Q&A; June 2, 2009

The stock market appears to need at least one more high to complete a five wave advance at a small degree (15min chart). From there, we'll see what type of decline unfolds to determine if wave 3 down has begun, or just another temporary pullback within wave 2 before it grinds higher toward my target area of 1067 S&P futures. While we wait for this correction to unfold, I thought I'd answer a question by a reader:

Is there a timeframe that needs to be met for a P2 wave ? If P1 was 17 months how long would P2 have to be to qualify? Also if you could identify a target on the downside for DOW/S&P as well as a timeframe for P3 to play out that would be helpful. If for example P2 ends this summer and P3 has to be longer in length than P1 does it also have to be longer in terms of time ? If so then would P3 have to be longer than 17 months to the bottom ? Thanks!

First of all I'd like to make a correction. Last post I said wave 3 has to be longer than wave 1. This is not correct according to EWP. According to EWP rules, wave 3 just cannot be the shortest of waves 1 and 5. Usually wave 3 is the longest though.

As for time, it's very speculative and EWP only has "guidelines" for elapsed time, no rules. Ideally, we look for a correct proportion of time in fibonacci sequences relative to the prior wave with the trend. So wave 1 down took 17 months, so the fibonacci time sequences for wave 2 would be approximately:

4 months - July (23.6%)
6.5 months - mid-September (38.3%)
8.5 months - mid-November (50%)
10.50 months - mid-January 2010 (61.8%)

Anything greater than this would be highly questionable and put the wave 3 scenario in jeopardy; especially because the rally has gone so far so fast.

My original analysis pointed toward the 50% time level around November. However the market has rallied so much so fast, and optimism has skyrocketed with it, I have my doubts this market can hold up that long. Also take into account this is a huge degree bear market we're undergoing, and most bear markets unfold fairly quickly. So it should be of no surprise that this market may be unfolding faster than what is typical for EWP patterns. I think the best timeframe to look for a wave 2 top is sometime between July and November of this year. But again, there are no requirements for time under EWP, so wave 2 can top any day. The key to remember is that the larger longer term trend is down, and I am going to align myself with that trend.

The S&P futures topped in 2007 at 1586.75 according to esignal's data. The bottom occurred this year at 665.75. So wave 1 was composed of 921 S&P points. As I said before, wave 3 can be shorter than wave 1, just as long as it's not the shortest of waves 1 and 5. But ideally, wave 3 is the longest. If this is the case, wave 3 would need to be over 921 S&P points. As it stands now (S&P 945), that would take the S&P into the 20s. Again, time is very speculative, but I would guess that wave 3 down would take anywhere from 1 to 2 years. The alternate view has the upcoming massive decline as a wave C instead of a wave 3. In that case, the only requirement would be that wave C come below the extreme of wave A at 665.75. So to sum up, regardless of which count is correct, the upcoming decline will come beneath 665.75 which is almost 300 points, but can end up well below 100. If the latter were to occur, we most likely wouldn't even be able to profit from it all the way to below 100 because the financial system would not be able to withstand such a horrendous decline like that, and the futures, options, and equity markets would probably become dysfuntional, and average retail traders like us will most likely have our profitable positions liquidated. So the key is to catch the early stages of the wave 3 or C down, and then get out when the government starts getting too involved and when financial institutions literally start imploding. I will be closing my positions and moving to cash, T-Bills, and gold accounts at some point. Then, when the market bottoms, it will bring about the buying opportunity of a lifetime and afford all the sage investors an opportunity to get rich in a short period of time.

So the above analysis is the "perfect world" EWP scenario. But rarely do the markets give us such fortunate results. I'm actually targeting the 400s for my profit taking point. It is a prior congestion area decades back, and it seems to be a good area to start closing short positions and hiding my capital in bomb shelters to protect it from disappearing like what will happen to most people's money, unfortunately.

My best analysis suggests wave 2 will top between July and November of this year aorund 1067. Then a devastating fierce wave 3 will ravage the global markets, taking the S&P to at least the 400s sometime in late 2010, and wave 3 should end sometime in 2011. It's a bit too early to get too specific on that.

I'll post any significant developments or if I get fully short. Right now I'm only have short and am selling options against my position.