or plow through like silver did?) It's funny what happens when the commodity exchanges raise margin rates on parabolic commodities.

Finally the thing that bothers me most:

There's a gap in the S&P index at 908. I've been watching SPY so much that it never occurred to me to look at the actual index. It has me very concerned.

The other thing that concerns me is Elliott Wave. This crash is looking to be a 5 wave crash. Of course, because it's motive. So is that little blip up at the top supposed to qualify as a 3 wave? I'm doubting it. I have to hold out the possibility that the S&P makes a much steeper 5/3/5 correction as I've painted here. The distances work out so that the gap at 908 would be filled. Ominous. Based on our market survey of individual stocks the implication is that the "quality" stocks climb up and then retrace back to about their current level or a smidge lower. But the "crap" stocks essentially fall all the way back to their 2009 lows. (Microsoft is perhaps the canary in the coal mine).

I definitely think it's worth going long at the 1060 mark (assuming the crash looks completed) but the wise move would be to choose a portfolio of quality stocks. An Apple a day keeps the bear away. I've take a stab at an EW interpretation of the Apple wave:

The short brown "1" wave is the tip off that this is a large wave that is extending. Apple will be under fire just like all the other stocks but it will weather the storm better than any other stock I believe. Stochastics are the only thing that should give pause but I believe they will find support and spell out the pattern I've outlined.

Anatomy of a Market Panic Fakeout

2011-08-11T14:30:00.000-04:00

I think the current market rebound is a fakeout and that the lows will be re-tested. Here is a chart from S&P futures:

The giveaway, I believe, is the A wave. It's a big spike up from a bottom but it's a 3 wave pattern. Even the correction within the A wave is 3 waves, and I believe serves as a reverse template for the correction at large.

The B wave is a classic consolidation pattern. Another leg down would have confirmed it for me but we just don't get lucky. Either way, you can tell that there are two distinct motive waves that look like waterfalls.

Now we have a motive wave as expected. I believe it's a C wave. My rule of thumb is always trade a major C wave because I've been tricked many times into thinking something is a C wave and it's really a motive wave. This may be another case although I would really be perplexed by the wave count. If so then oh well but here's what I really think...

I think this C wave unfolds like my blue lines and then comes back hard for the final down wave of the market panic.

The red bars indicate the red zone, or the likely areas where the C wave might end. Given the upward slop of the entire pattern I would say it would be higher rather than lower. EW theory says 4th waves end in the range of the prior 4th wave and it's easy to see the prior fourth wave which peaked at the top red bar.

If the market manages to get to 1210 then I think it would make an excellent short with a relatively tight stop at 1230.

If I'm right then the market should fall past the prior low of 1077. I would expect 1060 at the very least, and this would look like a "retest" which would not be out of line with technical expectations. However, I think it's quite possible, almost likely, that the market dips somewhat below the 1060 number. From a psychological perspective I think a market below 1000, or the DOW below 10,000 would be just the thing to get the bulls off balance.

1939 v 2011

2011-08-11T11:14:00.000-04:00

In response to Serge, I think this is a better analog:

Up, Down or Up Up?

2011-07-30T23:23:00.000-04:00

Most analysts will only give you two possibilities: (1) the market can go up or (2) the market can go down. I prefer to look at the broader picture and provide three possibilities.

1 - The Market Can Go "Up Up"

In my previous post I realize that I made a technical error in my wave analysis:

This correction is a "flat". It is textbook stuff, 3/3/5 wave pattern. It's not perfectly flat, but that is also textbook. The C wave is supposed to duck below the B wave. More typically the B wave will also be above the A wave (extended flat) but regardless, nothing wrong with this picture right now.

The problem is that I said that this should be followed by a "X" wave which would connect the pattern into an extended correction that would dip steadily downward. Well, I went back to the Prechter book "Elliott Wave Principle" and re-read what he had to say about flat patterns and immediately it put doubt into my mind. He says, that while a flat can and does connect, that it almost never connects to a descending pattern. While technically legal, he had never seen it do so. Granted, this was written in 1978 but still it's worth reconsidering my predisposition to a bear market that starts "now". Traders always want to short and they often short too early.

When you think about it, a flat does imply that the market is heading back up. It implies that there are enough bulls to keep the market from turning into a zig-zag or motive wave down. The bears briefly get the upper hand in the C wave but are then met with support. The implication for our own market is quite bizarre I think. It would mean that, based on my wave count, the most likely scenario is a bull advance that would look like this:

What I have assumed to be the final wave is in fact (under this scenario) wave 1 of a larger motive wave. Our current correction would be a wave 2 which quite reasonably retraces nearly the entire wave 1. Such a large retracement would imply that wave 3 would not reach for the stars. 138.60 is a likely stopping point based on several price projection techniques. Then one would expect a flat correction (triangles perhaps as in my diagram). A flat correction would be necessary to prevent the 4th wave from dipping into the 1st wave. It would also follow the alternation guideline in the EW principle. Finally a small 5th wave. Here I've computed a .618 multiple of the 1st wave to get us to 142.20, however based on analysis of the 2007 peak I think 144 is the more likely target if it gets that high because it is a "weak zone" in that peak, the support line between the 2007 corrective pattern and the crash.

Note I also assume one more dip on Monday as this wave pattern is not yet complete based on my count. I'll look into that a bit later.

Now, to support this theory I would expect wave 3 to look a lot like wave 1. That is, almost no corrections but a straight shot up. On the daily chart there is a gaping hole at 133:

That gap should act like a magnet pulling the market up. If the market blows through that gap then that is a good sign that this case is correct. Of course one can hardly expect that sort of convenience. More likely I think it retraces at the gap and then bounces off of the 50 day which would be right about 131 at that point. If the shot from 127 up to 133 is straight then it's not an X wave. A bounce off the moving average would be a big long.

DeMark has something interesting to say:

I'm not normally a huge fan of TD countdown (I prefer TD Setup) however during this SPY correction is seems to have performed well. See circle #1 and the black bar at the bottom of the screen. The black bar indicates that TD countdown has recycled. That is, it was counting towards a sell point and then suddenly realized the market was not ready to sell. It was a strong buy signal.

Circle #2 did the same thing. This point fooled traders along with DeMark! The purple circle at #3 is what I refer to as the "truncated bull market". Everything except Elliott Wave pointed towards a bull market right there.

Now we look at the green bars at the bottom of the screen. There are twelve of them. A thirteenth would complete a TD buy countdown which is a rare event on a stock chart and often indicates a major wave up is about to occur. I believe the market will be down on Monday which quite likely would complete this countdown.

2 - The Market Can Go Up

This case is basically the one I outlined in my previous post. The flat would extend with an X wave and then head down again, carving out a larger corrective pattern. Prechter's comments indicate this is unlikely so is it possible that I've miscounted?

The purple wave (5) is unmistakably a motive wave. While it is unusual in that the wave 3 is a straight shot while waves 1 and 5 are stubs, it is impossible to say that it was anything other than motive especially if you were trading it!

The green wave (B) is unmistakably a 3 wave pattern. I would challenge anyone to dispute that.

The blue wave (C) once again is unmistakably a motive wave, having all the characteristics of a C wave and being quite easy to count.

But what about the circled wave? I've previously counted it as a 3 wave but could it be a 5 wave???

This is a 5 minute graph from ThinkOrSwim which includes the extended hours including ARCA trades. It is thus the most complete graph I have of that period (a 1 minute would be more complete although I doubt it would offer anything clearer).

The middle pattern is the only one that is rather clear to me. The two blue motive waves sandwich a flat corrective pattern. So this entire middle section is a "3". That means that the part on the right, labeled "5" must be a 5 wave. It's awful to try and count it but it doesn't matter. Either interpretation forces this to be a 5 wave.

So the question now is whether the large motive wave indicated by the yellow line is 3 waves or 5? Here are two possible interpretations:

A case of being able to twist wave counting to anything you desire. If the left case is correct then we have a bull market. If the right case is correct then we have a bear market!

Looking at the big picture again Does it look like a zig-zag?

Again, I don't think you can say definitively. On the one hand it is definitely downward sloping which is indicative of a zig zag. On the other hand, a zig-zag correction is usually a quick retracement, which that first A wave was anything but.

Well, regardless of whether this is 5/3/5 or 3/3/5 is the market heading up?

Here I've used my software to project a close for Monday that would fall on the technical support line. Composite sure enough has hit support. RSI is darned close to support. I don't have stochastics in my software but they have bottomed. We also have volume equivalent to the volume that occurred during the previous correction bottom. Finally there is the DeMark countdown. One would like to see a DeMark setup at this point but we are 6 days away from that. If the market breaks the previous corrective low then this is no longer a corrective pattern but a motive pattern!

3 - The Market Can Go Down

The final case is that this is not a correction at all but the beginning of a motive pattern. What was previously classified as an A wave is actually the "1" wave in a downward trend:

A break of the support line indicated by the pink circle spells doom for the market. A more insidious motive wave might look like this however:

Here the market maintains itself above support but never breaches the resistance line, instead carving out a flat corrective pattern (which would follow the guidelines) before breaking down. Beware if the market rebounds but cannot break 129.63!

Have we seen a pattern like this before? 2007 is similar:

The orange arrow indicates a difficult to interpret wave that is clear only in the larger context. We see the twin towers although the lead in was more easily interpreted as corrective and it would have been hard to mistake this for a flat. The red light was evident to anyone following Elliott Wave however and provided a clear indication of where the market was heading. Still it provided numerous opportunities to get out at that level and even provided another opportunity further down the line to get out on a gap fill. Our own market has a similar gap. In 2008 one had to wait 5 months for that gap fill through a hideous corrective wave.

Another breathtaking twin tower occurred at the top of the 2000 market:

This also was a "lone" motive wave and one could easily have been fooled into thinking that one more surge up was coming. DeMark sent off a warning however (red circle) and both composite and RSI hit their support levels. The market is generous and dastardly at the same time though. Those who might have recognized this as the beginning of the motive wave down had to suffer through a four month corrective wave, which was a blessing for those who had missed the signals the first time around. Indicators for our own market have not been quite so generous.

More Guidance

For more guidance we might take a look at the rest of the market. I think that TLT is particularly interesting right now:

It took off with the market collapsing as would be expected. It has left significant gaps behind as indicated by the red lines. The bottom gap is a typical breakout gap and we'd expect that to be left unfilled for a lolng time however the gap at 94 looked like it was going to be closed before TLT took off. Likewise the "angle of attack" on this TLT wave is too steep I think to allow the breakaway gap at 96 to remain unfilled. It's worth noting that this recent shot filled a gap at 98 that I'd been expecting to be filled for months. That eliminates one target for TLT.

Now I think I've seen this pattern before in UUP only in reverse. Here's what I think is going on:

The wave count on the current leg indicates TLT will go further. I don't know how much further. Too much would put this interpretation into question (and of course the SPY would hit the red light if it went much further). UUP did this exact thing though. An extended B wave makes a lot of sense after a big round motive wave. A devastating C wave could close the gap at 94 and then some. That would correspond to a significant market rally.

Not much guidance from indicators here but note what volume might be telling us:

The last time we had a volume surge on a breakout like this it was a premature signal. The market quickly retrenched. I think we might see the same thing happen again.

Let's see what UUP (Dollar index ETF) is doing:

So far it is tracking to our initial thesis. I'm expecting it to fall further as indicated by the red line. If it bounces above 21.20 then this thesis is out the window though and the market is going down now. If UUP continues down, then the bulls still have a chance although not a guarantee.

A few things worth noting on the chart. The first is the amount of time that stochastics can stay "on the ground" if a security is trending down. UUP stochastics are on the floor but could stay there. The composite index hit support and then bounced. I believe that a retest of that support line will be the end of the down trend for UUP however it's worth noting that RSI is nowhere near support.

Finally draw your attention to the volume surge at the prior bottom for UUP. I would expect the same sort of surge when we get close to another bottom. This of course is most likely to happen when the Euro begins it's descent which I believe will happen on a gap fill:

The Euro threw out a number of bogeys to technical traders, first offering up a symmetrical triangle that faked a bounce. Then a momentum surge over the resistance line and fake break of the 50 day average. No doubt the gap will offer another opportunity for traders to take money from one another, so possibly FXE heads further north as indicated by the dotted lines. For the time being however I believe the gap will act like gravity, raising the Euro and sinking the Dollar.

Still, it does not appear to me that UUP has far enough to fall to maintain an extended bull rally. Nor does it appear that TLT will fall low enough to support such a rally. Therefore I remain skeptical of the bull case and wary for the bear case.

An Overly Generous Market

2011-07-27T22:21:00.000-04:00

I often say that the market is generous. It provides numerous opportunities to get in at the bottom and get out at the top. Let's count the number of opportunities the market has given to get out of the S&P at or near the top:

Four times by my count and this doesn't even include the absolute top. See, it's the absolute top that distracts us from the real opportunities. Few would have taken opportunity #1 as it was sudden. A devotee of the trend line or the moving average would have baled out a little before hand but then probably jumped back in during the next rally. That was me at the time.

The next rally being 3 waves (black lines) should have been a tip off to Elliot Wave followers. I was not following Elliott at the time otherwise I would have known that the market was toast around 133. However the bull market truncation at point 2 was surely a second signal although a difficult one to catch.

Let's zoom in to take a look at 3 and 4:

Here we see points 3 and 4 (the most recent activity) on the 30 minute chart. Point 3 ends a 5 wave rally as indicated by the black lines. This should have indicated that the Elliott Wave count was complete. A gap was left though which implied that the market would return. Still, based on my analysis this was certainly close enough for a big short. That an island was created should have again tipped off Magee devotees.

Next the pink circle indicates the .618 Fibonacci retracement that I blogged about. This was the first point where I expressed skepticism for the bull market. I still thought the gap would be filled though and that there was a small chance of surpassing point 3.

Now point 4. The gap was only partially filled. A dilemma. The wave count looked motive but then what should have been a 3rd wave was too damn short. I knew this and perplexed over it but didn't blog about it because I was still bullish and expected a retracement and a very short 5th wave. Technically possible although again the alert technician might have baled at point 4.

Next the two blue circles clearly indicated that this was not a motive wave because the retracement had violated the peak of the resistance line for wave 1. At this point I just displayed a willful blindness to EW principles. Because EW is tricky we tend to continually doubt it's veracity. However by doing so I missed two more decent opportunities to short above 135 as indicated by the orange circles.

Granted, I found the pattern disturbing and cut my position. Then later I spoke with my wife who is an excellent stock trader who has been sidelined while raising infants. She convinced me that I should go flat since I was no longer certain. Glad I did because we can see what happened next!

Now let's try to figure out what is happening:

When the market's subtle hints don't work it often hits you over the head with a hammer. It was the hammer blow from today's market drop that allowed this wave pattern to finally crystallize in my analysis. It's a simple ABC flat pattern. The waves are easier to see if we zoomed in even further but even without picking waves at the one minute level it's clear as day that A and B were both 3 wave patterns. Even clearer that C is a motive wave.

Now where are we in the C wave?

