Thursday, October 13, 2011

Rally Enters Corrective Phase; Signals New Price Targets for the Top

Sometimes as you're charting, you just have to stop and shake your head in wonder. 

If you've been following my articles for a while, you may have heard me refer to the aesthetic nature of the markets, and of Elliott Wave in particular.  I'm going to use this article as the perfect opportunity to not only discuss my projections, but also to illustrate how I reached those projections, and with that, the aesthetic I presently see in the charts. 

As a result of Thursday's price movement, the market has now given me two new data points to use toward refining my projections for this rally.  Amazingly, this small amount of new data steers the projections almost perfectly into the confluence of two very meaningful market events:

1) The successful back-test of the old falling trend-channel (at roughly 1160, then again at roughly 1140).

2) The successful back-test of the neckline on the head and shoulders top (around 1275).

Below is the 60-minute SPX chart with the new projections drawn in.  To me, there is a sense of harmony in these projections.  If we are (as I believe) currently forming "the rally that fools the masses," then this chart surely illustrates a perfect way for that rally to unfold in such a fashion that the price action alters the landscape of investor psychology.  Below the chart, you'll find my play-by-play describing each projection, along with my commentary of the psychological function each phase might serve.  Most of the math I've left for the end (the math is dry, and might be better left for Ben Stein.  Right, Bueller? Bueller?)

The initial projection leads to a back-test of the old falling trendchannel.  I arrive at this by using a very common Elliott tool: Fibonacci wave extensions.  In corrective moves, such as the move it appears we are in, wave c generally reaches a length either equal to wave a, or equal to 1.618 to 1.75 times the length of wave a.  To help everyone follow along, I've drawn a one-minute chart with annotations, shown below:

Regarding investor psychology: it can be anticipated with reasonable certainty that a successful back-test of the old trendchannel will turn some traders from bearish to neutral, and others from neutral to bullish. 

After the retest, the market should rally briefly (gray wave (b)-up, sixty minute chart), until the bears step in again.  From there, wave (c)-down should drive the market toward a second successful test of the falling trendchannel.  This drop below the (assumed) 1160 swing low will also serve to shake out the weak bulls, which will be necessary for the market to generate another strong rally leg.  Further, the successful test and bounce will then convert even more bears.  That will mark the bottom of the larger Wave B-down. 

From there, the market begins the big Wave C-up, which is the final leg of the Minor (2) counter-trend rally. C waves traditionally serve the function of getting the masses to errantly believe that the larger trend has changed. We can imagine that as the rally continues and the market breaks out of (what will by then be) a three month trading range, many will start to believe that the worst is over.  At that point, the market will likely consolidate for a bit (in the fourth wave of Wave C), just above the prior range -- this movement will give institutional investors a chance to distribute at higher prices; and the consolidation should serve to turn many small investors bullish again.  And then, to cap the rally, we get the final "sucker lunge" up to tag the head and shoulders neckline.  When we fail to rally through it, look out below, 'cause here comes the crash wave: Minor Wave (3)-down.

Beautiful, isn't it?

So that's my speculation.  Here's the math that got me there, which is actually fairly simple.  I already explained the first retest when we looked at the one-minute chart.  The second retest is based on wave (b)-up of B-down completing a common 50% retrace of wave (a)-down (see gray annotations on the sixty-minute chart).  Gray wave (c) down is then based on the traditional Elliott formula of (c) = (a); and then from the Wave B bottom, the large gray Wave C-up of Minor (2) is also calculated based on the same formula.  And there ya' have it!  So easy, even an early Hominid could do it. 

What's amazing to me isn't the commonplace math; it's the way the math adds up to perfectly target the bottom of the head and shoulders neckline.  It's almost as if the market already had the whole move mapped out beforehand, and we're just now catching a glimpse of the map. 

Will it shape up exactly as described?  Obviously, I have no way of knowing for sure.  But I have found over the years that when the aesthetic and the math are in harmony, the projections are often correct. 

