Monday, May 10, 2010

Triple Whammy Fueling Rally; What is the Wave Structure?

The rally today was mildly unexpected, more due to its size than just the fact that it rallied. The S&P easily broke the 4th wave triangle interpretation I laid out last week as it blasted through 1138 first thing this morning. As you can see from the above screenshot of the internals of this market, the move up is very strong, and the bulls are in full control. The internals, sharpness and strength of the rally suggests it's a 3rd or C wave at some degree. I discuss the possibilities below.

I think there are 3 things (triple whammy) at the core of today's action:

1) Greece got a bail out

2) Shorts are covering on the news of Greece

3) The typical Monday fund manager buying spree is in effect again.

So the combination of the 3 above factors has lead to this monster rally today, in my opinion. Let's look at the possible wave counts:

Correction Closeup (chart added late)

Primary Wave Count

This is my primary count because the rally from the lows is quite steep and long, and most other bearish counts put this as a 4th wave. It just seems too big for that. The strength and depth fits more of a wave 2 rally. But there is a slight flaw in this count anyway. If you look at wave 1 and compare it to wave (i), you'll notice that the larger degree wave 1 is much smaller than wave (i), so it doesn't have EWP's "right look". But it's still a possibility, and this may simply be due to the major battle of bulls and bears that occurred to form the top in place which throws the perfect wave count structure off a bit. But it violates no rules, so its still well in play. Regardless, the magnitude of the selling prior to this rally, along with this rally on the heals of a Greece bailout everyone knew would happen, leave me believing that this count is the most likely of the choices we have.

First Alternate Count

The above count is also a possibility but the size of wave (iv) compared to wave (ii) makes this count more unlikely than my primary count. Normally wave 2s are sharp and deep affairs and wave 4s are flat muted affairs. This count suggests the opposite, so it raises a red flag with me. The good thing about this count is that if it's correct, the S&P cash index cannot enter any of the price territory of wave (i) which starts at 1181.70. So a break above 1181.70 invalidates this count; making it easy to trade around.

Second Alternate (bullish)

Lastly, it's possible the market is still in a bull run, and this recent selloff was just an ABC declube as charted above. This suggests new highs on the year soon, but the strength and depth of this ABC decline does suggests that the entire bull run from March 2009 is probably weakening and very near an end anyway.

So there it is, two top bearish counts and one bullish possibility. I do see opportunities for the bears at current levels, and even more opportunities if the market continues higher from here. Risk is also easily defined at the wave (i) low at 1181.70 or 1219.80 for the bears.



Dave426 said...

Todd - Assuming P3 is indeed underway, this 3rd wave will be longer than P1 or P2, right? Since P1 moved 895 S&P points (57%), and P2 moved 546 pts (82%), what would you use to gauge the minimum P3 movement - % or raw points? If we use %, P3 will have to fall at least 82% (putting P3's bottom at 218). If we use raw points, P3 will have to fall at least 895 points putting P3's bottom at 317. Am I thinking about this correctly?

Todd said...

Yes you're on the right track. At this point I'm just thinking about "minimums". In other words, what's the minimum the S&P should fall if it's a wave 3? And you are looking at percentages and raw points just as I am.

But remember, wave 3 doesn't have to be longer than wave 1 if wave 5 ends up smaller than wave 3. Wave 3 doesn't have to be the biggest of 1 and 5, it just can't be the smallest. So it gets a bit tricky thinking that far ahead. Right now I'm looking at a minimum break of the March 2009 lows. From there, I'll get more detailed in where we go from there, depending on the structure that unfolded to that point. At least, that's just how I'm playing it.

Make sense? What do you think?


Dave427 said...

Todd - Right, wave 3 just cannot be the smallest, not that it has to be the longest - had that mixed up a bit. EWI believes that P3 is underway - no question - and Prechter is calling for the decline to the bottom of P5 (P5 not P3) to be the worst in history with indexes losing 90-95 % of current value. I have not been an EWP follower long enough to have seen anything like that (who has?), but my limited educated view is that we will take out the March 2009 lows.

Can the durations of P1 and P2 be used to predict the duration of P3? P1 was 15 months, P2 was also about 15 months. Seems I remember wave 3's are faster than 2's . . . is that right?
Thanks again for your blog - it is an education for me!

Todd said...

I'm right on track with you Dave. My focus is on the March 09 lows. The fact that we declined in 5 waves into those lows tells me we have to at least break them one more time. Once that's done, I'll look at other potential for futher decline.

I'm not good with time relationships because I haven't found much value in them myself. Time is very speculative and there are only guidelines to look for. The only relationships I am familiar with at best is there tends to be fibonacci relationships at times, i.e. wave 2 will take 61% of the time to unfold compared to wave 1. As far as wave 3s, they do whatever they want. Trying to project and estimate wave 3's speed and size is like trying to herd cats. The best thing in my experience is to just let them run. Anything else would just be a mere guess. So I haven't spent any time studying an estimated time for wave 3. Although Precther does suggest an estimated time this entire depression/bear market will last, so that may help you get somewhat of an idea how long wave 3 may last.

I'm not sure if you subscribe to Prechter's "Theorist", but he went in great depth this month on time relationships. It might have an answer to your question in there. I'm sorry I couldn't be much help in that area, it's a bit out of my strategy.