Counting an extending motive wave such as this one is fraught with the possibility for error but I've given it a shot. It's possible that the green lines are redundant (a product of a possible running 2nd wave). Extended hours waves are hard to read as well. Regardless, I don't think this wave is over. It should however be somewhat symmetrical as indicated by the red, green and purple strokes on the right, as 4th waves often retrace back to the same level. Not surprisingly this would mean that the market would "skid" along for a day or two. Just long enough for the politicians to go right down to the wire for a debt deal announced Monday afternoon in time for "Turnaround Tuesday?" Maybe.

A better way to analyze the length of the C wave I think is to look more broadly:

The pattern is called a "flat" for a reason. They tend to be flat. We have a gap to fill as indicated by the blue line and we have strong support as indicated by the black line. This is an oft visited area:

As is the area where I expect this C wave to "skid":

Indicators seem to affirm this analysis:

Stochastics are still running which is a very strong indicator that the down trend is not complete. Meanwhile I've drawn in support levels for RSI and the composite. I would expect these levels to be reached by the time the market is ready to swing back. Let's actually take a look using my own software and a capability I recently created called projections:

Here I've added three bars down to the level I expect the C wave to end. The system then computes out the RSI and composite. We can see that the composite does indeed hit support but that the RSI itself is still well above support. What would it take to hit that support level on the RSI?

Well, hardly a flat anymore but it doesn't look like a totally unreasonable wave pattern. It would bring us right back to familiar territory in the 126-127 range. RSI would hit support as expected in that range and composite would hit deep support from way back in the way back.

Let's look at some of the other indexes to get a wider scope:

This is the Nasdaq and it is more satisfying as we have a clear 5 wave pattern that ended. Today's drop stopped neatly at the .618 retracement from the minor wave but can we expect it to end here? I don't think so. There's the gap to fill at the purple line. Stochastics are running as indicated by the red circle. We got stopped at one trend line but I think the lower trend line is a better stop (it also coincides with the .382 retracement from the intermediate wave). A bounce off the 50 day moving average (purple circle) is perhaps the last stand. Note that we have bearish divergence on the RSI and composite. I will say that the wave pattern on the small chart however looks rather complete:

As indicated by the green lines, however that doesn't look like a motive wave. Wave 3 ought to be much larger and the congestion at the bottom is from a stock that is falling further. I therefore think the pattern as indicated by the red and blue lines is more likely and that this stock will soon be at 57.

The Dow Jones had been falling more of late and started today at the black line:

Had the markets been flat and DIA closed the gap indicated by the right hand circle then I probably would have gone long. It kept going though and almost has closed the gap at the right hand circle! A Two-fer. Here we have a very nice flat correction however I think DIA is dipping further. It also has an incomplete, complex motive wave. As has been the nature of the Dow recently however I think it will hold it's ground better than the other indexes.

Finally IWM (Russell 2000) demonstrates how weak the broad market is:

Assuming the measured distance for the two green legs is the same then IWM should bottom out around 79.30.

What happens after bottoming? A market rally is a possibility but it would have to be a stupendous rally to make the wave count work and I don't think that's in the cards. What I think is the inevitable result is a that this is the first part of what will be a complex corrective pattern that slowly slopes downward until SPY hits 107. As this pattern is an ABC flat, one would expect an "X" wave to create a connector to the next corrective pattern:

The X wave is a 3 wave pattern. It almost never reaches the top of the previous C wave. Here I have the X wave retracing to the (ostensible) .618 Fibonnaci, which happens to coincide with a decent looking resistance area. Still, this is generous and it will take good news to get the market here.

Let's take a look at the dollar and where we are sitting in the general theory. Recall that it is a falling dollar that causes the market to go up:

This is UUP (the dollar index) and so far it is just picture perfect. My overarching theory calls for UUP to make a new bottom with this being the final 5th wave (C wave). As expected it filled the gap from the left of the page and then bounced. Textbook says it should retreat to the level of the previous 4th wave and we're just about there. It can retreat further, or it may "hang out" at that level for a few days to allow the market to work through it's machinations. If my theory pans out however then it will make one last dive as indicated by the green line on the right.

It shouldn't go far though:

As indicated by the stochastics. They can stay nailed to the floor for a while of course, enough time I think for the dollar to slip a bit further but it's definitely trying to catch a falling knife and if this pattern hadn't been playing out to the textbook for a few months now then I would almost certainly have gone long the dollar yesterday.

Let's look at some other currencies. The Euro is clearly toast:

It is the major contributor to the dollar boost today but it will likely get a little kick at the 50 day average and trend line. Maybe enough to carve out what looks like the same necessary tiny 5th wave to match the inverse of UUP.

The Swissy didn't even acknowledge the dollar surge today:

Still heading for the trend line, ever so slowly now.

Here's the Australian dollar:

Shooting up today despite the headwind of a falling dollar. It is emerging out of a long grueling corrective pattern and I think this one is going much higher before it finally capitulates.

Treasuries are in "wait and see" mode, presumably until the debt crisis is resolved. I'm hoping for a gap fill in the meantime. Silver and gold took a little bit of a spill. They are overdue for corrective action and need a "recharge" if they are to power on. Soft commodities were surprisingly up today. They will not be taken down until the dollar puts a real surge on.

Oil is slipping:

Note the bearish divergence against the composite index. Stochastics running hard.

Finally let's look across the market. I've often said, as goes Apple so goes the market:

The incredible rally that generated a 30% increase in a matter of weeks is about to end. The blue circle is a perfected and completed DeMark. It has done this before and yet pushed on, but this time the signal is occurring in a congested area. Notice the green oval indicates bearish divergence. The gap at 380 is certainly vulnerable.

Microsoft also has a perfected DeMark:

The bearish divergence is even more pronounced.

IBM another high flyer does not have a DeMark count but does have a gaping hole to fill and again pronounced bearish divergence on the composite:

Caterpillar is stopped at a .618 Fibonnaci:

And some technical support but if it slips past that point there's nothing to hold it up. This is a big Dow component.

Altria has been weak:

Here it's at a critical juncture. It either rallies off the technical support (and DeMark buy signal) or it becomes a head and shoulders pattern. (Note that it can still dip a little bit and pull a H&S fake out).

Walmart has some technical support:

Including a former DeMark support line (circled). We'll see if the trend line holds.

I had been hoping AMP would rally so I could short it:

But instead is plummeted. It will probably find support at the DeMark green line on the left. It is simply playing catch up with the other financials now.

Here's Wells Fargo:

AMP will probably bounce just like WFC did. Amazingly, WFC held up rather well today. It looks like it has only little burst left in it but then the rest of the market is now playing catch up with the financials who have taken a beating for many months.

Conclusions? Hopefully we'll get one more opportunity to short the market from a higher perch.

"Franc" enstein

2011-07-26T22:33:00.000-04:00

Currency traders have created a monster, and a nightmare for the Swiss economy. The villagers are coming with the pitchforks though:

The trend lines demonstrate the metronome action of currency traders. Watch out when FXF hits that top return line.

On our indicators we see a "pop" on stochastics which is a drop and then pop back up to resistance. We see bearish divergence brewing on the composite and resistance on that indicator. Finally we see a downslope resistance line on the RSI.

This currency is a sharp knife because it can rally off of the dollar or the Euro. My guess however is that when the dollar rallies, the Franc will drop like an axe.

FXY vs. SPY

2011-07-26T22:14:00.000-04:00

I found an interesting similarity between the Yen chart and the S&P chart. Here's the SPY chart at 30 minutes:

Here's FXY (Yen ETF):

Notice how both begin with a big rally (incidentally in both cases a rebound from a drastic fall). Then both retrace. SPY retraces deeper. Both then rally again with what looks like a 3 wave form. Then both fall into a slightly curving wedge (actually the FXY is truly curved while the SPY just looks curved because of the internal wave forms but in fact has a straight top).

Now let's see what happened to FXY:

I don't mean to imply that the S&P will take off like quite the rocket but it does bode well for the current pattern, even if it dips a bit further. Neither does it invalidate the bigger picture because FXY is due to drop just as soon as UUP rallies.

If we took the FXY picture and dropped the retracement down to a .618 like the SPY did then we get something like this:

FXY is clearly reacting much more vigorously than the S&P but this does provide perhaps some insight into what currently is a very confusing wave pattern.

SPY in the Doldrums

2011-07-26T18:21:00.000-04:00

We're ever so close to the end. I'm being careful not to be impatient. First let's look at the SPY on the big chart:

Here we see a definite bearish outlook. Even if SPY climbs from here it is unlikely that the RSI and very unlikely that the composite RSI will show anything other than bearish divergence. I think we're going to see a "W" of some sort on the composite. Stochastics have turned over but I think they're still heading up to resistance.

Now the smaller chart:

Here we see that there's no way this is a motive wave as the current retracement has ducked below the previous peak (black horizontal lines). This implies that the previous wave was the final wave of the larger Elliott Wave. However we're clearly not in a motive wave downward. So we're in some sort of weird corrective wave. I think it's entirely possible that the market hurls itself downward to fill the gap at 130.40. However given the bullish divergence on the indicators I'm tempted to believe that the market first attempts to close the gap at 135.20.

The Nasdaq looks quite different:

Well, looks like a case of bearish divergence and maybe a completed motive wave? Stochastics should bottom out soon.

DIA (Dow Jones ETF) demonstrates most clearly that the party is over:

This security looks determined to fill that gap. It will probably then bounce but I don't see any way that it will clear the prior top. I believe this is now a bear trend for the Dow.

Let's look at the dollar. Here's UUP (dollar index ETF) on the small chart:

I've attempted a wave count here. I believe we're heading into a 4th wave correction which will lead to a final 5th wave. A resurgent dollar tomorrow could set the stage for DIA to fill the gap and for SPY to sink a bit further. Let's look at the big chart for UUP:

My original thesis called for UUP to make a new low and as you can see from this chart that thesis is right on track. We're just a few pennies away. We filled the gap today which should trigger the bounce I mentioned in the small chart. Then one last drop. Notice how the indicators have all found support levels. The bounce should create a "W" on the composite and will allow the RSI to fall to the lower support level.

Finally let's take a peak at TLT (treasury ETF):

Gratefully, the inverse relationship between SPY and TLT reasserted itself today. I'm counting on that for building my treasury position for the bear market. A dollar rebound should set TLT a little bit higher, but I am expecting it to retreat and fill the gap before finally surging upward. Note that stochastics are at resistance as is RSI and that composite has made a W. All signs are for TLT to head downward, yet I still expect a little blip up first.

The chart itself is jagged as all get out. This is generally a B wave which indicates that we're retracing a motive wave that has already begun. The next wave would be a 3 wave which should be quite powerful.

So after writing this blog post I decided to reduce my long market position! Still not time to go short but the market looks set to fall before it rises. I'm happy to be wrong and let my now small position make a little bit of money but happier to be right and then increase my position on a day that looks like it clearly will surge.

TLT Technical Heaven

2011-07-22T20:38:00.000-04:00

Quite a few technical indicators point to one place on the TLT chart:

That place is 94 or pretty close to it. Let's count them:

Fibonacci retracement .382 from peak to peak of entire rally
Gap
Trend line (blue diagonal line) with 4 respect points
Horizontal support line with 3 respect points

Boy a moving average would really seal the deal but frankly this is good enough for me and this is the point where I'll be accumulating a treasury position.

The green circle is the biggest risk point. I feel that this is a breakaway gap as characterized by the gap occurring at a "re-test" point near the bottom and by the fact that the chart "broke away". When we look at long term breakaway gaps we almost invariably see a strong trend that never reaches back anywhere close to the gap. Contrast this with the gap at 94 which in no way would anyone ever call a breakaway as the market has come right back to that zone and (to me) quite obviously intends on filling that gap.

Not to say that TLT needs to stop dead in it's tracks at 94. It could reach down further although there are a lot of technical points that will be fighting further decline so I think it's a high probability short term trade and a very high probability long term trade. The highest probability trade would be to wait for a bounce and then buy on the up trend although this would be difficult to automate with a stop until TLT dips a little further.

Using Indicators to Call Time of Death on SPY

2011-07-20T17:58:00.000-04:00

Consider the following chart of SPY (ETF for S&P 500) and the indicators at the bottom.

First and foremost I want to draw your attention to the two green circles vs. the purple circles. I would ordinarily be worried about stochastics stopped dead in the middle of the chart but this pattern looks awfully similar to what happened in mid April. Next the RSI has dipped to about the same level. Finally the composite has made a "w" shape at about the same level. All of this points towards an upswing. Now look back at the chart and these patterns look pretty darned similar wouldn't you say?

Next let's take a look at resistance levels on the indicators:

The red bars on each indicator show where SPY has been topping out in the recent past. If it gets back up to here then the end is very close. Note the "w" shape in the composite is generally a sign of reversal. One shouldn't count on a "w" but instead look at the smaller charts to ascertain whether another blip is coming. It is of course possible for a strong rally to send the security up past these levels but I would still consider that level to be high probability for the end.

Next consider how the indicators gave good signals near the prior peaks:

Divergence such is seen on the first two peaks should not be ignored. The absolute top did not give us divergence but both stochastics and the composite spelled things out pretty clearly after a few ticks down. Finally (had I been paying attention) there was a definite buy signal from all three indicators at the bottom of the prior valley.

Finally we must consider the possibility of a fake out:

What looked to be a resumption of the bull market was brought to an abrupt halt on June 1st. This one I was lucky enough to catch. I noticed that the prior day had ended with a hammer, a peculiar candlestick to see at that point in a rally. I shorted the next day and made money. Unfortunately I covered about halfway through that red candle, never expecting it to go as far as it did.

The indicators were not very helpful here. Stochastics gave a false signal (black bar). Granted, if you had bought early enough on that signal you still would have gotten out whole. RSI was giving no information. The composite was the only one giving information. We didn't get a "w" shape but also it had not fully dropped to the support level (green bar).

This is relevant because as you can see, this past nadir also did not drop to that support level. We will have to be on the lookout for another truncated rally. This time would almost certainly spell the beginning of the bear market.

Silver vs. SPY

2011-07-20T15:28:00.000-04:00

Well, silver did exactly what I thought it was going to do. Unfortunately I didn't get back in. It fell almost precisely to the point that I thought it was going to (the blue bar on the graphic). I was nervous though because silver and the market seem to have become inversely correlated and I thought the market was going to keep going up today. Instead it retraced it's gap, which of course is another thing I typically expect. Frankly, I was just too busy with household duties this morning to trade the minor trend and as such I ought to have just stayed long silver. If one doesn't have the time to trade the minor trend then only trade the intermediate trend and live with the consequences!

Anyway, this chart is a 30 minute comparison of SPY (S&P) and SLV (silver). I'm most baffled of late by the sudden inverse correlation. The green bars on the chart indicate periods where the two assets were positively correlated. The red bars indicate periods where they are negatively correlated (in regards to direction rather than price level). The strength of silver has mostly been in that it did better in the overnight than the S&P. Since the S&P began rallying however, silver has suddenly take a different course. One had the feeling that this was going on for a while but to see it starkly gave me pause. Since I think the market is going to rally does this mean silver is going to drop? Not necessarily and since it's a lottery ticket I suppose I ought to just have stayed long and watched it play out.

I like looking at the 30 minute chart to analyze minor trend and look for potential entry points. The stochastics are particularly interesting on the small chart. One less is just never to go against stochastics when they are running the middle. They tend to slide back and forth rather quickly and you want to make your decisions at the end points. Here we see that the S&P stochastics are falling fast (brown line) and we should expect them to bottom out at the same point that they did on previous corrections. Note that it is not necessary for the price to drop in order for stochastics to "recharge", but better safe than sorry.