Either way, I never cling to my speculations with an iron grip.  If the market starts deviating significantly, then it's back to the drawing board.  But as I studied the charts, counted the waves, and worked the math, I found a certain beauty in this that I felt was worth sharing.

Trade safe!

The original article, and many more, can be found at


  1. Thanks you very much for your sterling analysis. I have become a regular reader.

    Jaco Strauss
    Cape Town
    South Africa

  2. You're very welcome! And many thanks to you for the encouragement. :)

  3. Also wanted to give a quick shout-out here to Randal for his donation yesterday. Many thanks, Randal, your support is very much appreciated!

  4. As a new follower, and new to Elliot waves, I appreciate the detail in this post. You have helped me see a bit more behind the curtain of magic.

  5. great and best analysis available on Elliott wave by far

    a question...

    s+p target very short term 1130 or 1160..??? 38,2 or 61,8 fibo?


  6. Thanks.

    First target would be 1160, asssuming the correction IS underway. Futures going nuts this morning, so it will be interesting to see if we get a double-top.

    I will be quite surprised if we go much higher... the first wave down was a very clean impulse wave, which almost always leads to lower prices. We *could* still exceed the top in an expanded b-wave correction, though, and then head lower in c. What happens today should be very revealing.

  7. Today's price action seems to be following your 1-minuute chart posted above. So your analysis seems to be playing out. (Though the day is still young.)

    Thanks for your analysis.


  8. thks so much..just enter short with luck up to now... on the top with SDS and QID with sell order @ 24 sds and 50 qid
    very impressed by your job

  9. Today's high becomes important now. A break above should indicate there's more upside left in this market.

    Below 1207.46 should confirm the next leg down is underway.

  10. it is impossible to predict top and bottom...but Elliot waves show how fast we can pass from mania to depression
    situation in europe is much more worst than people think...involving horrendous domino effects in the global financial system..but ok this is for wave 3...the recognition wave..!!!

    for now let's see how intense the mania could go...


  11. loved reading it and understood every single word of it. right now S&P500 is at 1215, pretty much spot on where you've plotted top of "b", with the understanding that the c-leg is just drawn in using the available space.

  12. are we in bad shape with the action today...? volume..last minute push...???


  13. I'll be interested to see your analysis now that the SP has made a new short-term high. Could this be an extension of the A top?

  14. It's most likely an extension... after glancing at the charts, my instinct is still that we are *very* close to the top of A.

    On Tuesday, I posted a chart of the NDX, with a target range of 2337-2380 for the top (today we closed at 2371); and yesterday pre-market, I talked about how I was a little bothered that we hadn't made it up into that range, and that there might be one more push coming.

    Then after the action yesterday, when the VIX bounced off the bottom of its range and moved back up through RSI 30 -- coupled with the breakdown yesterday in the BKX -- both led me to conclude the top was probably in.

    And it may be -- I honestly wouldn't be surprised to see a gap down on Monday.

    All of that said, this market "feels" an awful lot like March '09 to me... it's one of those rallies that seems to violate all the normal rules of charting. The difference is: in March '09, I was *expecting* a long-term bottom. I have a really hard time seeing it here. Even beyond the market charts, the liquidity just isn't present in the system to support a long-term rally.

    But with all the violations today, this is one of those days that will cause me to break out 20 charts and start doing inter-market analysis -- while challenging all my assumptions in the process. *Usually* when that happens, everything turns in the next day or two.

    I'll be sure and update everyone as soon as I can: I've got a lot of charts to sift through, so I'm thankful it's the weekend! I'll probably need the extra time.

  15. A quick shout-out to John: thanks so much for the donation today. Very much appreciated! :)

  16. correct if i am wrong please...but im starting thinking what we saw today on the s+p 500 and well seen on a 2mn chart

    a) a fantastic shooting star candle
    b) followed by a sharp drop...
    c) followed by 2 sharp exhaustion gaps...coming to the level of the shooting star candle

    which mean we are very very over extended..mainly when it occurs 10mn or less before the close on a friday afternoon...!!!!!
    in my opinion that smells the end and a sharp correction is due
    have a nice week end

  17. Jason, thanks for the reply. I can imagine you getting deeply lost in thought this weekend. I'm still at the beginning stage of feeling good when I can follow your analysis. As you say, if the down wave starts Monday, it will all fall in to place.

