July 25, 2008; Wave 2 Corrective Rally Closeup

Above is a 15 minute chart showing a closer view and wave count of the corrective rally unfolding. As I’ve said before, the rally is a large wave 2. It appears a “zig-zag” correction is unfolding. The count fits nicely for wave a being 5 waves, wave b being 3 waves (a-b-c), and now the wave c rally seems to be in the beginning stages which will be a 5 wave rally.

For a bigger picture, explanation of wave structure, and price target for the wave 2 top, please look at prior post I just posted a few minute ago below.

July 25, 2008; Wave C is Likely Underway

All my positions in the stock market are closed (at 11,462 in the Dow). I’m waiting for a strong wave c rally to get underway which may have started today (Dow up 60 points at time of writing).

Above is the previous chart I posted where I called for some pullback for wave b (top chart) to around the 1250 level. Which actually happened yesterday. The second chart (bottom chart) shows the updated wave count. If wave b is in fact over, then we need to start looking for a price target in wave c. Wave c should be a five wave rally off the wave b low (1251 in the S&P). It appears a “zig-zag” correction is unfolding (wave a rallies in 5 waves, wave b falls in 3 waves, and wave c rallies in 5 waves). If so, then often times wave c equals the size of wave a. Wave a was about 88 S&P points. So a good target for wave c would also be 88 points. So 88 points higher from the wave b bottom at 1251 right now is 1339 in the S&P. So my current price target for wave c is 1339 in the S&P. If the market makes a new low beneath 1251, it means wave b is extending lower. This also means the price target for wave c will be lower. The bottom line is that wherever wave b bottoms, wave c’s target area will be 88 points above that area. A rally above 1289 in the S&P should confirm that wave c is in fact underway.

One concerning area in my forecast for a wave b bottom in yesterday is the daily stochastics are very bearish (see bottom circle on chart) and there is a bearish candlestick formed by yesterday’s weakness (see top circle on chart). But seeing as this is all part of a larger wave (3) decline, and the rally is counter-trend, momentum indicators are not as reliable.

Summary:

1) The market is in a wave 2 rally within a larger wave (3).
2) Within that wave 2 rally, it appears wave b has bottomed yesterday at 1251.
3) If wave b is complete, then a price target to complete wave c of 2 is 1339.
4) The wave c rally will unfold in 5 waves.
5) After wave 3 of c is over, I will start looking to establish short positions again.
6) When wave 2 of (3) is over, wave 3 of (3) will be underway which should be a massive sell off. It could quite possibly be almost a straight line down to new lows. That’s one move I don’t want to miss out on.

July 24, 2008; Closed all Positions

I closed all my short positions (QID, SDS and DXD) when the down hit -170 (11,462) on the day. I did this realizing that it's probably too early seeing as that wave B should last at least a day or two. But the 5min chart showed a bullish divergence, and it's possible to count a full 3 waves down from the highs yesterday, leaving the possibility that wave B is ending right now. I'm not trying to catch an absolute bottom of wave B, I just wanted to wait for some pullback to exit at a better position and preserve capital, and lock in those large profits I made all the way back from when the Dow topped a few weeks ago at the 13,100 area which is about a 1,600 point profit in the Dow alone (which is a 24% profit for double short ETFs).

Wave C of 2 should begin early next week. It should be a strong wave that sub-divides into a 5 wave rally. That will offer an opportunity to re-enter short positions at a better price in preparation for the next wave down.

Right now I have no positions in the stock market.

July 23, 2008 8:35am PST; Wave B is Underway

Today's weakness can be counted as a B wave of 2, however breadth is very weak and momentum indicators suggest further losses. But seeing as this wave 2 rally is a counter-trend move, that's expected. I'd like the S&P to get to the 1260 area to start cutting down my short positions (currently at 1265). But I don't want to get too greedy; B waves are the hardest waves to trade, and the upcoming wave C rally to finish this bear market rally will be fierce. I definitely don't want to get caught holding short throughout that rally.

One thing to consider is time. The wave A rally has lasted 6 trading days, so I expect wave B to last 1-2 days, so further weakness is likely.

All-in-all, it's time to start looking for targets to exit short term short positions.

July 22, 2008 8:45 PST; Alternate Count Bigger Picture

Today had a nice rally to a new high just like I thought it would however the resulting decline and structure and breadth and ferociousness of this rally is concerning to my preferred wave count. I need to start thinking about the alternate which is gaining stature very fast.

The attached chart shows this alternate count in the daily S&P. With 5 waves up from the bottom it should complete wave a of 2. Also, with 5 waves complete, or almost complete, at least a correction to the downside is due. Also if you look at the stochastics on the chart, they’re starting to cross down (bottom right circled). So some selling pressure should ensue soon, but judging by the structure of the rally it appears the selling coming up will just be a wave b of 2, not a wave v to a new low like I originally thought. B waves are the hardest to trade because they’re quite sloppy so I don’t want to get too cute here. I just want some weakness in the market so I can exit all my short positions. Once the b wave of 2 is complete, we’ll go on a ferocious wave c of 2 rally that will complete the wave 2 correction. This should occur sometime in August. This c wave should be about the same size as wave a (about 80 S&P points). The last stages of that wave c rally will give me an opportunity to start re-entering short positions. Once wave 2 is over, it will give way to wave 3 down. This is a wave 3 within a larger wave (3). So according to EWP, this should be a mass panic and selloff. In my opinion, it will almost look like a straight line down on the charts, and just destroy the major indices.