It's also worth noting that stochastics can stay nailed on one end for a long time while a market is trending so one should either turn to other analysis or wait for the stochastics to make a more certain turnaround before re-entering.

The composite RSI meanwhile gave us really good exit and entry signals for silver (orange lines). The RSI did as well be bouncing off of it's moving average and then slicing right through it. A possible re-entry for silver will come when stochastics dip down and when the RSI bounces off of the top side of it's moving average. Are the markets actually inversely correlated or is silver merely working out a wave pattern that coincidentally is inversely correlated? I don't know. I do know that treasuries and the S&P have suddenly become correlated so something fishy is definitely up.

Let's look at USO (oil) vs. TLT (treasuries) at the same 30 minute chart.

Note how treasuries and oil are now correlated whereas they were clearly uncorrelated prior to July 14th. The stochastics on TLT are at their support level (black line) with the fast stochastic but the slow stochastic has a little ways to go. I've been expecting TLT to dig deeper and fill the gap it left behind but when this happens I don't know. One usually doesn't expect a gap to be left so close to a consolidation area so at some point I think TLT is going to reach down. stochastics could stay nailed to the bottom long enough for this to happen. If RSI or composite turn up though then that would be bullish divergence and probably indicate that treasuries (and the market) are heading higher imminently.

Meanwhile the minor trend trader could certainly have made a lot of hay trading oil based off of the stochastics signals (orange lines). There was even a wedge which I observed in real-time but chose to ignore since I wasn't playing the minor trend. I'm a little surprised that oil didn't dip down to fill the gap.USO is not a religious gap filler like TLT or SPY but I still wouldn't be surprised to see a gap fill and a stochastics pattern like I've drawn in.

Further Analysis of Historical Stock Cycles (Part 1)

2011-07-19T15:14:00.000-04:00

This article will explore the historical cycle that I first pointed out in The Upcoming 2011-2012 Bear Market. To quickly recap, I believe that there exists a repeating stock cycle that looks like this:

Approximately 20 year bull market
Stock bubble and crash
Recovery and financial panic
Recovery and recessionary period

The analysis is timely because I believe we are currently at the peak of the second recovery and heading into what I call the recessionary period. My first article delved into technical analysis and Elliott Wave theory. This article will focus on the historical record and investigate how the cycle affects and is affected by with macro-economic and political circumstances.

(A quick note regarding Elliott Wave. My original article (I now believe) incorrectly classified the two recovery periods as peaks in a triangle pattern. It appears that in fact the final recovery period is the 1st leg of a motive wave with the recessionary period being the 2nd wave retracement. My reclassification is largely academic as the market's path remains the same).

This is certainly not the first article to identify long term stock cycles, however the vast majority of literature regarding cycles focuses on fixed time periods. While it is certainly compelling to see financial crashes occurring with regularity I don't believe that this is very useful as a tool for determining when one should be in or out of the market. I believe a more accurate rendering of the stock price cycle can be made using milestones based on the character of market peaks and valleys. The analysis in this article might convince you that both the amplitude and time (x and y axis on a chart) are variable and non-deterministic even while the cycle itself appears inevitable.

The Charts

I first discovered this pattern by scanning through historical stock charts with my own charting software. Many charting platforms do not include historical data and long term charts mask the pattern because of the extreme swings on non-logarithmic charts. Even on logarithmic charts the pattern is difficult to see because the amplitude and timing of the pattern varies with each period. Finally, prior to 1950 the best record is the Dow Jones Industrial Average which is a poorer reflection of stock market levels than broad market indexes such as the S&P 500.

I've managed to identify four instances of the pattern as demonstrated in the following chart:

I've drawn in the period from 1885 through 1896 because my data does not go that far and I needed to extrapolate. Also the period from 1914-1949 did not fit cleanly in a screenshot so I penciled in the tail end of the 1946-1949 recessionary period. Otherwise, each chart begins where the previous chart left off, and obviously, the current period is yet to play out.

The first observation of these charts is that they are indeed wildly different, especially in regard to amplitude. It would be difficult to identify 1929/1937/1946 as comparable with 2000/2007/2011 based on the look of a chart alone. Let's therefore look at each chart and attempt to identify some of the variables that affected the cycle.

1885-1914

This cycle saw an incredible blossoming of technology and productivity that began with the Victorian era railroad boom and culminated with the beginning of World War I. I mark 1885 as the beginning because I've identified the panic of 1873 as the panic leading into this cycle, and the period from 1873 to 1885 as the prior "setback" period.

The stock bubble during this period was a dramatic double top in 1899 and 1901 which I believe was affected by the turbulence of the time. In 1898 the US fought the Spanish American war. From 1899-1902 the US was engaged in the Philippine-American war while the British fought the second Boer war. As we will observe in future cycles, armed conflict tends to reduce the amplitude of stock waves. The most dramatic waves will be observed as those that occur during times of peace (the so called peace dividend). Had peace been prevalent during this period then I believe the stock market top would have been at the same level as the 1907 and 1909 recoveries.

The stock market crash of 1901 saw the plummeting in value of railroad stock, the dot.com of the late 1800s. Then 1903-1906 saw a rapid recovery, no doubt enhanced by the ending of the previously mentioned wars. Much like today, an Earthquake was responsible for taking the head off of the rally but this only revealed underlying weaknesses that culminated in the financial panic of 1907. Much like the panic of 2007, the financial system ended up on the verge of collapse, rescued only be the collaboration of government and Wall Street.

This article (The Remarkable Efficiency of the Dollar-Sterling Gold Standard 1890-1906) had the same perfect timing as Ben Bernanke's "Great Moderation" speech of 2006. In the context of a 20 year bull market and recent recovery a monetary theorist can be forgiven I suppose. As it turns out of course, monetary expansion had reached it's tipping point and signaled the end of the cycle.

The recovery into 2009 was swift but (as I predict will occur for the 2011 market) a new high was narrowly missed and a 25% bear market correction took place. The stock market then went "dead" until 1914. A World War was certainly good reason for the stock market to drop suddenly. It is interesting to observe that even under these conditions the market found support at the level of the previous financial panic. 1914 marked the beginning of the next cycle, a cycle dramatically affected by two world wars.

1914-1949

This period saw two world wars and a depression that severely warped both the amplitude and timeline of the natural cycle. It also saw an amazing bull period driven by the widespread adoption of mechanization, the modernization of industry and dramatic advances in transportation and communication. While the shape of the 1920s bull market is dramatic, the overall growth is roughly equivalent to the growth seen in the 1949-1969 bull market and the 1982-2000 bull markets. World War I in this case I believe caused the growth to be compressed into a shorter time period and thus take on a parabolic shape. IF we were to instead stretch the 1920s bull market over the full 15 year period it might have looked like this:

The stock market drop was dramatic. I don't have a good explanation for why the 1930 crash went as low as it did. Elliott Wave theorists would say that this was the end of a big old wave and they might be right. What I can say though is that in 1933-1934 the dollar was devalued by 40% which I believe once again affected the amplitude of the chart. Had the dollar not been devalued the chart might have looked like this:

Finally, war broke out in 1937. The US did not enter the war until 1942 (the bottom of the "V"). I believe the effect of World War II was once again to delay the cycle. Sans WWII the chart might have looked like this:

This chart is now looking considerably more like those of the other periods including our current cycle. Still noticeably different is that the valley out of the panic is higher than the valley out of the stock crash. Also, the 1946 recovery peak is still higher than the 1937 recovery peak. I believe this could probably be attributed to further easing by the government during the course of the war. Possibly Roosevelt era economic policies had an effect on the amplitude of peaks and valleys as well (socialist structure reducing oscillation?). Regardless, what I believe is important is understanding that the cycle conforms to the pattern and that in the future one should be ready to adjust trading timing if dramatic conditions are in place.

The end of World War I saw the 1946 recovery and then slip into a recessionary period that lasted until 1949. This is the first cycle we're observing where the end of a war ushers in a recessionary period. We will see this again in the 1970s and I believe in the coming years. The end of a war however provides an economic springboard for the next bull run.

1949-1982

The post war boom was witnessed by a rather jagged 20 year bull market. The bull market was once again held back for three years by the Korean War. The end of the Korean War ushered in the first motive wave that saw the market rise 100% in less than 3 years. From 1957 through 1962 the market continued upwards but more cautiously. I believe this was due to escalating tensions with the Soviet Union. The growth of the entire bull market might have been even greater than it was had the cold war not been an ongoing drag on the US and world economies. After the Cuban Missile crisis, with tensions easing, the market once again rocketed up 100% into the stock bubble of 1969.

Once again in 1970 the dollar was devalued. This time the effect was paradoxically the opposite. Inflation took root which inflated the nominal value of the stock market and the amplitude of the 1973 top. Inflation continued to drag on the market until the early 80s.

Finally, the end of the Vietnam war in 1975 ushered in a temporary recovery and then brutal economic period (technically not a recessionary period but stagflation probably was worse). The spring board of an ending war once again set the stage however for a powerful bull run.

1982-current

Readers of this article will be most familiar with this period but perhaps not be aware that the overall growth of this bull run was almost twice as much as the prior periods. A quick look at the chart shows that the market accelerated beginning in 1994. This coincides with the introduction of the Internet but I believe the real effect was the peace dividend obtained from the fall of the Soviet Union in the early 90s. This period demonstrates the potential for a bull market that is unrestrained by armed conflict. The 90s bull market was roughly equivalent in growth to the 1920s bull market which was also a period without armed conflict. I believe that a 20 year cycle that is unconstrained by armed conflict could produce 1000% aggregate returns.

As one can follow from my logic, I believe we are closing in on the end of the second recovery period. While quantitative easing has been in effect, we have not had a devaluation in the currency. However, the Afghan/Iraq war I believe will dampen the top of the recovery much as the Vietnam war dampened the top of the 1977 recovery (relative to the 1973 recovery but not relative to the 1969 top which was pre-devaluation). It is worth noting however that the 2007 peak was higher than the 2000 peak which one would not expect given the level of military commitment at the time so it is conceivable that the market could progress to a level that would challenge the prior top (assuming one took a liberal Elliott Wave count).

Evidence From the 1800s

I haven't been able to find raw data for stock market levels from the 1800s. All I have been able to find so far is this chart from the Elliott Wave International:

I've drawn vertical lines based on the periods that I've identified in the 1900s and then drawn vertical lines for two additional periods in the 1800s. It's a small chart but one still clearly identify the double peak during the early 1800s. The panic of 1837 was a financial panic so this doesn't follow the pattern of a stock market crash unless one considers that at the time London was the financial capital of the world. Britain experienced a railway stock mania in the 1830s. Historians hold that it was the financial panic in America that caused the railroad bubble to pop but possibly it was the other way around, the popping of the railway bubble caused a run on American gold and silver which caused the financial panic.

The panic of 1857 followed with expected results and finally a very small "tepid recovery" shows up as a blip next to the vertical line.

The similarity between this period and the 1914-1949 period is interesting. In both periods the initial crash was much steeper than the secondary crash. Unique to the 1812-1860 period is the length of time that this cycle took. Almost 50 years passed from one point to another with 20 years separating the two peaks (however the boom period is almost precisely 20 years and so maintains that pattern). It is a bit horrifying to realize that the stock market level on this chart began and ended at the same level. That represents a 50 year period of zero returns!

Unseen on the American stock market chart is the London market crash of 1825 which I believe represents the "breather" for this period.

The following period from 1860 to 1885 is less distinct. We certainly can see the tremendous period of growth that followed the previous cycle but must keep in mind that the first few years here were during the American Civil War which was an inflationary period. The panic of 1873 was a definite stock market bubble, the second of three eventual railroad bubbles although it was accompanied by a demonetization of silver which reduced the money supply and prompted the eventual debate that we would see in the next cycle.

It is difficult to divine our pattern in this period from so small a chart. Part of my identification process is looking at the "shape" of the waves which requires a close up view.

While the period prior to 1810 is drawn in by hand, again we can make out a pattern that looks distinctly like an episode of the modern pattern from 1780-1812. Woe be to those who bought at the top of the South Sea Bubble (the spike in 1720) who paid a price level that wouldn't be seen again until 1870!

Breathers and Volatility

The concept of the breather is a recent addition to my thesis. I discovered the breather by accident as I was trying to identify the stock market bubble for the 1885-1914 period. I found the stock market crash of 1893 in Wikipedia and was confused. While there was clearly a stock market crash in 1899-1901, from the account of the Wikipedia entry the 1893 crash appeared to have been much more violent. It then struck me that this crash occurred about a decade before the bubble eventually burst, quite similar to the crash of 1987 which was considerably more horrifying than the 2000 crash both in terms of economic effect and the effect on individual investors.

I then began to look at the other periods and sure enough discovered severe corrections that occurred about midway through each bull period. "Breather" is probably a terrible term because in fact these corrections share the trait that they are severe and they are sudden. A close look at the 1987 crash or the 1962 crash reveals that there was very little time to get out and only the subtlest of warnings that it was about to happen. The rapidity of these collapses left investors startled.

Thus, part of my thesis is that one should expect a severe correction about a decade into a bull market. It would be nice to be out of the market when this happens but the real lesson is to buy the market at the bottom since the bull market can resume quite rapidly (although it can take a year as in the case of 1987). (It should also be noted that the 1950s/1960s bull market was peppered with numerous harsh corrections as was the 1890s bull market. It might be said that these markets were breathing heavily).

While my pattern I believe is repeatable it is predictive in regards to timing and amplitude in only a few places. The two decade bull market is a relatively stable variable given the absence of a major war. The magnitude of the bull market ranges from 400% to 700%. I think it is safe to assume that if the market crashes after a 200% gain that one has experienced a breather. The valley out of the initial crash is variable however. In some instances it returns to what is approximately the mid-point of the bull wave but in other instances it retraces the entire wave (1929, 1873). The amplitude of the secondary peak is highly variable as is the nadir. The third peak is generally lower than the secondary peak and the final retracement is quite reliably at the mid-point of that final rally.

In the famous 1987 documentary "Trader", Paul Tudor Jones states that he found incredible correlation between the 1929 bull market and 1986-87 bull market. He famously predicted a 1988 crash (which occurred earlier than his initial prediction although he did catch it) based on this correlation along with Elliott Wave theory. What he was dead wrong about though was his prediction as to the depth of the crash. He had expected a crash of the same magnitude as the 1929 crash. He had also expected similar economic results, namely a 5 year depression.

The correlation between these two bull periods is in fact quite evident and makes an interesting point, that bull markets absent war time conditions will look similar! Crashes will also look similar. My own analysis of market tops has found incredible similarities right down to the minor trend patterns. Yet this is not predictive as the market is subtly different at each market top. The thesis is therefore helpful as a kind of road map through those tops and bottoms. Using this thesis one would be on alert for a market crash as was Tudor Jones, however knowing that a breather was expected rather than an end point, and knowing the effects of war time conditions, one would not have expected as severe a crash as 1929 and would have been perhaps readier to buy the bottom.

