Friday, February 10, 2012

Intermarket Divergence in Place = Bearish for Stocks; Euro Pullback is Bearish

The Dow's new high has created angst in the EWP community, and rightfully so I suppose.  For EWP purists it's tough to explain it away and still try to justify a major top in the overall market.  I am more flexible with my analysis and although I'll never violate an EWP rule, I use EWP as a basis for my overall analysis, not the be-all know-all form that must be adhered to as if it were an infallable law written in stone.  The key is make sure we don't violate any EWP rules, and use our best objective judgment when using EWP guidelines.  I will say, with the experience I've had in these markets, EWP is the most reliable out of all other forms of technical analyis I've tried.  I can't tell you how many times when all technical indicators point to the market moving in one direction, but the EWP count suggests the opposite, the EWP count proves to be correct.  It happens a lot. 

With that little preamble out of the way, let's try to take a basic common sense look at the market.  The Dow made a new high, suggesting that its Primary wave ((2)) did not end last may as previously projected.  The Dow only has 30 stocks in it, and is the bluist of the blue chips for that matter.  So I'm not sure it's the best proxy for crowd psychology as EWP is based on.  This is why I follow the S&P, it has 500 stocks (or close to it), and is much more diverse and touches a much larger crowd than the Dow can.  The larger and more diverse the crowd, the more reliable our EWP wave counts will be.  The S&P has so far failed to confirm the Dow's new high, keeping the original wave count that its Primary wave ((2)) has topped already.  And with today's modest decline, it leaves the potential for a major intermarket divergence to be in place between the Dow and S&P. 

The bottom line is that the market rally is stretched, I think it's hard to argue that.  So what are the plays here?  1) Getting long here at this point in the rally without any meaningful pullback?  I don't think so.  Not wise in my opinion.  2) How about getting short now with a stop above yesterday's high?  This seems like a great risk/reward opportunity I'm jumping all over, despite it being a Friday.  3) And lastly, sitting on the sidelines doing nothing is another options.  Certainly a viable option, at least until we get confirmation a significant top is in.  Regardless of the choice, trading is all about probabilities, not certainties.  So I make every trade with assumption that I'm going to be wrong, and manage my risk accordingly.

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Above is another possibility for the Dow.  It suggests that it's in an Intermediate degree "flat correction".  This suggests the larger trend is still up, and pretty much destroys Prechter's call for the past several years.  So I'm not confident in this count at all.  However, it's worth noting this count for at least the short term because even though the count suggests a larger bullish move is still underway, the downward correction still has to undergo a major Intermediate wave (C) pullback that will be fast and deep, about 2,500-3,000 points.  And although it seems unlikely, it's still a valid wave count and therefore must be respected.

The bottom line is that I think the best plays here are to look for shorting opportunities with tight risk and then jump on them, or just wait on the sidelines until solid confirmation of a top comes in.  But getting long here at this point, just doesn't seem like the risk/reward is on your side.

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The euro appears to have completed an A-B-C correction and is now pulling back.  Whether a major top is in, or just a short term top is in, is still in question.  For currencies, I usually don't jump in on a Friday since Sunday afternoon when the market reopens we often get a gap in price which is very tradeable.  I want to get short so I hope we gap-up Sunday afternoon so I can short aggressively at a better price than today AND get the odds of a gap-close on my side.  On the other hand, if the euro gaps lower I can simply wait to get short when it rallies to close the gap.  Either way, I feel I can get the most optimal positioning on the short side if I wait until Sunday afternoon.  Either short on a big gap-up, or if it gaps-down then just wait for it to rally and close the gap before getting short.

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