Right now the key is to look for weakness in a wave b so we can exit our short positions at a decent level.

July 22, 2008 8:42 PST; Alternate Gaining Stature

Here’s a close up (15min S&P chart) of the alternate count. It shows a clear 5 wave rally complete, or almost complete. The project decline coming soon will be a wave b and will provide an opportunity to exit short positions before a large and strong wave c rally occurs.

July 23, 2008 8:40 PST; Preferred Counting Losing Stature

Here is a close up (15min S&P chart) showing the preferred count which is losing stature quickly. It shows a clear 5 wave rally complete, or almost complete, as wave c of a “flat correction”. The impending decline will be wave v within wave 1 which will take the indices to new lows. Judging by the breadth and strength of the rally the past week and the strength I see today, this wave count looks more and more unlikely unless a big selloff occurs by the end of the day on with big underlying weakness accompanying it.

July 22, 2008; Overview of S&P Flat Correction (Daily Chart)

Today’s rally at the very end of the trading day was unexpected and a bit concerning as it now completes 5 waves up from the bottom. The larger trend is still down, so I always look to align myself with that trend. The wave count appears incomplete, and momentum indicators are still bearish.

Noticing that today’s close was right near a prior high from a few days ago, it makes it possible that it’s a “flat correction”. This would explain the 5 wave rally from the lows because C waves are always composed of 5 waves. Also, in flat corrections, wave C often reaches the beginning area of wave A (see red horizontal line on chart). So the flat correction (counted a-b-c) on the chart above is in play. But in order for it remain a high possibility, it’s important that the market turn lower soon. Any further strength into a close tomorrow or the next day will start to shift the evidence to wave 1 being complete, and a large strong multi-week wave 2 rally being underway.

Even if a wave 2 rally is underway, with 5 waves up being traced out and perhaps already completed today, it means that at least a correction is due soon. The breadth, volume, and overall strength of the market move down will tell us a lot about whether it’s a correction downward, or a wave v down to new lows. Under both wave counts, the market should fall late tomorrow and perhaps until the end of the week.

July 22, 2008; Closeup of S&P Flat Correction

Here’s a close up look at the 15 min S&P chart of the possible flat correction unfolding. Today’s strong rally at the end of the trading day looks a lot like a small wave 3. That would mean a small consolidation in a wave 4, and then one more slight rally to a new high tomorrow morning to complete wave 5. That should complete wave v of C of the flat correction and lead to a selloff.

Even if it’s not a flat correction and the market is not on its way to a new low in the short term, with five waves up from the lows complete, at least a correction to the downside is warranted. The technical strength behind the move down will tell us if it’s a B wave in a correction, or if it’s wave v on its way to a new low.

I may sound stubborn, but the larger trend is clearly still down, and the evidence does support the idea that a new low must be achieved to satisfy the preferred wave count. Another strong rally tomorrow and close on the highs will make a strong case that wave 1 down is complete, and no new low will be achieved in the short term. It would mean that a wave 2 rally is underway, and will take the indices to much higher levels. Tomorrow should be a very important day and tell us where the market will go in the next few weeks.

Close up Look at S&P 15 Minute Chart

Here’s a close up look at the 15 min S&P chart of the possible flat correction unfolding. Today’s strong rally at the end of the trading day looks a lot like a small wave 3. That would mean a small consolidation in a wave 4, and then one more slight rally to a new high tomorrow morning to complete wave 5. That should complete wave v of C of the flat correction and lead to a selloff.

Even if it’s not a flat correction and the market is not on its way to a new low in the short term, with five waves up from the lows complete, at least a correction to the downside is warranted. The technical strength behind the move down will tell us if it’s a B wave in a correction, or if it’s wave v on its way to a new low.

I may sound stubborn, but the larger trend is clearly still down, and the evidence does support the idea that a new low must be achieved to satisfy the preferred wave count. Another strong rally tomorrow and close on the highs will make a strong case that wave 1 down is complete, and no new low will be achieved in the short term. It would mean that a wave 2 rally is underway, and will take the indices to much higher levels. Tomorrow should be a very important day and tell us where the market will go in the next few weeks.

On the Edge of a Cliff

More sellers than buyers in the market today with NYSE breadth negative and the Dow's decliner volume is higher than its advancer volume even though it's slightly in the positive. Notice in the S&P daily chart above that the stochastics are now overbought and starting to cross down.

The market is headed lower to a new low (S&P below 1200).

SELLOFF TOMORROW LOOKS LIKELY!!