Hard Money

One area that we should explore is the role of monetary policy and it's possible impacts on the cycle. Here in 2011 the call for "hard money" in the form of a gold standard has become vogue. Gold and silver prices have rocketed. Have similar situations occurred in past cycles? (It is interesting to note that the 1896 election turned on whether the country would retain a gold standard or a silver standard. The silver standard at the time was essentially a stand-in for fiat money. Fiat money itself would have been unacceptable at the time. The gold standard won the day. The price of silver did not seem to be affected by the politics).

This graphic shows the price of silver during the first three cycles. The red dot indicates the bubble peak. The green dot indicates the price at the bottom of the financial panic. The purple dot indicates the price at the peak of the final recovery heading into the recessionary period. I picked silver because the price of gold has been fixed for so many years. Silver by comparison has been relatively free to fluctuate with only small periods of price fixing.

There are few conclusions to be drawn. Certainly there are some patterns. In the first two charts the price of silver declined during the bull period. This also occurred in the 1982-200 bull period (not shown). The exception is the 1950-1969 bull period although the price was relatively flat. While a dollar index would show a declining dollar, that would be relative to world currencies. From a hard money perspective it would appear that the dollar strengthens during a bull period (as one would expect as rates should rise).

Next we see that in each circumstance silver comes alive heading into the first recovery. Gains during this period are roughly equivalent to gains in the stock market. This leap therefore I believe is probably demonstrating a rising price of all assets, most likely representing loose money heading into the financial panic. We'll investigate whether this is indeed happening.

Finally we cannot really draw a conclusion regarding the price of silver heading into the final recovery or recessionary period. The 1970s Hunt Brother's corner represents a dramatic turn upwards in the price of silver. We can also see that silver exploded heading into the World War I period but this would be expected in war time so we cannot attribute this to cycles. In fact, the 1946-1949 period saw a decline. My conclusion therefore is that the price of silver (and by proxy rates and inflation) is not determined by the stock cycle, although it does appear that if a silver bubble is going to appear that the end of a cycle would be a good place to look for one.

This concludes part 1. In a future post I will dig deeper into other economic variables and how they may or may not be affecting the pattern.

Silver Correction

2011-07-19T14:03:00.000-04:00

I believe silver has completed a 5 wave and is now correcting after which point it will extend. Here's the 30 minute chart:

We had no idea really how far silver would go. That last wave kept extending. The colored lines indicate what I believe is the wave count. If so, then one would expect SLV to retreat back to 37 or thereabouts before moving forward again. Since silver has moved inversely with the market during this rally I suppose this development isn't entirely unexpected. How long silver and the market will remain inversely correlated is an interesting question.

I noted the bearish divergence on RSI last night (brown lines) but decided to hold my position. I set a stop in the gap.

The black line on RSI indicates positive reversal building up, at least on the 30 minute chart. For positive reversal to occur SLV would have to sop before it hit 37.20 though. The implication here is not to wait too long. Possibly we only get a gap fill (happening as I write this post).

I SPY The End

2011-07-18T22:02:00.000-04:00

Today was a grizzly day for those of us maintaining long positions. I just had to shut down my computer and walk away. While commodities held up, the stock market really took a nose dive. Oddly, treasuries also fell. The dollar did shoot upwards a bit but I think that stop loss orders helped to propel the market lower. I'm still maintaining my position that the market is going to rebound but the odds of a big rally now look remote.

Today's bottom bounced squarely off of a .618 fib, this time drawn from top to bottom less the top spike. This is a pretty satisfying picture since this is my go to method for Fibonacci retracements, and the hammer marks a bottom nicely. RSI looks about right, landing on a trend line. The composite can liberally be read as positive reversal which technically points to a rebound up to 138.03 although I am at this point skeptical that a bounce from a .618 fib could get us that high.

DIA bounced off a .5 fib while QQQ merely retested it's bottom:

The red line that it bounced off of is a Fibonacci that I'd calculated some time ago. Note how the bars are respecting those three red lines. If the market falls further then I'd expect that final red line to catch it. Also worth noting is that QQQ is still above the 50 day moving average. It's just my bad luck that I chose to trade SPY for this period of time rather than QQQ or DIA which are usually the instruments I prefer to trade and have held up much better.

A question we need answered is how does a market respond to a .618 retracement coming out of a correction? One interesting episode occurred at the top of the dot.com bubble in 2000:

While the wave pattern is much more complex than our current top we can still see similar action. A strong rally out of the steep correction from the top then fell to a .618 fib. Surprisingly (to me) the market bounced off that fib and completed the rally with a slightly higher top, essentially a re-test of the extreme top of the market. This would be the equivalent of today's market getting to 136 and then dropping precipitously. This would be a welcome turn of events.

The 1994 correction also had a .618 fib retracement that played out very differently:

Here the retracement came off of a very different type of rally. It indeed fell short and pulled a Crazy Ivan that would have shaken a lot of traders in both directions. It then looked to be heading into a crash, only to bottom out and begin the greatest rally of all time! I don't think this is going on of course as the character of a consolidation is very different from what we're experiencing now. In general, consolidations don't provide many .618 retracements.

1981 gives us another interesting view into a market top:

These waves look familiar the more tops you look at although it's often a mix or match game in regards to the order of the waves. This top looks a lot like the 2000 top but our .618 retracement shows up in a very densely traded wave. It rebounds but does not make a top. It too pulls a Crazy Ivan. See if you can spot it. Plenty of warning in this market top to get out.

Our doppleganger the 1977 top gives us an object lesson in what happens if the .618 is broken:

The green arrow marks a big stop day much like today's action. The next day the market dips below the .618. For several days the market holds the close above that level but eventually capitulates at the red arrow. One would have been lucky to bale out with one of the spikes between the green and red arrows. The market then goes into a "trading market" but once again the market is generous, providing a third and final opportunity to get out at the .618 level at the purple arrow. It's all over after that.

To summarize I'd say that 136 is not completely out of the question. The market has worked off a lot of that rally and the bulls may be ready to push on. The commodities in general look like they still have a solid wave left in them. We will have to keep our eyes on the individual stocks and various markets to attempt to divine a turning point.

It Ain't Over Til' It's Over

2011-07-17T22:19:00.001-04:00

Looking across the market I see a number of key stocks at support, further indication of an imminent market rally.

Altria (trend line)

INTC (Fibonacci confluence zone)

DISH (former resistance line)

IBM (former resistance line) Already bounced.

HD (former gap turned support)

What will drive the rally? How about earnings. A last hurrah I believe but hope you weren't short GOOG!

Odds seem pretty good for AAPL to get a momentum breakout.

Financials still look incredibly weak but I think they'll put up a fight. Don't bet on a head and shoulders for COF!

Not yet at least...

AXP (Trend line) A minor trend line to be sure but positive reversal (composite) indicates that this is good for a quick burst.

Come on Microsoft! Call it a bottom and buy RIMM already. 20% would close that gap.

SPY, Building Up Steam

2011-07-15T17:17:00.001-04:00

The market has been consolidating now for a week. It's been a nail biter. It makes sense however that such a consolidation should occur after the incredible rally that preceded it (which itself came out of an grueling consolidation).

What I see on the chart for SPY is very, very compelling. First take a look at the bullish divergence on the RSI. SPY has been fluctuating pretty wildly but the fluctuations have been diminishing. What we have is a triangle from a technical perspective. Now normally a triangle is bearish but the thing about triangles is that they switch character when the chart gets closer to the apex. They become bullish. The triangle represents a war between bears and bulls. Here we see the bulls have set a hard, almost flat floor around 130.60. That floor has been tested numerous times. The bears have been driving the price down but the bulls have not conceded.

Meanwhile, the RSI has been ticking upward. If this were occurring on an intraday chart I say "look out!" but on the minor trend chart I'd say this represents a potential springboard action.

Consider the shape of this consolidation on the 30 minute scale vs. the prior consolidation on the daily scale:

Similar looking right? I believe the same result will happen at the small scale as happened at the large scale, an explosive rally. Whether that rally takes us to a new top or just gets us closer to the top I don't know.

It's also worth looking at the fibonnaccis for the current consolidation (small scale):

Here I've drawn the fib not from the high but from the gap into the high. I believe the high represented an overshooting of the rally, probably a firecracker set off by stops. That leap, literally into the air, throws everything off. Things start to look more sensible if you draw the fibs like this, with the floor just a hair below the .382 fib. What I've drawn in here is the absolute low for this consolidation which was 130.14. This occurred at 4:00 AM and my charting software does not include those quotes. As it turns out, that low is precisely where the .5 Fibonacci retracement lies.

Finally I think we should look at UUP as the dollar continues to influence the direction of the market:

This is the 15 minute chart and within the minor trend. For now we have a definite resistance ceiling marked by the green line. We have a distinct curved top which looks to be the end of this micro-consolidation. Finally the RSI is making a rounded top. This of course only indicates a red bar down to the blue line which has marked the support line for a very long dollar consolidation period. If it bounces there then all bets are off however if it breaks through that line then we will almost certainly get the second half of the previous rally.

Meanwhile AAPL has made a new top which is certainly a warning bell:

However the RSI shows that there's plenty of room for this stock to go up. The black line marks the highest prior peak which was at 80. Again, after such a lengthy consolidation (longer than the market itself) a strong rally shouldn't be unexpected. It does not look like we will get a negative reversal as occurred heading into the prior consolidation, at least not in the short term. This itself may indicate that AAPL has quite a bit further to go, although I won't be going long this stock!

COW, Trendlines Are Back in Fashion

2011-07-14T22:11:00.000-04:00

The corrective period has taken so long and I've been focused on other analysis techniques that I almost forgot about the humble trendline. Lying awake at 3:00 am last night it occurred to me to plot the silver trendline which I blogged about yesterday. Today it occurred to me to take another look at COW.

Pretty tasty. Today's action stopped dead at the trend line. Draw a parallel return line and you see a pretty interesting situation. The return line crosses at several key support or resistance areas. What I believe the return line also tells us is that the big wave was in fact a 5th wave. This entire structure should be a 5/3/5. This would then put us somewhere in the second 5. Where? Either finished or 1st wave I think. Wow, that's saying nothing I know.

Let's look out our indicators:

Uh oh! Bearish divergence on the intermediate trend (small red bars). Negative reversal on the big trend (big red bars).

Asleep at the wheel again I was. We also got perfected DeMark signals at both of these peaks.

That said, yesterday's red bar created a gap. COW then bounced neatly off the trend line. I wouldn't be surprised to see that trend line broken but then I think COW may actually just sort of skid against the line if the market drops tomorrow. I would then expect an uptick to cover the gap it left behind. That would briefly lift RSI and set up the actual collapse.

In fact on the 60 minute chart we have positive reversal on RSI!

Not only positive reversal but the composite is deep in negative territory. Probability is high that we get a good bounce here which will set up a terrific intermediate trend and possible major trend short.

Treasuries Up or Down?

2011-07-14T21:47:00.000-04:00

The long bond (in the form of TLT) provides an interesting conflict between technical analysis techniques. Consider the daily chart:

At first blush this looks decidedly bullish. We have a spike. We have TLT making the golden cross (50 day crosses above 200 day average) and we have what looks like a security that is above the 50 day and ready to bounce off of it and follow the path of the green line.

On the other hand on the RSI we have negative reversal and on the composite RSI we have a very steep negative reversal. On both RSI and composite the line has hit a prior resistance level.

It's worth noting that today's spike did not fill the gap on the far left and while it is likely a signal for where TLT is heading we should look at the prior spike back in March to see that a retracement was in order before that signal would be recognized by the market.

Here's a zoom in on what I think might happen:

I'm getting the overall feeling that tomorrow is going to be a down day for the market which would make it an up day for TLT. Here I think we're just about finishing the 5th wave of the larger pattern. On the small chart, the zig zag action looks very much like an A/B/C consolidation. C is digging deep which would mean that the coming wave 5 could be quite a blast. I'll be setting a buy stop to catch it.

Upon completion of the 5th wave, TLT should be begin the larger fractal retracement necessary to start the next big wave. This I think would be where we finally get the remainder of our stock market rally. How far it retraces is a good question but the negative reversal on RSI indicates a little below the last retracement, in the 93 range. EW guidelines would also suggest that the 5th wave retracement would end in this area.

As I believe that the much larger picture for TLT is a 5/3/5 correction, this would then complete the first part of that pattern (5). Our retracement could be jagged or it could be quick. Once complete, we'll get another 5 wave that I think should take several months to complete. 93 or thereabouts, I believe therefore represents an incredible buying opportunity.

The other possible action is that what I believe is a C wave is really that retracement. This would certainly be welcomed by me as I'm long the market. This is why I suggest buying the 5 wave with a stop rather than catch a falling knife that keeps falling.

And of course the last possibility is that I'm dead wrong and TLT rockets upwards and never looks back. It would be hard to imagine that happening without the composite RSI backing off quite a bit so I do believe that if this is the case that we'll get an opportunity to re-evaluate.

Silver, Asleep at the Wheel

2011-07-14T21:21:00.000-04:00

I was asleep at the wheel today and it's going to cost me with silver.

Here's a snip of the past few day's action with silver. Had I looked mid-day and noticed this I would have sold.

The 60 minute chart is even more stark:

Big bearish divergence on the composite and flat on the RSI. Note that the composite was trending down all morning and the RSI signal came before the red bar. Even after the red bar there was an opportunity for profit taking on the bounce.

Hopefully these signals end up being false signals! My luck is rarely that good though and now will have to hold this through an uncomfortable retracement. By my count that was a 5 of a 5 so the support line can theoretically be violated if silver wants to cover the runaway gap. That far of a fall would probably be enough to recharge the RSI.

Silver Wakes Up

2011-07-14T05:37:00.000-04:00

Silver definitely woke up yesterday. This morning it is up even further. I expect the dollar to continue to fall precipitously which should elevate silver and gold. Here's a chart:

Here's SLV (the ETF that holds silver) with channels drawn in. This was a very strong channel until recently. I felt that silver had support until it dropped below the lower trend line and then I wasn't so sure. Now I believe that the trend is back on.

It's always a marvel when a trend line intersects with a popular moving average, in this case the 50 day. Notice how during the silver crash the market gapped over the spot where the 50 day and trend line intersect. It then bounced briefly back to that point but returned to the lower trend line. Now under the 50 day it followed that path right to the point where the 50 day intersected with the lower trend line. Again, yesterday it gapped past that intersection point.

So now I believe that the upper channel marks the resistance line. I don't expect another parabolic rise so I can't exactly see how silver gets much further than 42. Still, that's a pretty nice potentially quick return.

I believe that if silver retraces to the bottom trend line that it is a gift. The market is often generous to the observant with second and sometimes third chances. Momentum is so strong right now though that this may end up becoming a bona fide runaway gap.

1977 Market Morphology vs. 2011 Market Morphology

2011-07-13T14:08:00.000-04:00

This article will quickly look at the morphology (shape) of the 1977 market peak and compare it to the peak of today's market in an effort to extrapolate a possible resolution.

The top chart is the 1977 market. The bottom chart is the 2011 market so far. History does not provide carbon copies and the two charts do not look alike at first glance. However, upon closer inspection startling similarities appear. I believe that historical patterns can provide templates for current markets if you look within. To me it is the same as when a zoologist looks at a fossil and determines that it is a sort of flamingo based on the structure of the ankle bone. Of course this is subjective and prone to error and we need to be careful not to stamp our emotional desires onto the charts.

