Tuesday, February 2, 2010

Market Correction Underway; AUD/USD Short Trade May Be Coming

The market surged higher today suggesting a longer break from the downtrend is underway. This should not break above this year's highs. What I'm doing is looking for potential reversal points for the next wave down, which would be a wave (iii), and even more powerful and faster than wave (i), which will be impressive. If I get a good risk/reward and highly probably opportunity to add to my shorts, I'll do it. Right now I'm looking at the wave structure and that 3 wave drop to a new low I mentioned yesterday stands out. The 3 wave structure suggests it was counter trend. But it made a new low. So I'm labeling it as a "flat" correction. In this particular case, EWP states that flat corrections are ABC affairs where wave B exceeds the extreme of the most recent wave 5, then moves in a wave C to finish off the correction. Right now we are in that small wave C up. Normally in flat corrections, the C wave will rally to just above the wave A extreme before topping and reversing. This level is at 1096.45. Another potential reversal point is the previous 4th wave at 1100.22. Above that is the fibonacci 38.2% retracement at 1105.74.

With that said, even though I'm projecting a "flat" correction which means that wave C should not exceed wave A too much, I do see an open chart gap below 1116.10. This is also right next to the 50% fibonacci retracement level as well. This would probably mean that this wave (ii) rally was not a "flat", but something else. Wave 2s tend to be sharp and deep affairs, and a rally to or above 50% retracement is likely. Seeing as that an open chart gap is there makes this level even more appealing. If the market has enough strength to get to that level, I'll add to my short positions.

So initial resistance is at:


One other thing to note is that the higher risk Nasdaqs and the Russell 2000 small cap index have been outpacing the S&P and Dow to the downside, and underperforming them to the upside, especially yesterday and so far today as the Nasdaqs are almost negative as I write. The higher risk indices are lagging so far, suggesting again that risk appettite is fading and that the larger trend is now down for the foreseeable future. With the VIX at such low levels with this type of behavior, it sets up a huge and long sustained move to the downside which fits well with the wave [3] or C projection for the long term.

My GBP/USD position has now become vulnerable with the rally in equities and dollar weakness. My stop remains the same at 1.6115 which locks in a 125 pip profit. I do see a possible short trade coming in the AUD/USD. Last night it dropped sharply lower to a new low, but has since found a bid and rallied higher. As a momentum trade, if it rallies close to .8900 and shows signs of topping, I'll enter a small short position with a stop just above .8926.



Dave427 said...

Todd - A basic question: since we saw a 5-wave decline from 19 Jan, we are now due for an a,b,c correction up right? And, typically, a,b,c corrections are less then the preceeding 5-wave movement, so, if the market might now rally back up to near 1150, how can the current movement be an a,b,c? Can a,b,c's retrace a full 100 % of the prior movement? If so, wouldn't that signal a not-so-strong downtrend overall?

Todd said...

Hi Dave, an ABC correction cannot exceed the start of wave 1 of the preceding 5 wave decline. So the S&P cannot rally above 1150 if it is in fact a correction.

But I doubt the market will make it back to the 1150 area, that's quite a deep retracement, however EWP rules state that wave 2s can rally up to 100% of the preceding decline. So it's possible, but unlikely. As a "guideline", rallies shouldn't go past the 78% fibo retracement, so a strong rally past that level would raise concern. The depth of the countertrend rally doesn't necessarily signal a weak downtrend. As long as it stops short of 100% retracement, then all it means is that the ensuing wave (iii) decline will be longer and probably faster than if the wave (ii) were a flatter corrective affair.

May I ask why you're looking at the 1150 level for a retracement?

I'm looking more at the 1116 level for firm resistance of this rally myself.

Hope that answers your question.


Dave427 said...

Todd - Thanks, that explanation helped a lot. I was looking at 1150 only as the high of Jan 19.

Martynas said...

EWP points out that in rare cases in an expanded flat, wave C is 2.618 times the length of wave A.
So C could be at 1118.64 without breaking ex. flat rules. That would be perfect, I mean nice ~61.8 retrace, filled gap an so on.

Todd said...

Good point Martynas. That gap should act like a magnet before the downtrend resumes. If the rally continues on this straight up trajectory to that level, I'll keep the "flat" on the table. If it churns up and down with overlapping waves, then it's most likely not a C wave, but something else. But regardless, that gap area and the fibo retracements should act as a solid ceiling to this rally.

Thanks for the comment!