The blue chip indices popped to a new high this morning and then reversed, just as I forecasted last night. However they did not selloff as hard as I anticipated. The market’s structure is definitely weakening again, and momentum indicators are bearish as seen by the two orange lines on the above chart. You can see on that 30 minute chart above that price was making new highs (top orange trend line) while the stochastics were making new lows (bottom orange line). This bearish divergence is also occurring on the 1 hour chart as well, and signals some type of big decline is coming. MOST LIKELY TOMORROW.

One thing I’ll be watching during this decline is the breadth, volume, and wave count of the move. In order to have confidence in my current wave count which calls for a wave v to a new low, I’d like to see weak breadth and strong volume with small 5 wave declines on the way down. Today that did not happen. Wave structure is unclear, and breadth was slightly positive on the NYSE with 65% of all stocks advancing, and 53% of total volume going to advancers (Scottrade). However today’s total volume was not strong at all, and the indices actually closed slightly down. So it appears like a “nothing day”, with no one really participating and no one really winning on the buy or sell side. This type of behavior often happens right before trend reversals, the calm before the storm affect, as everyone stops trading because they’ve done what they’ve wanted to do up to this point and they’re now waiting for direction. According to the wave count I have, and the bearish divergence in the stochastics, it seems clear to me that the next move is down.

Tomorrow (Tuesday, 7/22) will be a big down day.

-Todd

Bottom Line

The bottom line for the short term is that the market is setting up for a nice fall to new lows (beneath 1200 in the S&P). So aside from a very brief rally Monday morning, which should stay below 1280, the market will hit fierce selling again and take this market down hard again the rest of next week.

The key for the bears here is to wait for the capitulation decline. That is, once we see a huge massive selloff and then quick reversal and rally on strong volume and expanding breadth, we could be confident that short term trend has now switched to bullish and I'll exit my short positions. I am current short the Nasdaq 100, Dow, and S&P by using the double inverse ETFs, ticker symbols QID, DXD, and SDS.

The ensuing rally should be sharp and deep because it's a wave 2 within a wave (3). EWP says that wave 2's tend to be strong waves because most people are in denial about the larger trend, which is still down. Unsophisticated investors will buy the market up thinking the worst is over and another bull market has returned. They will be very wrong. Wave 2 will not exceed the beginning of wave 1 though, and the market will then roll over under very very fierce selling pressure in a wave 3 of (3). This should look almost like a straight line down when it occurs. Wave 3 of (3) should start in about 3-6 weeks which is late August to early September. That next wave of selling will absolutely destroy the market. And it will be the fastest and fiercest decline I'll have seen in my entire trading career.

S&P Futures 1 Hour Chart

And finally, I’ve posted the S&P futures hourly chart. Here you can see my wave count up close for this rally. I have it labeled as an a-b-c correction in wave iv. Once this bear market rally is complete, probably early Monday and under 1280, the market will fall in wave v of 1 to a new low beneath 1200.

S&P Futures 8hr

The above chart is of the S&P futures on an 8 hour timeframe. Here we get a closer view of current market conditions. As I said on my earlier post, the S&P appears to have one more modest high to make before plunging to a new low. This new high, if it even happens, should occur early Monday morning, and should remain under the 1280 area.

EWP states that corrections often are attracted to prior 4th wave areas, as well as Fibonacci retracement levels. The 1280 area in the S&P should prove to be tough resistance as it is both the prior 4th wave area as well as the 38% Fibonacci retracement level. If the market even makes it there, it should be all out of steam and quickly reverse sharply in another wave of heavy selling to a new low beneath 1200.

S&P Daily

The above chart is of the S&P 500 daily. It shows a more detailed picture of how the wave count is playing out. As you can see, the huge decline into the beginning of this year is labeled as wave (1), and the alternate best count would have it as an A wave as part of a correction. The choppy, overlapping rally that stalled and reversed at the Dow’s 200 moving average on the daily chart in March, is counted as a W-X-Y combination correction composing wave (2). The choppy overlapping waves, weak breadth and volume during the rise told me that this was clearly a correction and not a new bull market. Because of that, I was able to position myself heavily short during that rally in preparation for the next wave of selling in a large wave (3). We are now undergoing that very large wave (3) which should be a relentless wave of hard selling. EWP states that wave 3 cannot be the shortest of waves 1 and 5, and wave 3’s usually are the largest and strongest of all the waves. So far, this wave has fit that model perfectly, as the selling from the March highs has been ferocious, as seen from all the red candles on the chart above, and breadth has been atrociously weak on the NYSE during the decline telling us that no one wants to buy stock. They only want to sell them.

Drilling down a bit further, the current decline I have counted as waves i, ii, iii already played out. This little bear market rally that started last week is simply a wave iv that probably has one more moderate high to make on Monday before fierce selling brings the S&P to a new low beneath 1200. This will complete wave v of 1 and a sharp, multi-week, wave 2 rally will occur. But the indices will remain well below their March highs before turning lower. Much lower.

S&P 500 Weekly View

Attached is a chart that shows how bearish I feel this market really is. The horizontal red line is wear the market bottomed after the dot-com bubble. With the current fundamental and technical breakdown occurring in the market right now, it should be attracted to that low like a magnet. That low sits at around 769. That's about another 500 S&P points, or 39%, lower from current levels (1260).