The first thing that is worth pointing out on the chart is the two sets of 3 wave patterns. The first set is the brown lines and the second set is the blue lines. Now these charts are on a different scale but the pattern matches quite nicely. A key matching point is that the top of the blue pattern is higher than the top of the brown pattern in both circumstances. So while back to back 3/3 patterns are not unusual, a back to back pattern where the second is higher than the first is unusual at least as far as major market indexes go.

The second pattern that is quite interesting is the purple slide. Both patterns end with a distinctive curvature, like a playground slide. Both patterns also demonstrate a distinctive hump (purple circles) at the end of the slide. If one were to squeeze the 2011 chart horizontally so that the slopes matched then the pattern would be much more obvious.

The first anomaly is marked with a purple X. The 1977 market did not have a midpoint spike. I believe that this spike in 2011 was a "would be bull market" that was truncated by news events. This is the first tricky part I believe to the interpretation of the charts. This bull fake out caused the 2011 market to stutter. As a result it did not slide down as much as the 1977 market. If you compare the positive of the purple triangles and blue circles on the two charts you'll see that the 1977 market retreated much more deeply from a relative position. Don't be fooled by the earlier correction on the 1977 chart. It is a red herring.

Next we see the two charts maintain their remarkable similarity with a steep rally out of the bottom. While both rallies demonstrate a V shaped retracement, the 1977 market demonstrates another anomaly in that it paused earlier on for a sideways consolidation before resuming the rally. I believe that this consolidation did occur in 2011 but at the bottom of the rally.

When I first noticed the correlation between these charts I believed that the 2011 market would end without making a new high, just like the 1977 market. Now I believe however that we will see a higher high. The key is the location of the purple triangles relative to the blue circles. The 2011 market is an expanding market by nature of the truncated bull spike. The height of this rally should be higher than the previous top since it begins from a higher initial rally point than the previous top.

How much further the rally goes is of course the salient question at this point. My caution is not to call the rally over prematurely. It is entirely possible that what I've labeled as the V shaped retracement is in actuality a sideways consolidation at a higher point. Such a condition would point to a significantly higher top. If however the V shape in 2011 is respective of the V shape in 1977 then I think we will eek out a marginal high over the prior top.

A further drop off from this point without first making a new top would send my opinion quickly over to the other side. The blue circle is a definite line in the sand in regards to seeing any new future highs.

Silver Lottery Ticket Still Available

2011-07-08T17:15:00.000-04:00

Silver (along with gold) has continued to carve out a bullish path since my last post. It never dropped below 32.53 so from an Elliott Wave perspective the beginning of a motive wave is still on the table.

Recently I've noticed something interesting:

The top image is silver on a 60 minute chart. The bottom image is TLT (20 year treasuries) on a daily chart. The scales are very different but the pattern is remarkably similar (a chart for short bonds is even more similar). This is a rounded top. It usually works itself out by finishing where it started. After that however a rebound is likely. This is what I'm expecting for TLT in the intermediate term (6-12 months) and what I think is a reasonable possibility for silver in the short term (4-6 weeks). Whether we get a gap fill or not is a good question. A gap at the beginning of an extended uptrend often remains unfilled, so if silver or treasuries bounce before filling their gap then I'd take that as a very positive sign.

One can have more fun with rounded tops:

This is a chart for TLT (treasuries) flipped upside down. Here once again it looks pretty clear to the naked eye that the rounded top will finish itself off (going down, which is really going up since this is turned upside down). In this case, a completed rounded top would get TLT to the 106 - 109 range. There is a gap in fact right at the top (er, bottom) at 107.62. If the pacing remains the same then that range would be expected in the October time frame.

Treasuries concern me in the long run. I don't know how long the anticipated bear market will last but I think it will be only getting started in September and certainly not be over by October. If treasuries were to continue their inverse relationship with stocks for that length of time then they would end up back at levels during the financial crisis. Certainly this is possible but there is another possibility which is very ugly.

The other possibility is that rates begin to rise while the market is falling. That is the beginnings of stagflation and it is what began in 1977. Our economic environment is very different than 1977. Ours is significantly weaker, which while it bodes ill for jobs and the market, bodes well for rates. Rates ought to remain low. However I could see the possibility of an ill fated QE3 that backfires, causing rates to rise due to a market that is concerned about a debased currency.

This is crystal ball conjecture and there's no need to make such a call at this time but it's worth keeping in mind as a possibility. Treasuries are not an automatic long in a bear market.

It is also worth noting that in 1977 silver began a climb upwards at about this point as well. It was not the famous 1979 Hunt Brother's corner rally but rather the weak sentiment dead cat bounce that presaged the mania that would come about two years later. Such a dead cat bounce is exactly what our current lottery ticket contemplates.

The other possibility:

The other possibility is that we get a little uptick on treasuries to the 102 area and then it heads downhill. (I'd be careful not to call what we're see a "bear flag" since it's a pattern that has traced out over six months. While it looks like a bear flag from this distance I don't think there's any justification for that perspective.)

There is a big fat gap at 98 that is begging to be filled and that may give us a clue as regards timing. If the rounded top heads down before filling that gap (as I am expecting) then that adds weight to the first case scenario since treasuries would have a tremendous amount of momentum from the "spring action" of hitting bottom three times. The little white bars that jut out of the top of the rounded pattern allude to future upward action.

If however it reaches up and closes the 98 gap during this retracement then I would consider that a more negative sign for treasuries as it would break the rounded top and leave less "incentive" for treasuries to climb back off the floor.

COW Crap

2011-06-30T22:26:00.000-04:00

I suddenly realize that I may have made a crucial mistake with my COW count:

What happened in the overnight where the arrow is? If that V is what happened then it changes the wave count dramatically. A weird looking wave but hey this is commodities. It's frankly a much better explanation for the waves to the left. Either wave count it's a short. The only difference is that it will retrace rather than making a new high. Time will tell.

The only good thing here is that Elliott says we've got 100% chance of making money, just a question of how much :)

Silver

2011-06-30T14:45:00.001-04:00

Silver was another great call of mine that I botched trading:

The arrow shows where I shorted. The brown bar shows where I had my stop set! Ended up losing quite a bit of money when had I traded it properly I could have financed a year of retirement. Live and learn. At the time I was not wave counting. I made the short based on sentiment. It was a good indicator but not wave counting and having never traded the top of a parabolic before I was pretty much doomed. Whether my stop was going to get hit or not was just a question of luck.

Meanwhile, I am now bullish on silver. The wave pattern is satisfying. The A wave was a clean 5 wave drop. The B and C waves are only clear in retrospect. It would have been impossible I think to parse them in action. I can only do so now with confidence because the blue line is making a crystal clear motive wave. The key here is that the C wave is a bearish diagonal triangle. Considering the support at 32 it's not unexpected. That's where the parabolic started so one would expect a wave pattern that reflected strong support.

I believe there will be two buying opportunities in the 33.60 range and then silver will be off to the races, sort of. Here's what happened in 2006:

Also a parabolic upswing and fast retreat. Then it drifted up to a new high (chart is messy, the new high was actually a few pennies higher). I say drifted because it was not parabolic. Sentiment never reached the lofty highs previously. At the top it fell into a meandering (complex wave) decline. It's not a perfect match because conditions today are different than 2006 but this pattern is typical for silver. Consider the long term chart:

This pattern was pretty much the same as what we saw in the late 60s and 70s as well. The implications for silver when it does actually reach it's peak (probably late this summer) are not good. Probably right back to where we are right now is my best guess but maybe we see 22 or even 8 again if this is the end of a 5th wave. Don't assume though that just because it's a big wave that it is ending. Silver was trading in single dollars in the late 70s when this started so even the price of $8 in 2004 here represents an 800% gain over the course of a few decades. A logarithmic chart would look less towering but I don't have one for this data set.

What Could Go Wrong?

I could be wrong about that bearish diagonal triangle. It should have a 3/3/3/3/3 pattern. Looks a little funky. One closeup gives me some confidence:

The 1/3/5 legs of a triangle are supposed to be zig zags. This one does look like a zig zag although with the price of silver moving at night it's hard to tell what is going on. The other troubling thing about the triangle is that it is not contracting. That is, it is not wedge shaped.

Here's an alternative wave count possibility:

This is a real possibility, and often the easiest parsings of corrective patterns are incorrect. This is why I'll categorize silver as a "lottery ticket". The arrow marked "crossroads" will give us more information. If that leg crosses below the starting point of our current motive leg then silver is not going up but down. If it stays about that point then things are still up in the air. One must always be on the right side of the market (or at least flat) with Elliott Wave although the best thing about it is that you know when you're wrong!

Let's look at the current minute action to see what might play out:

This I believe is the likely scenario. I've painstakingly made a 5 wave count but really I don't think it's necessary. The eye can quite easily pick out that we're in a minor trend corrective pattern with one more leg up (wave 5) without verifying every little uptick. It is gratifying however to be able to validate.

I predict we'll be seeing swings. Again what I have here is textbook and there's no reason why the correction can't technically extend. The evidence for quite some time has been that every asset class is currently correlated right down to the minor trend. So these swings pretty much mark what I believe the market action will also be (although each asset is swinging different lengths thus making different patterns). As is my usual play, I'll be looking for signals not just in the wave count for silver but also in wave counts and technical indicators for all the asset classes. Why is everything correlated right now? I think the answer is leverage. What we are witnessing is an over-extended market that is dominated by market Beta, and whenever Beta is strong leverage is at work. There will be a point when it will all unwind. But we can trade nimbly in the meantime.

You can see the markings for where each day ends. I believe the morning session will get us to the first sell point. It's a pretty good sell because there is a hard limit on how far it can go. My preference would be to wait for that B wave to make a strong uptick and then enter the trade on a stop and exit on a limit well above the maximum legal limit. Basically, catch the bus for one stop. Then catch it the other direction! This time ride it further (assuming it's making a motive wave) because this 5 wave could extend who knows how far. I would exit this on indicators preferably although if I couldn't watch the market or trading hours were ending I wouldn't carry the position overnight because the next leg is down.

The final down leg is a very good trade. If we are indeed back on the silver bull then I would expect that wave to stop in the same vicinity as the prior blue wave. That is the EW guideline. It might go to the bottom however because there are still a lot of people ready to short silver back into place. If it does indeed bounce before breaking the motive wave then I'd say there's a good chance that the game is on. I wouldn't miss that uptick.

Here's the potential back story. They say that the three waves of a motive wave represent the buying market. The first wave is enacted by first movers. These are people with a vested interest in accumulating the security. In technical parlance the first wave represents the actions of "support". It might also represent the actions of either savvy traders or lottery ticket players! Regardless, right now there are plenty of people ready to short silver back into place.

What happens if the silver shorts can't get it to break that line? Well, the trend line fails. Indicators fail. All sorts of things fail that were expecting the trend line to continue. Thus begins the 3rd wave. The third wave is composed of technical traders. Once they recognize silver as "alive" then they will begin hoping on board and will drive the price up. It will get to a level and then correct. If the 2nd wave was hard down because of this back story then the 4th wave is most likely to be a sideways correction. This is when the participants in the 5th wave jump in: retail investors. The technical traders will begin to unload as the buying public comes onboard. The sideways correction gives everyone plenty of time to recognize the uptrend.

Now why is silver so particularly potent? It is because of what happened in 1979 with the Hunt Brothers corner. Every two bit trader dreams of a repeat and riding it to the top. Prior to the recent crash the chat boards were loaded with people that were willing to hold silver to 50, 70 or higher. Will those people sit idly by and let another opportunity slide by?

Let's look for more clues. Check out the RSI:

We have a positive reversal signal between points 1 and 2. Granted, the amplitude is very high so it's not a high probability signal but it's a start. Also notice however that during the crash the RSI only dropped to 30 from a high of 90. Prior to the parabolic run-up the RSI dropped significantly below that level so we know that for a few years at least that this current level of RSI is a support level.

Looking at the most recent activity we see that RSI formed a "W" right after the crash. Not unexpected. We are now re-testing that level. Finally the averages are crossing. If we see the short term bounce off of the long term as the point that the RSI crosses then I believe that's a bullish signal. It's happened twice on this chart and both times signaled uptrends. The one time that it crossed ever so slightly it was a turning point.

Finally let's turn to the big wave:

Long term wave counts are always sketchy but I have dug into these waves and verified that they are all motive. The best thing about this pattern for a bullish silver outlook is that the red corrective wave was a 5th wave correction by nature of how deep it dug. The remaining waves can only be organized this way because of the rule that the 3rd wave cannot be the shortest as well as 4th wave violations with other arrangements. As such I believe we have one more wave to complete the big wave and that it should eek out a modest price high over the previous high. RSI positive reversal predicts 56.58. Or, you can add the height of the first wave to the top and you get 55.6. We should be so lucky.

COW

2011-06-30T14:15:00.000-04:00

COW was a good call that I botched as a trade. It's in an overall bear trend but had been retracing for several weeks when I noticed that it had filled a gap, hit a fib, perfected DeMark, hit a RSI resistance line, and had negative reversal on RSI. The wave count also looked good. I shorted and made some money but not as much as I should have:

See, I shorted right at the top. Almost to the penny. A wonderful trade. Then I noticed however that the 5 wave had not completed. That red A wave traced out on the day that the market bottomed and then the B wave started to climb. Realizing that this wave was eventually heading back north I decided to bale less I have to eat a loss with a strong rebounding B wave. Unfortunately this is about where I got lost in the weeds and didn't notice that the B wave hadn't rebounded but had gone soft. The result is what you see, a meandering C wave that is just about to head into it's 5th wave down.

The two red lines are a fib cluster zone I'd computed during the retracement. Based on general market action (slow and climbing) I'm guessing that this C wave traces back to the lower fib (probably bottoming in conjunction with the next S&P retracement). That still gives it plenty of head room over the 1 wave. Then it will climb north along with the market for a final rally.

This will mark a buying opportunity although COW isn't a highly volatile entity so the profit potential is not that much greater than the market in general. I would watch for RSI to bottom out at 20 and of course would look for some motive action before jumping in. This is a slow moving target so I wouldn't worry about missing much upside.

I also see nice positive reversal building in the RSI that indicates COW is getting quite oversold. I'm guessing right now that the final peak will be the .618 fib at 30.90 but will calculate positive reversal when the bottom finally arrives.

Finally, the potential short when the 5th wave completes will be a thing of beauty and worth 20% as another downward 5 wave plays out. The last 5 wave played out in 2 months so that's a rather quick profit compared with what the market is likely to offer.

Dollar Ah Hah!

2011-06-29T23:33:00.000-04:00

After being beaten over the head with a bull rally I think I've finally come to my senses. I am putting my brain through a cold rinse and washing away all the preconceptions that I had held. Basically, I was wishing for a correction bottom that we already got. In fact I actually called the big day and traded it. The market fell mostly in the overnight and then rallied on news of a Greek austerity plan. It's right there plain as day:

How I could have missed this is remarkable. I was in fact merely married to my price projections. I had projected 125.40 and it only went as low as 126.19. I had started trading that day hell bent on catching the bottom. The bottom came and I just flat missed it. Then I had another two opportunities to catch the bottom on the following days! Yet I willfully ignored the obvious. Shouldn't 79 cents have been close enough to take a long position for what I anticipated would be a 10% summer rally? Live and learn I suppose. Meanwhile it has cost me a 3% potential profit. Lucky I was flat and not short!

