Monday, December 21, 2009

Dow 5 Wave Decline Intact, is the Dow Telling us a Top in Equities is in?

In my last post I illustrated a clear clean 5 wave decline in the Dow Industrials (click here to see that post for context). Other indices didn't follow suit last week though, and today we see why. The other major indices, especially the S&P, have made new highs yet the Dow has not, so this explains why the other indices did not decline in 5 waves like the Dow, it's because they were correcting and were going to charge to new highs, while the Dow has possibly topped and reversed. Observe the 15min Dow cash chart attached. It shows the 5 wave decline from last week and today's 3 wave rally right into the fibonacci retracement level of 78.6% where it reversed at. So this suggests the Dow has topped and is in a downtrend. If not, I'm easily proven wrong with just a few Dow points higher above the 10,511 level. So the risk/reward at this point is desirable for the bears.

The Dow was the leader higher a few weeks ago when other secondary indices were lagging, i.e. the Russell 2000 and XLF, so it's possible the Dow is telling us that it too has finally reversed trend. Regardless, as I said in Friday's post, because of the 5 wave drop in the Dow, any significant rally will bring a great risk/reward shorting opportunity for the bears. That opportunity has arrived as it currently is trading at 10,430 and one now short with a stop above the 10,511 level (the start of the 5 wave decline).

In addition to the Dow's wave structure, gold and silver appear to have topped. Observe the daily gold futures chart attached and notice the blowoff top and reversal, which is typical of major commodity tops, just look at oil's surge higher to $147 last year where it reversed to around the $30 range in short order afterwards.

Also, the dollar uptrend remains intact and the series of higher highs and higher lows remains solid. However it does seem to be trading a bit sideways at the moment and losing some steam, but that may just be its way of correcting itself. The uptrend momentum may be so strong that it will correct sideways to alleviate its overbought condition, instead of actually declining to alleviate the condition. As you can see in the USD/CHF chart attached, I'm placing the 1.0385 level as the key level for the short term uptrend to remain intact. A drop below there would break the series of higher lows, and therefore warn that a larger correction was occuring. But any significant drop in the dollar would just bring about a good opportunity for dollar bulls to start establishing new positions.

So the dollar has bottomed and reversed, commodities have topped and reversed, the XLF and Russell 2000 appear to have reversed, and now possibly the Dow has finally topped and reversed. Slowly but surely market after market is reversing. Eventually it will catch up to all equities, and the reversals in stocks will be just as fierce and relentless as that seen in the current precious metals decline and dollar rally. If 10,511 is broken in the Dow, it will invalidate the 5 wave drop and suggest that perhaps a final blowoff top in stocks is occuring if the upper end of the range is solidly broken. I'll deal with that occurance when it happens. But for now, my focus is on the dollar and the Dow's wave structure.



JD said...

FYI - A fellow named Daneric made this EW call (below) last night.

Tuesday, December 22, 2009
DOW Transports.... 75 - 85% Chance P2 Tops Tomorrow.

Todd said...

Interesting call, we'll see how it turns out.

Thanks for sharing JD!


Peter said...

The elliott wave is a great way to analyse the market from a long term perspective, IMHO EG positioning for months and years, possibly weeks ahead. I have been really frustrated by the Dows movement as I had also believed in the dollar rally but assumed that stocks would top out the same day........but I guess that is how the human mind thinks. I know a few people who were lightly long the USD and heavily short the Dow and that has caused a nightmare - having a great trade but still losing money, especially when leverage is involved. Do you have any thoughts on this?

Todd said...

Hi Peter, it's not unusual that correlated markets reverse at different times. I think it's actual rare that correlated markets will both reverse at the exact same time.

The dollar appears to have bottomed and should rally for several months. This will put tremendous pressure on equities over time. The fact that equities are up, at the moment, while the dollar has surged could be due to many factors. I won't pretend to know exactly what the reasons are, but can guess that it might be that end of year positioning, tax considerations, light volume, and just the typical buying action in stocks at the end of year is in control for now and might completely reverse once trading gets back to normal the second week or so in January. The dollar rallying for a week or so may not do much damage to equities, but a long sustained dollar rally should definitely deflate this equity balloon. It's just a matter of time.

Also, on the fundamental side, 2 weeks of dollar gains have only hit commodities, but a sustained dollar rally should pummel firms conducting business overseas as their products and services will become more expensive with the stronger dollar. This will take time to hit Wall Street's analysts and traders.

So let's give it some more time and let the dollar's ascent lay those body blows on the stock market until eventually it drops to its knees.

Hope that helps.