  18. What a day to have been Short kumba (like me :( ) The thing went up over 5% in SA today and almost 10% on NYSE! Hope it had been a question of short covering and not something more sinister...

  19. Pretzel, you say this rally 'feels' a lot like Mar '09. How does the volume of this rally compare to the one in Mar '09? Today, we are rallying with fairly light volume. I'm guessing in Mar '09 we had much more volume relative to what we see now. Your thoughts?

  20. jaco-

    This rally sure smells like short covering. As Lee Adler likes to say, "Bears are their own worst enema."


    The volume now *is* much lighter than March '09 -- however, it's all relative. The declining volume was also much lighter than the declining volume leading into March. I'm working on a volume comparison chart, which I'll post later this weekend.

  21. blackjak --

    I didn't end up posting the volume chart, because it was just getting to be too many charts (I actually have several other charts I also didn't post). But you can see the SPX volume on the first chart. Compare the current situation with the correction in 2010, and you can see that the volume now is pretty inconclusive as an indicator.

    March '09 was different, in that up volume increased significantly; but the current rally volume doesn't look too dissimilar from 2010, so it's hard to say it means much for the bear case. We have to look elsewhere.

  22. Had to share this with you guys. Minyanville has my article posted about "Debunking 5 Myths and Fears Around Elliott Wave." There's a guy who comes and posts on my articles sometimes, who has it out for EWT. He has this long-ass blog post about why Elliott Wave can't work. It sounds like his college thesis or something.

    Anyway, not to take anything away from the guy, he sounds intelligent enough -- but his major argument, in his own words, is this:

    "The point of the Fundamental Error of Elliott Wave Theory is to demonstrate that this basic assumption of EWT is false, because the types of input variables responsible for stock market movements are fundamentally different from the types of input variables responsible for the patterns (including fractal patterns and fibonacci results) we see in nature. Once this error has been demonstrated, I see no need to do the "impossible", i.e. to disprove EWT empirically."


    The problem is, he has it completely backwards. Elliott Wave didn't start out as a theory intending to prove that you could fit the market to nature; it came about because it was *observed* that the market was actually already moving in ways that fit natural patterns. So here was my reply to him:

    "The key point is that you have the argument backwards. Elliott Wave Theory was arrived at by decades of back-testing and observation. It was not reached by some intention to attempt to fit the patterns of the natural world into market movements: it was reached by observing that the patterns of the natural world actually *are* present in the market.

    In other words, the theory is an attempt to explain something which has already been observed to exist.

    Your argument about input variables being fundamentally different, which thus should lead to Elliott Wave being invalid, is wonderfully well-written from a theoretical standpoint. However, it is defeated by simple observation.

    Theoretically, it is aerodynamically impossible for bumblebees to fly. And yet they do.

    We can write all the essays we want about why bumblebees can't fly, and even prove conclusively therein that flying -- for bumblebees anyway -- is an exercise in futility. If we're feeling particularly philanthropic, we could start a movement imploring bumblebees to just give it up, since there's no way flying *can* work for them and they're - tragically - wasting their time trying.

    Or we can walk outside and actually *observe* the bumblebees flying... and then be humble enough to recognize that perhaps there's something at work which we don't quite understand."

  23. Added one more little part:

    Your argument, at its core, isn't about Elliott Wave; it's about how the market moves, and why it's "not possible" for the market to move in accordance with natural patterns. Once we understand, however, that the market *does* move in these natural patterns (provable by observation), regardless of whether we believe this is possible or not, we can see that the fundamental premise of your essay is flawed. Your essay is, in essence, attempting to tell the market why it shouldn't behave *as it does*.