Meanwhile, the dollar finally fell into place now that my blinders have been taken off:

Again, this pattern was flat out obvious if only I'd been willing to look for it. A simple contracting flat. We are not in fact in a C wave but are in the final motive wave down for the dollar. How far it will go is anyone's guess although it must break new lows (if my newly regained prescience is correct). When that wave completes (the red arrow) we will finally get the black arrow which signals the bear market.

How willful was I in ignoring this?

Willing to ignore the very pattern I predicted for the oscillator! Not only did I correctly identify the oscillator as a leading signal but I also predicted that the triangle would break to the down side, bounce off of long term support and then head for the sky. Here it did that exact thing and I took a short on FXA in the morning session. In fact, I was the very first trade to break the upper resistance line. How's that for irony?

Okay, missed opportunities aside I actually feel incredibly relieved that I am finally ready to get on the right side of the market. It's still a dangerous trading environment and a retracement is imminent. That will be a good time for an entry in time to catch the 3rd wave of this (presumed) motive.

As Goes Apple So Goes the Market

2011-06-29T22:41:00.001-04:00

If not losing my religion, this market certainly has me questioning my faith in my underlying hypothesis. Whenever this happens (and it happens regularly as I suppose it should) I go looking at individual stocks. Indexes are often difficult wave counts and right now I'm seeing conflict between the four indexes I follow (Nasdaq, S&P, Dow, Russell 2000). I believe that Apple is the bellwether for this bull market and so tonight I'm going to take a closer look. I write these as I am doing the analysis so I don't know what I'll find out. Here goes:

Here's the current wave for Apple on a 30 minute chart:

This appears very much like a contracting diagonal triangle, or wedge. The wedge is a 5/3/5/3/5 pattern. The inevitable outcome of the wedge is crystal clear: it will end, and with the end will come a retreat. But how far? A nice thing about the wedge is that it offers some determinism. It can only occur in position 5 or position C. The much more elusive "leading wedge" can only occur in position 1. We can't totally rule that out so we'll look at that possibility as well. First let's try to figure out when the wedge will complete. This following diagram is wrong:

While these waves are indeed 5 counts our attention is called to the RSI indicator. This is very close to a "positive reversal". Essentially, point 2 is just as oversold as point 1. Yet the price is much higher! The implication is that this wedge is not complete. Since point 1 and point 2 are very close however it tells us that the wedge will get back to approximately the same high. Let's look at what I think is really going on here:

As much as it pains me, I think this might be a more accurate picture. A small drop in the morning tomorrow would allow a "W" to form on the RSI and hit support at the bottom of the wedge. The gradually decreasing slope of the waves is more what we would expect from the wedge.

It's worth taking a step back though to see whether this analysis fits into the bigger picture. Here is a 60 minute chart:

This chart is encouraging. First you can see on the 60 minute chart that it looks like AAPL bounced off the slope line. Trend lines can trick the eye. Here we have four points. The trend is up which is how we left the day today so I'm encouraged. The big picture looks good too. The A wave here is an easy count. The B wave looks like a 5/3/5 but one has to zoom in to the 5 minute chart to see that the 3 wave is actually not where you'd expect! Regardless, our wedge fits the C pattern nicely so once again things are heading down. Finally, the rounded bottom on RSI looks pretty good from this angle although it's still clear that the uptrend is not complete.

Might the wedge complete quicker than expected? Let's zoom in to a one minute chart:

This shows today's one minute action based on the green section of the inset. Remember that what you see is what occurred today in a 10 hour stretch (includes extended hours). The final part of today's action looks to me like an uncompleted 5 wave. We would need to make at least 3 of these before the wedge could be called complete, although it could be many more if the wave extends. It's certainly possible that this could happen tomorrow although it would also create a wedge that ignores the slope guideline so I'm labeling this one as "hopeful". We'll see what happens in the morning session but so far it looks to me like a long for the day. And it looks to me like this god awful market rally is going to drag out.

Before we call it a night however let's look at the big picture to see where we're heading and what we might trade:

Unfortunately I can't make heads or tails out of the big red circled area. For this to be a continuation pattern we should have seen an X wave but that wave is almost certainly a 5 count and it makes a new low which is unlikely. So I have something wrong or something not obvious is happening, such as perhaps that our wedge is in actuality a leading wedge of a new leg up, far fetched as that may sound it can't be ruled out. When can it be ruled out? Only when AAPL falls below 310.56 and violates the rule for a 1st wave.

Can we trade it? By golly we can. Any way you slice it (leading wedge, diagonal triangles, some other unidentified B wave) it's coming down. My preferred trade would be the following:

Patience is required. My trade would be an entry with a sell stop. I would set the stop at least a dollar below the trend line to account for throw overs. As the wedge moves I would move the stop up the trend line. This could even be done mid-day to gain a few pennies.

Once the trade is entered I would exit with a bracket of a loose trailing stop on the top side and a limit order at the start of the wedge. If the entry point is broken then there will probably be an opportunity for another short but that is unlikely to happen in one day. The market has a sense of irony and even if it intends to go further it will most likely pause at that spot for a retracement that will have my head scratching again.

If one is sitting at the computer screen then it should be possible to day trade AAPL between the trend lines although I believe most of that action will occur in the morning session.

Addendum!

After looking at the markets for another hour and seeing positive reversals on the QQQ as well as an extending wave count on copper I realized that I have to consider that the market is going up and that I've missed the bottom. It is starting to look like the only thing that makes sense in the big picture. Before going to bed I decided to take one more look at AAPL in this vane and suddenly it fell into place:

It is in fact a picture perfect correction wave count. The only thing is that our wedge must be a leading wedge!!! Yikes that's scary. There's still going to be a wonderful opportunity to catch a short on this one but I would set my profit taking much higher, and really I think now it's merely a setup for a long and for AAPL to make new highs this summer.

Loonie as an Oscillator

2011-06-29T15:45:00.001-04:00

Unfortunately my FXA oscillator broke the apex of the triangle and stopped working. Today I found a new one. FXC (the Canadian dollar) has been oscillating regularly. The oscillations off of support and resistance predict the market direction.

I'm definitely the boy who cried wolf but this oscillator is telling me where to put my money and it ain't long. Of course I'll wait for confirmation before putting any position on!

Municipal Bond Outlook

2011-06-28T16:38:00.000-04:00

I've been long munis for a little while now. I first caught munis back in early April on pure technical analysis:

This is the ETF MUB which is a basket of major municipal bonds. Munis came out of a long crash during the "flash crash" period. They made a picture perfect "V" shaped bottom. That's when I started watching. It's a technicians dream. "Fan" analysis would have worked perfectly. First we got the breakout signal that alerted us to watch the stock. Then it started making a descending triangle which should have meant a downturn, but as it got closer to the apex we knew it might fail. Then there was a second signal on April 1st of high volume buying and a break of the top side of the triangle. I got in on the next red bar and was flabbergasted by the climb out!

The long term view is not so rosy however and Elliott Wave shows us what was going on under the covers:

The crash was a 5 wave pattern down. The implication is therefore that our current climb is temporary. More downside to come. Doesn't take a rocket scientist to figure out that munis are in for a downturn but when and how far? One would typically expect a 5/3/5 wave which would mean lights out from this interpretation. A usual though, EW rarely matches the textbook pictures.

From this picture I've deduced that the leap out of the bottom was in fact the first leg of a motive wave. The correction out of that first signal spike is quite tricky. Elliott analysis can almost always point out where a technical pattern such as a triangle or rectangle is going to fail. Here we basically had a descending flat with a very long C wave. I believe Magee does warn that descending triangles out of market bottoms are bullish.

Next we have the most crystal clear motive wave you'll ever see (wave 3). Nary a red bar in that month long burst. Then we get to what looks like a rectangle to a technical analyst or triangles to an EW practitioner. Let's look closer:

An objective look at the patterns shows that we're not in a correction at all. We've already completed the first leg of the 5th motive wave! The trick here is to mark the 5 wave patterns first. They are the easiest to identify. Then find a corrective pattern that matches. What looks like a 5th leg of the rectangle is in fact the same deadly C wave that we're seeing in charts across the board. My guess is that it does not reach the floor. A technical trader would have been tempted to short at the top and go long at the support floor but I suspect that they'd miss their long.

Let's look at the current correction with a super close up of recent action:

Here I believe we have actual triangles! I've put the interpretation underneath so that you can see the bars. The C wave is in fact an E wave! Granted, this is a horrific little pattern to try and parse but it does mostly look like 3 waves. That second leg looks like it might be a wedge but I think it's impossible to know for sure.

Regardless, whether this last wave is a C or an E the implication is that it's turning around,. How so is at this point academic.

How much of a ride can we expect? Less than 4.81 points for certain. Probably closer to 3 based on .618 ratio of the 3rd (smallest) wave. The nice thing here is that wave 1 has finished it's ride below the top of previous wave 4. This indicates that wave 5 is extending so we'll probably get close to a full ride. For me it all amounts to a very high probability trade with tax free yield for a few months to boot!

After this leg though we can expect a downturn. Recall that the crash was a 5 wave. This is also now a 5 wave. That means that the next leg will be a 3 wave and should bring about new lows.

Timing is interesting. Unlike most other assets, munis essentially corrected a year and a half early. The uptick right now is a retracement. Therefore I think we'll see the 3 wave play out rather quickly, perhaps less than a year. Followed by another dead cat bounce for a few months. Then finally the completion of the correction that started in August 2010 with another 5 wave down.

Of course the other possibility is that I'm wrong with my crash count. If that was in fact a 5/3/5 zig zag then munis may be going sky high. The wave from the financial crisis to the top in August 2010 sure looks like a wave 1 from this distance. Makes sense as well that if we're heading into a deflationary bear market that bond prices will continue to rise. One month at a time I suppose.

Updated UUP wave count

2011-06-28T14:43:00.000-04:00

I finally have an updated UUP wave count that is satisfying. It is more satisfying than my original wave count which was calling for triangles. Instead we have an A/B/C flat with an upward slope. C of course would be a 5 wave impulse. What I appreciate about this interpretation is that the fibonacci expansion off of what (presumably) is wave 1 of C gives us a target of 21.91. This is damn close to the 21.96 retracement target that I'd computed months ago when UUP first bounced. The little "V" shaped divot at the top of our current position was screaming "expanding B" but I'd willfully ignored the implications because I was impatient for the market to drop.

Again we are lucky in that wave 3 of our current little itty bitty C is smaller than wave 1. So this puts a lower bound on how far this market will climb before heading back for the ground. That lower bound currently is 21.3 but I think that 21.35 (the .618 fib of 1 or 3) is the likely target. Still, that provides the market with plenty of breathing room to climb up before we start seeing some big red bars.

3's are always difficult to parse because of the zig zag action (although a more experienced EW practitioner would likely have had less trouble than I). I was helped out on this by looking at the chart for natural gas (UNG) which required a double take:

This chart looks like a logical interpretation of text book triangles. The bounce off of an old support line and flat bottom would be taken as high probability signs by technical analysts. However closer inspection says, why is wave 1 a 5 wave but not wave B? That deserves a closer look and I believe reveals something different:

Pesky 3/3/5 flat pattern again. It is in fact an expanding flat with B taking it's sweet time. What was a D wave previously is clearly a 5 wave in hindsight.

The implication is critical! It means that gas has one more leg down to complete the C wave. The deadly C wave. Right now technical traders who got stopped out when gas broke the trend line have given it a second try off of the backup support lines. Gas will likely climb back up to 11.30 and could climb as far as 11.80 but then will plummet back. It could go as low as 10 and not violate EW but I'm guessing that irony will be at work and bring it back to 10.40 for another bounce off of that old trend line.

No surprise that UNG and UUP are correlated as are every other asset in existence. The smart trader (smarter than I probably) is checking each day for the chart that is giving the most readable signals.

The Upcoming 2011-2012 Bear Market

2011-06-25T02:01:00.001-04:00

As I've been extremely busy with child rearing I have not found much opportunity for blogging. I've not been able to do much of anything as toddlers, babies and pregnant wives demand considerable attention. Whatever activity one pursues must endure frequent interruptions. The activity I've engaged in for the last few months is stock trading and it is well suited to such an environment. I've learned some things and, while I am still exceedingly busy, I thought it would be worth the time to communicate what I know to friends and family as the market has turned extremely volatile and many might be wondering whether to dump their stock portfolio or not.

Here's what I think is going to happen (S&P 500 numbers. I'll cover numbers based on the DOW later in the article):

The market will fall further in the coming days. Not further than 1174.14. Most likely to 1239.59.
The market will then rally. It will at least get as high as 1344.07. The likely top will be 1344.55.
The market will then enter a bear market. There is no way to measure how far it will go. My best guess is that it will end around 1050 for a loss of about 17% from here, or about 22% from the likely next peak.

Here's a picture:

Got your attention? Predictions to the penny? First let me state quite clearly that I am not an investment advisor and do not give investment advice. Make your own decisions! Okay let me explain how we get here.

Technical Analysis

My predictions (an awful word) are based on technical analysis. That is, by analyzing the price action of the stock market. This is opposed to fundamental analysis that makes prediction based on economic information. One finds analysts in either of these camps. The technical analysts are quite happy to take money from those who trust fundamentals.

To determine market direction I rely primarily on Elliott Wave analysis ("rules" that govern the movement of markets) and back this up with historical analysis (repeating patterns). Finally I cross reference multiple markets to look for correlation.

To determine specific price points I use Elliott Wave analysis, Fibonacci analysis and gap fill theory.

A Gentle Introduction to Elliott Wave

Terse books have been written about Elliott Wave theory. If you've never traded then you probably have never heard of the theory. It will sound like bunk. Many technical traders believe it is bunk. Most people who try using Elliott Wave fail. Most of them give up. The others don't make much money at it. There's the caveat. The thing is: it works.

The theory goes like this. Markets always go up in the long run. (Heard that before right? The catch is that they can go down for long periods of time, some hypothesizing as long as 400 years as in the dark ages). We all know markets go both up and down, so for markets to continually go up in the long run requires a basic mathematical function. Either (a) up waves are bigger than down waves or (b) there are more up waves than down waves. Elliott Wave theory incorporates a little of both.

The main part of the theory is what drives markets and is called the "motive wave". It looks like this:

There are 5 waves. Waves 1,3 and 5 are directional waves. Waves 2 and 4 are correctional waves. Since there are more directional than correctional then the market's movement is up. There are also a few rules. The 3rd wave must not be the shortest (in terms of price differential). The 4th wave must not enter the price zone of the 1st wave. The 2nd wave cannot go beneath the 1st wave. These rules ensure that a motive wave is completely directional.

Yes, this works. No-one told the market it has to do this but it does. It has always done this and Ellioticians have combed through hundreds of years of stock charts and not found exceptions (well, there is one known exception but it is quite rare).

The directional waves are themselves motive waves. If you dig into wave 3 you'll find it is a motive wave:

As you can see, note every directional wave looks as picture perfect as the first one I showed you. This is part of what makes the theory difficult for many. You have to be good at spotting waves and also good at making sure they don't break the rules. You can drill down like this right down to 1 minute charts and see the waves. Once you practice, you can even sit there and watch a ticker and see the price action moving in waves in the span of seconds.

