Thursday, July 19, 2012

SPX, Oil, NDX, CVX, COMPQ: This Round of Easy Money is Probably Over

The market turned into a sloppy mess yesterday, and the preferred count continues to suggest that more upside is likely in the coming sessions.  This leg of the rally has now completed a very nice 3-wave form, which is where the easy money usually ends (with the peak of wave 3 or c -- assuming it has indeed peaked). 

In fact, traders who followed the NDX chart I posted waaaaay back on Wednesday captured an easy, draw-down free, 50 points of profit ($1000 per NQ contract).  Here's the updated chart, which I really like for the clarity of its waves:

In looking at the chart, one can see why I consider third waves to be "easy" money.  I could be cute here and do a Three Things I Like About Third Waves:

1.  There is usually limited drawdown in a third wave (sometimes zero, such as in this example).
2.  The targets are usually pretty clear, and are usually hit.
3.  The end of the third wave is where the possibility of a c-wave comes in -- meaning there might not be any more upside (or downside).  Personally, I don't like banking on fifth waves, partly because fourth waves are usually the Ultimate Trading Nightmare (almost always loaded with whipsaws).

But I hate cutsie stuff, so I won't do that Three Things About Third Waves gig. (?)

What makes third waves challenging for some traders, especially the inexperienced, is that third waves virtually always require you to buy when the prevailing sentiment is bearish, or sell when the prevailing sentiment is bullish.  There is a lot of fear at the beginning of a third wave up; and a lot of euphoria at the beginning of a third wave down.  Some traders have trouble taking action against that, because the majority will always be on the wrong side of the trade, strongly doubting the move and telling you to either sell it or buy it (whichever is wrong; depending on which way it's going).  Ironically, that's what gives third waves their strength.

This is also why I'm watching this market carefully here, for signs of what's bullish and bearish.  The next wave will likely be a third wave (due to the market's position, it will be a third wave up or a third wave down), but a much larger third wave -- and we don't want to get caught on the wrong side of it.

In any case, I consider third waves my bread and butter, and I strongly suggest learning how to recognize and trade them.

Going back to the charts: what long-term bears do not want to see immediately here is a top.  A top from this level would almost certainly indicate that the recent wave up was wave b of an expanded flat, which would mean a solid decline (nice for short-term traders), then a much bigger rally.  I've outlined this as the second alternate count, in green on the intermediate SPX chart (below).  I don't view that option as terribly likely here, but one never knows -- and it would make for the ultimate head-fake to both bulls and bears...

The SPX short-term chart is below.  Where to place the top of the current (3) (if it's topped) is more than a bit ambiguous on the 1-minute chart, so I just keyed off the NDX and went with the price high.

CVX has developed an interesting pattern, and it's one of those patterns that makes you just want to turn the chart upside down and throw darts at it.  It's either an abc up, or an abc down.  Both patterns suggest a very strong move is brewing, but it won't be 100% clear which way it's headed until after it starts breaking.

Oil also suggests some more upside is probably due:

And the Nasdaq Composite also suggests another leg up due... barring the 2nd alternate, of course. 

If and after we get that next rally leg, then that will be where we find out who's for real. I'm largely expecting the market will head up toward the preferred count target zone, then it will probably retrace back toward the breakout level. What happens from there will be critical to both bulls and bears. A solid whipsaw will indicate the bear count is probably on the way... but a successful back-test will mean a powerful rally coming.  The good news is: along with both options comes the next round of "easy" money.  Trade safe.

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