Those are the rules. The implication from these rules that is most noteworthy and relevant to price prediction is that the directional wave can extend. You can see in this chart that we're forming another directional wave at the top of the chart and that these waves together will form a larger directional wave...or will they?

Correctional Waves

While there is only one type of directional wave there are three main categories of correctional waves. The art of Elliott Wave is really in parsing the correctional waves because they are ill behaved compared with the motive waves. The main thing about correctional waves is that instead of being 5 waves they are composed primarily of 3 waves. The main types are:

Flat:

Zig Zag:

Triangles (I had to go to the 2004 market to find an example) :

A flat is composed of 3 waves (A,B,C) that are 3, 3, and 5 waves respectively. A zig zag is 5/3/5 waves. A triangle is 5 waves that are all composed of 3 waves (3/3/3/3/3). Like motive waves, correctional waves can also extend and do so by adding an extra 3 wave in between. They can then attach together kind of like atoms in a molecule.

Those pictures are pretty straightforward but what about this one?

Yup, that's the current correction. Note that the B wave is higher than the last motive wave. This is actually fairly common and a key reason why many fail at wave counting. Note also that the third wave is a question. If it turns out to be a 5 wave then the whole thing is a flat, which probably means we head up. If it is a 3 wave then we definitely continue. The reason I said "likely" is because, as I stated earlier, a correction can extend. That's the thing about Elliott Wave. It is not really deterministic. It is semi-deterministic. It can tell you where you will go but not how you will get there.

Where Are We Now?

Back to our picture. I'm reasonably confident that the wave that is developing now has become a C wave. It requires a few more directional waves to complete, and it must go lower than it is. The price projection I gave was 1239.59. This is arrived at from Fibonacci analysis. Quite simply, market waves tend to be Fibonacci ratios of prior waves. In this picture:

I can multiply the length of wave 3 by .618 and it projects the price point that the correction will land at. I can also multiple the length of wave (i) by .618 and it projects the length of the as yet uncompleted wave (v). These two projections end up within a few pennies.

Likewise, the projected top of the theoretical final wave 5 (in red) is a .618 projection of wave 3.

We are very lucky with our current wave count because wave 1 happens to be larger than wave 3. Since the rule states that wave 3 cannot be the smallest, this means that wave 5 will have to be less than wave 3. That provides the theoretical roof. The other rule that wave 4 cannot penetrate wave 1 gives us the theoretical floor.

It is possible for the motive wave to expand. What I have labeled as wave 3 could become wave 1 of wave 3. It is highly unlikely in general but this is why I use historical analysis and cross market analysis to rule out such possibilities.

Back to the big picture though you might be asking, what about the final 5th wave? Shouldn't this be going way past that red five wave? In fact many, many people looking at Elliott Wave believe this. In order to recognize that this isn't the case we have to zoom out:

This is a chart of the S&P from 1982 until today. Most everyone has heard of the 20 year bull market but the picture is striking. It is also wonderful from an Elliott Wave perspective. The bull market is a 5 wave pattern. The exact location of the waves is somewhat debatable as there are always many theoretical wave counts in a long wave but any way you slice things, it is done. The red waves are (A) dot.com crash, (B) Real estate boom, (C) Financial panic, (D) Current Recover, (E) My predicted bear market. You'll note that each of these is 3 waves. Crucially, A/B/C are all 3 waves which means that this must be a triangle correction and therefore that D and E will exist and will be 3 waves. The other wonderful thing about triangles is that (excluding the possibility of extension) they always end in another up move.

Correlation With the Dollar

It is no secret that today's recovery is financed by a weak dollar. Criticism of the Federal Reserve's "money printing" is widespread (this blog included). What is not understood by most however is that this is not a recent phenomenon:

This is a chart of the dollar index (buying power of dollar relative to a basket of international currencies) since 1970 when it was floated off of the gold standard. Note how the high points for the dollar line up with the low points for the US market. More importantly for our current analytic use note the two small triangles in the bottom of right of the screen (most recent dollar action). You can count the waves: A/B/C/D... Let me zoom in:

Looks familiar? A/B/C/D are all 3 waves. We are currently in the final 4th wave correction with a projected bottom 7 pennies lower than the previous bottom. It is the oscillation in the final purple triangle that is causing the volatility in the market. Those purple lines will trace out D and E triangles which will mark the bottom. The market will then recover during the 5th wave. Then finally, the dollar will soar (relatively, please consider the big picture still) for a wave E which will effect a bear stock market. After which the dollar will resume it's unceasing slide.

To show you how global markets are interconnected consider the following picture:

This is a recent chart of the Australian dollar. Note how it forms a triangle pattern. The bottom of the triangle is "support" and the top is "resistance". I stumbled on this a few days ago. The black bars indicate up days in the US stock market. The red bars indicate down days in the US stock market. One could watch the Australian dollar oscillate between these support/resistance zones and call the movement of the stock market. Of course this is really movement of the US dollar but the global dynamics created an amazing leading indicator.

The brown bars indicate days that are both up and down. This is logical since the width of the triangle at the apex is so small that the Aussie is bouncing intra-day. As the bounces on the currencies speed up, so do the swings in the US stock market. What is evident from this chart is that it cannot go on like this indefinitely! Somewhere between now and the apex it will have to break in one direction or the other. If we were futures traders we would be buying the Australian dollar. Which indeed is what the triangle indicates. People who are buying form the bottom bar (stable) and people who are selling form the top bar (less and less of them). Soon there will be no-one selling, at which point it will go through the roof (only to collapse later when all the recent buyers find no-one to sell to at the top!)

Note that currencies are a global market and the oscillations are continuous despite the fact that we only see the 9:30 - 4:00 action on this chart. The S&P is also 24 hours (traded on the Globex futures exchange) and much of the Elliott Wave occurs behind the scenes! This makes daily wave analysis quite difficult on the S&P. I have access to extended hours charts which helps but in a pinch one can always cross reference the individual charts of component stocks to make sure something wasn't missed.

Historical Evidence

Whew. You may have heard about the potential for a horrific end of days crash. This is prevalent in the Elliott Wave literature (the dark ages scenario). Thankfully, the triangle pattern ensures that we are heading up, not down. Of course there's nothing in Elliott Wave theory that states how far we must got up but for some comfort we can turn to some historical reference points:

Look familiar? Look at the numbers on the right of the chart to see how far we've come. This is the stock market from 1950-1980. Evident will be a 20 year five wave bull market (note quite as crystal clear as 1980-2000 but just as motive). So 1968 was a stock mania and crash. Instead of Internet stocks it was conglomerates. Just as nuts as our own dot.com fiasco. In 1970 we went off the gold standard which created a financial boom (and massive inflation). 1973-1974 was a financial panic, the infamous bear market. We then experienced a tepid recover into 1976. This was followed by a recession until 1980. If this pattern doesn't hit you over the head with a hammer then I don't know what will. Maybe this:

Stock mania. Currency devaluation. Financial Panic. Tepid Recovery. Recession. Not quite as easy to see but again the wave count is 3/3/3/3/3. Part of the problem here was the currency devaluation changed the scale of the dollar. Also World War II slowed down the first wave of the "tepid recovery". You might note the shape of the 1942 bottom and compare it with the shape of the 2009 bottom. Quite dramatic however is what you see when you zoom in on 1946:

The top of the market (to the right of the gap) is A/B/C. The wave patterns match our own market quite strikingly. Note the second test point of the correction is just a few points shy of the first correction just as I'm predicting for our own market.

Unfortunately history never repeats exactly. The top of this market was the lobe to the left of what appears to be the top. It is a slightly different wave count from our own and demonstrates how Elliott Wave can shape a market the same way using different patterns. I see this all the time when I see a stock going up and down with the market even though the market is in a directional wave while the stock is in a correctional wave! I believe this sort of thing could throw a lot of traders. They might look at the 1946 chart and sell their stocks way early. (Or go short, think they are wrong, and lose a lot of money in a so called "bull trap"). Of course the other possibility is that my own wave analysis is wrong. The nice thing about Elliott Wave is that you know when you're wrong relatively quickly and I would be sure to blog such an update.

How Far Down?

Elliott says nothing about the potential length of the E wave down. It could bottom out at the floor we found in 2009. It could go further. It could go just a few points. Again we look to the historical context for clues. Notice how both in 1946 and 1976 the market bottomed half way down (look on the 1929-1946 chart as the zoom is only showing the top half of that market). I believe that the point that the E wave finished represents the "mean" of the market. It is the pivot point that the market has oscillated around for a decade. There is a theory that the market prices trace out a bell curve over periods of time and I believe that this point would represent the mean on the bell curve.

However I have another useful tool for predicting the extent of long drops. Gap fill theory:

This is a chart of SPY. This is an ETF that tracks the S&P 500 and is the most widely traded security in the US market. It has been traded since 1993 and what you are looking at is a portion of the market around September of 1996. Gaps are spaces that are created in a chart when a stock opens higher than the previous days high price. A "gap fill" is when the market retreats to cover that open space. In this chart you'll see the blue arrows that indicate gaps that were left open but which the market back tracked to fill. This actually happens probably two or three times a week and represents very high probability trading! What is noteworthy however are the two black gaps. The market never back tracked to fill these gaps. They were left open. Gaps that are unfilled represent points in time when the market "takes off". Often they are good places to look for the start of powerful motive waves.

That lowest unfilled gap was at 67.73. Now take a look at this:

This is the lowest point of the 2009 market bottom. The low for the day? 67.1. Yes, the market reached back 16 years later to fill the gap. It's incredible and I challenge anyone to dismiss this as coincidence. There were in fact 3 gaps in that one motive wave 9/96 and 11/96 which means it was an incredible propulsion point. The market gained 20% in the next 6 months in a dramatic motive wave. No doubt this was related to widespread adoption of the Internet. Aside from those 3 gaps there were no unfilled gaps that the 2009 crash covered. It reached down specifically to fill those gaps.

Not to say that all gaps are filled. There is one more unfilled gap in the SPY at 46.57. No doubt some of those who were calling for the S&P to reach 400 (DOW 4000 or so) were looking at that gap. Quite possibly it does in fact represent some future low for the market in a dreadful time when this extended supercycle wave collapses. 2040? One can only imagine. The triangles however give us reasonable assurance that this is not where we're heading today though!

There are of course gaps that are unfilled going back even further in time. There is a gap in the DOW at 671.46 from January 1975. The 1980 bear market reached all the way down to 729 but didn't chase this gap. Surely there are also gaps going back to the 1920s. Whether these will be filled or not are a matter of conjecture. One will know if the market is heading there long before it gets there.

What is relevant today however are the most recent unfilled gaps. While there are gaps in the S&P index there are no gaps in the SPY below 98.09 and it is only a penny and the market clearly reached back for it. I think this is an aberration. The lowest unfilled gap therefore is at 105.98 on the SPY, roughly equivalent to 1053 on the S&P (multiply by 10). There are further gaps at 111.61 and 119.17. These gaps could be called "yawning". They are begging to be filled and the lowest unfilled gap is exactly at the same position that the 1976 and 1949 markets bounced.

1050 is therefore my prediction based on (a) the existence of the gap and (b) historical precedent of stopping at the mean.

How Long?

I do not have a good method for predicting time lines. I think any analyst who tells you "the market will be at X at the end of the year" should be tossed out the window (perhaps ironically, timing systems based on astronomical data are more accurate than analyst predictions!). The 1946 market collapsed in a panic while the 1976 market was a dreadful 2 year ordeal. I think some indication can be taken from the waves leading up to where we are. I believe the 1946 drop was hurried because the 1st wave dragged out. You'll recall that the first wave of the 1946 rebound was essentially put on ice by World War II. The market moved very quickly at the end of the war as if it were making up for lost time.

The 1974-1976 market took two years to rebound, just a few months shy of our own rebound. However, the stock mania and financial panic played out much more quickly than our own. I suspect our correction will go quickly but probably not develop into a panic. My best guess is a year. Timing is one of the ways in which news and political decisions can affect the market. The other way is amplitude (noting how much higher the 1970s financial boom was compared with it's stock mania due I believe to the currency devaluation). Also affecting both the 1970s and 1930s markets were the horrific combination of currency devaluation and price controls. These completely uneconomic political solutions probably caused these corrective periods to last much longer than necessary and possibly increased the amplitudes.

Unfortunately the only way to really know is to watch the wave count as it unfolds and/or make gut decisions. (Or take up Gann analysis and start charting the planets).

The Aftermath

Again one can look to historical context for a clue as to what comes after the bear decline. In both 1948 and 1978 we slipped into 2 year recessions. The stock market did a little better in 1978 than it did in 1948 but both were highly volatile. The 1970s market also must be put in the context of inflation. While the market gained 10%-27% depending (literally) on which day you measure, purchasing power was being eroded at 10% annually. Unfortunately the aftermath is a market where there is no place to hide. One can't even short the market. Likely the next 3-4 years will be a very difficult period which is why I think it is so important for people to preserve their investments right now!

The Dow

One of the problems for most average investors is that they judge the stock market based on the dow jones average rather than the S&P. Very few people are invested in the dow jones average. Most passive stock funds are based on the S&P and most active funds are somewhere in between. The averages can be misleading:

The top picture is the S&P chart for 1964-1980 while the bottom is the Dow. Note the difference in amplitude where the arrows are. Note how the tepid recover went much higher on the Dow than the S&P. Finally note how the S&P was moving upward during the 78-80 recession while the Dow stood still. This is reflective of the difference in the indexes. The Dow Jones Industrial Average is designed to reflect the economic vitality of the country. I think it does a fairly good job. It is a much better indicator of how well the economy is running and how people feel about the economy, notably it is much more indicative of the recessionary periods. However it is much worse at representing stock prices unless one is actually buying the Dow component stocks!

My advice is to understand specifically where your assets are and track that index rather than the Dow, and if one wants to track the general state of the stock market then the S&P is the true benchmark.

Trading It

Traders incorporate what they call "money management" into their trading. This is essentially a mechanism to not lose all your money. Like pacing yourself with small bets in Vegas. A basic money management scheme says the following: never risk more than 3%-5% of your capital on any one trade.

That doesn't mean don't invest all your capital. It means don't risk all your capital. A trader will place a trade and have a target for taking profits. They will also have what is called a stop loss. That is the point at which they recognize that they've made a bad trade and get out. Such money management is critical because traders are placing trades several times a day, week, month or even minute. If they lost more than 3% on any trade then they would be set back immeasurably (as are many hedge funds who don't or can't implement stop loss because of their size or the complexity of the products they trade).

Amazingly, the average investor does the exact worse thing that a trader can do. They put *all of their capital* into one trade without any target or stop loss! A trader incorporating this strategy will be out of business in short order. An investor with a 401k on the other hand might end up out of business after two decades! (Recall 13 years for that gap fill).

What I've provided here now is a target. The target is 1344.07 on the S&P. Once you get there: set your stop loss at that point. I'm not an advisor but if I was, at that point I would tell you: GET OUT! However if you're diligent then you can attempt to ride it higher. Just don't ride it any lower.

Meanwhile, what if I'm wrong? How low will you let things get before you decide to bale out? Did you consider baling out at any time during the 2007-2009 crash? Tough questions that traders must face every single day. Unfortunately most investors defer the question and accept the "stocks go up in the long run" argument.

The most basic thing to do of course is to sell your stocks at or near the top. Cash is better than a loss. The loss from the top will be somewhere on the order of 20-25%. Importantly, all asset classes will suffer. Bonds will suffer. Commodities will suffer. Even gold will likely suffer (I still need to do a wave count but logically if the dollar is getting stronger then the gold bug argument evaporates). Since markets are global there will be no foreign market or currency in which you can hide. The dollar will be king. Cash will be king.

There are two potential trading strategies then. The first is to buy treasuries. They should behave inversely to the stock market. This means that they will go down for a few weeks while the market rallies. Then they will go up during the bear market. Then they will go down again during the ensuing recession. Therefore buying treasuries is extremely sensitive to timing. You'll earn 4% while you own them but missing the timing by just a few weeks could eat up that yield through price loss. The best bet for treasuries (if you're not counting waves) is to buy them when you are definitely in the slide and then exit before the end of the slide.

When considering treasuries it's worth thinking about inflation during the 1970s. We think of it as a high inflation period, and it was, but the bear crash from 1976-1978 represented the only period during the 1970s when inflation retreated. It still ran at 6% but it declined. The price of oil also went down during this period. It was inbetween the embargoes (which of course didn't cause the price spikes but probably exacerbated them).

The other possibility is to go short. While many view short trades as inherently risky I would argue the opposite. When money management is brought into the picture then short trading is less risky than going long. Consider this. How often does a market drop 20% in the course of a few days? A few times in our lifetime for sure. Now, how often does a market rise 20% in the course of a few days? Never. For prudent investors, shorting is a way to earn money when the market goes down and these days can be accomplished quite easily by purchasing inverse ETFs. Unfortunately 401ks will be unlikely to have this option so you'll be stuck in cash.

For people who would consider shorting one can consider the different indexes, individual stocks, commodities, currencies, etc. Everything will go down. It is just a question of degree. The Nasdaq will drop about 5% more than the S&P. The Russell 2000 will likely drop a few points more than the Nasdaq even. The Dow will probably drop about the same as the S&P although the top is different and I haven't done a wave count. Apple might drop 30%. We'll have to see how high it climbs first.

Conclusion

I will post updates as my wave count continues. The wave count through this correction has been very complicated as you can see from this image:

It's an extremely difficult wave count which might be encountered on a daily chart maybe once or twice a decade. As it turns out though, such a chart shows up daily on at least one asset class on a one minute intraday chart. So day trading, or at least following intraday activity, really is the practice one needs to do effective long term charting. With such a crazy chart though it is quite easy to be wrong and I spend about an hour each day revisiting and cross referencing with other charts, retracement levels and indicators.

The little question 5/3/5 or 5 count was answered today. It was indeed a 5/3/5 zig zag yesterday which means we're still heading down. I am a bit puzzled as to how it will play out because there are still two waves down remaining and not much space between here and the projected Fibonacci level. I fear this means that the chart will continue to be extremely complex but I will keep at it knowing that in the imminent future it will crystallize and provide a tremendous investment advantage.

The Paradoxical Effect of Quantitative Easing: Rising Rates

2010-12-12T09:19:00.004-05:00

Why are rates rising when the Fed has announced $600 billion of quantitative easing? This is somewhat puzzling when viewed strictly from the perspective of supply and demand.

Quantitative easing simply means that the Federal Reserve has become a new buyer of US treasuries, primarily the 10 year note. One theory for why the Fed is buying 10 year notes is because many adjustable rate mortgages are based on the 10 year note. When the yield on the 10 year note falls, adjustable rate mortgages remain cheap. This results in fewer foreclosures and is in the Fed's best interest because fewer foreclosures means fewer troubles for the big banks who are close to, or over the edge already. Destabilization of a large bank would create a severe economic shock that the Fed wishes to avoid and this is one (rather expensive) trick to head off that situation. So by this reasoning, the Fed should be able to throw a large sum of money at the 10 year note and drive down yields. But it doesn't seem to be working. Why?

First, to simplify the discussion, let's abandon the question of rates and simply focus on the price of treasuries. The rate (a.k.a. yield) is simply a calculation based on the price of a security and how much it pays. Every asset has a yield (or a theoretical yield) and every asset has a price. Because the Fed wishes yields to go down and they therefore wish prices to go up. This should be easy peasy. Typically, when demand for an asset outstrips supply the price goes up so create demand right? Those who are old enough can remember the demand for Cabbage Patch dolls in the 1980s and how the price of those dolls went through the roof. Likewise, when a snowstorm threatens, demand for gasoline and milk is created and the price goes up (wherever law permits). One would think that a buyer stepping in with $600 billion of freshly minted money would cause prices to go up!

The Fed however is not market demand. The main difference between the Fed and organic demand is that the Fed is a "sure thing". They have announced the intention of buying up these securities and they have even done so with a time frame. As such any one who owns treasuries, any potential seller, has additional variables to consider in this situation than they would in one where prices were going up for some unknown reason (market conditions). Unlike a bull market run, sellers right now are reasonably sure when this run will end. That means that they must consider what will happen when the run ends, that is, what will happen when the Fed stops buying? This is akin to when the used car salesman says that the price is only good for today.

I believe that this consideration results in the paradoxical effect of prices going down while the Fed is buying. What it shows is that supply actually outstrips demand. That is, there existed a pent up desire to sell these securities before the Fed stepped in. Those sellers were either on the fence or they were waiting for market conditions to create the right price to sell. Now however, the Fed represents a certain buyer. The Fed represents liquidity and it is not clear if that liquidity will still exist after the Fed stops buying. So anyone who wishes to get out of treasuries might be smart to get out now while a buyer exists. If no buyers exist in a few months then their treasuries might be worth even less.

Why would one want to sell their treasuries? It probably depends on who the owner of the securities is. As it stands, these securities are owned by almost everyone: individual investors, banks, institutional investors (pensions and college endowments for instance), state and local governments, corporations and of course foreign investors and foreign governments. It is therefore hard to tell exactly what is driving the phenomenon. Still there are a few distinct possibilities that we can focus on:

1) Reallocate capital - Those who are bullish may perceive an opportunity to move their capital from treasuries to other investments. Losing 20 or 30 basis points on a treasury by selling now may be incidental if one wishes to purchase equities or commodities with perceived double digit gains. Individual and institutional investors are likely to fall into this camp.

2) Liquidity - Institutions may want to take advantage of instant liquidity in order to pay off debt, make loans or build cash pools for acquisitions or expansion. Banks, corporations and municipalities are likely to fall into this camp.

3) Move along the curve - The US treasury still represents the safest investment in the world and many wish to stay in that investment but there remains the question of which treasury to own. One might wish to move into the 2 year (to increase liquidity) or the 30 year (to increase yield) and just be waiting for the right opportunity. With $600 billion of liquidity, investors can make large moves without roiling markets. Foreign governments would likely fall into this camp.

Seen in this light one might be less surprised by the unexpected drop in price (and thus rise in yield) of treasuries. The main question for investors then to consider is: what happens when the Fed stops buying? What we know is that there will at that point be $600 billion of additional cash in the system. There are again a few possibilities for what that might imply:

1) If the market is booming then that cash will likely circulate through assets and create upward momentum for the stock market and commodity prices. That is, it might fuel a bubble.

2) If the economy is booming then that cash will likely be used to fund corporate expansion and be channeled into new loans.

3) If neither the economy nor the market are booming then that cash will be sitting in bank accounts earning 0%.

Possibility number 3 is what happened during the last bout of quantitative easing. Rates rose during the entire period that the Fed was buying securities but when the liquidity spigot shut off rates fell off of a cliff. Suddenly there were a few trillion dollars of cash earning 0% and nowhere good to put that money. Owners immediately looked to earn more on their cash and thus began buying back the treasuries - which then drove down rates. So really the Fed achieved it's goal but it was a delayed effect. It should also be noted that during the previous QE period the US Treasury Department was selling an unprecedented amount of debt in order to fund the growing deficit and fiscal stimulus. So even despite that additional supply, rates continued to sink. One might expect a similar replay and perhaps an even steeper dive in rates absent an additional government spending binge. But one should also not discount the possibility of further rises in stock, bond and commodity prices as this new cash joins existing cash in the chase for yield.

The Thrashing Student

2010-06-15T21:37:00.003-04:00

Computers multitask. People don't. When a computer switches from task to task it is called "context switching". Video. Sound. Video. Keyboard. Video. Disk. Mouse. Mouse. Disk. Keyboard. Under normal conditions the computer performs this chant as effortlessly as a Buddhist monk recites Sa Ta Na Ma while contemplating the essence of nothingness.

When you ask a computer to do too many things however (that is, when you overload the computer) the meditation quickly morphs into dysfunction. Each context switch itself takes some time. Ask a computer to do too many things and instead of doing work is spends all of it's time switching between tasks. This phenomenon is referred to as "thrashing". Ever sit there while your computer is hung inexplicably for several seconds while your disk light flickers furiously? That's thrashing.

The latest studies all indicate that our personal performance suffers dramatically when we multi-task. You might say that humans thrash as soon as they're asked to do two things at once. Drive. Chat. Drive. Chat. Crash. A recent Frontline episode famously demonstrated that by allowing computers into the classroom, MIT has given the green light to student multi-tasking and in the process unwittingly set them up to learn very little. The effects of multi-tasking are on their way to being well understood. Yet I believe a slower, less obvious but equally potent form of multi-tasking has been occurring in our K-12 schools for years and years which also yields less than optimal results. What I'm referring to is the practice of switching classes during the school day.

The Wall Street Journal quotes a teacher as saying, "When you're teaching kids exponents and you have kids who don't know the multiplication tables, how are you going to teach them?". It's a rhetorical question. This teacher knows that obviously you have to stop and teach them multiplication tables. The problem though is how are you going to do that with only an hour each day? Well, you can't. The kids who can keep up will keep up. Those who cannot will fall behind.

The traditional strategy for helping those kids who fall behind is to provide remedial tutoring. Basically, give them more time. This leads me to a hypothesis. Perhaps children are thrashing? Think about an adult's workday. Phone call. Email. Meeting. Work. Phone call. Email. Work. Meeting. Did you get anything done? Compare that example with the days when there are no meetings or when you shut off the email or when a lot of people were out of the office and it was exceptionally quiet. Work. Work. Work. A steady block of time to work can be very satisfying. Think about this: what is the optimal amount of time that you would ideally have each day for a block of work?

A study indicates that when you are distracted by an email it takes 15 minutes to refocus. Now imagine that instead of an email you are given 5 minutes to hustle between classes. In the hallway you are nudged face first into an open locker door by a bully. Then your head is spun by the girl you have a crush on as she walks by, binder in hand, giggling with her friends. Your pals call from the end of the hallway reminding you about after school plans. This is supposed to serve as a mental amuse between subjects as diverse as math and history. Perhaps it will take 30 minutes to gain focus under such circumstances - if you're an adult. If you are a child or teenager with an underdeveloped frontal lobe and weak inhibition reflexes then maybe you don't regain focus at all during a typical 55 minute class. Perhaps you glide through an entire day without learning anything. Think back to your days at school. Do you remember that happening?

Computer programmers are known for their ability to focus. A motivated, undistracted programmer will slide into "the zone" within an hour. Once in the zone the programmer might continue typing until physically hampered by the need for sleep. Where I used to work it was not uncommon for programmers to forget to eat or simply to choose to skip a meal because they were too engaged in their task. In the interest of the United State's reputation on workers rights, lest a programmer perish on our watch we kept the office stocked with sodas and snacks.

Most types of work however are not so conducive to long stints. I suggest that 3 to 4 hours is the optimal length of time for most tasks that require heavy thinking (or heavy lifting). In the luxury of my retirement I stay engaged in several past-times. I write music. I grow vegetables. I study economics. I have an old car sitting in my driveway ready for restoration. My original plan was to devote a couple of hours each day to each task however I've found my brain and body unwilling to accommodate that schedule. Once I'm in the garden my body finds itself in gardening mode. Three or four hours is required to accomplish anything. What's more, the next day I often still find myself unwilling to switch to music or economics. It seems that once I start down the gardening path my mind wants to stay focused for quite some time. After a few weeks it gets out of my system and then I can switch to something else. Maybe one day I will even start work on my car.

This homegrown observation I think is applicable to the more serious task of educating children. I believe a better approach to education (one that is more compatible with the natural mechanisms of the human mind) is to teach fewer subjects - exclusively - for a shorter number of days. So instead of teaching math, science, history, English one hour per day for 200 days we might instead teach math for 3 hours a day for 60 days; then science for 60 days; then English and then history. I believe this would allow students to focus and grasp their subjects because they would learn them one at a time and avoid the overhead and lost cycles of context switching. The alternative I fear is that a large portion of the student body "tunes out". (This strategy is ideal I believe for older children rather than young children. Young children are learning basic skills such as reading or arithmetic that are essentially learned through constant repetition whereas the education of children in secondary schools is focused on knowledge building).

The increasingly popular 4+4 block schedule is heading in the right direction but for the wrong reason. The 4x4 schedule arranges the school year into two semesters each with four classes (as opposed to the traditional full year with six classes). Each class in the 4+4 schedule is taught for 80 minutes, a vast improvement over the traditional 55 minute class when one considers the effect of context switching. However the raison d'etre for the 4x4 schedule is to push students through more classes (8 per year rather than 6) by reducing hallway time. I contend that four subjects is still too much to learn all at once. It's the equivalent of signing up for a job and then having to spend 80 minutes a day doing marketing, 80 minutes a day computer programming, 80 minutes a day keeping the books and then another 80 minutes a day running lab tests. A frustrating schedule that only the highly motivated or highly compensated would sign up for.

Obviously sitting through a 3 hour lecture every day could be painful and unlikely to produce more learned students. (One recalls signing up for the once per week 3 hour class in college; the allure of the 3 day weekend and the collective yawns in the lecture hall about 2 hours in and subsequent inability to study after the lecture). This is not what I'm suggesting. I think that 80 minutes is about the right amount of time for a lecture - the length of a short movie. Students however need both lecture and practice in order to master their subjects plus an occasional dose of individual attention from educators. A 3 to 4 hour session would afford the time for these tasks without the intrusion of context switches. A great example is science classes in college that require both lecture and lab time. One subject fully understood before lunch and another after lunch. Subjects might be mastered in a month or two instead of a year. Those who are eager to learn more can continue their pursuits outside of school without having wait for a lingering class to catch up. Those who have trouble with the subject are afforded ample time to focus and understand the curriculum.

Arithmetically there is no difference between the traditional schedule, the 4+4 schedule and my proposed schedule. There is however a significant difference in how the brain will adapt to each of these schedules. Furthermore, the longer class schedules highlight the copious amounts of time spent in non-core activities such as transit between classes, home room, and study halls. So much so that the 4+4 schedule accommodates two extra subjects per year over the traditional schedule. My 2 class schedule would afford even more additional time but I believe it would be better used to extend the hours available for a teacher to work with their students rather than attempting to cram even more information through the sieves we refer to as our children's minds.