In Friday's update, we looked at some of the signs that bears may have more firepower. In today's update, we'll also take a closer look at the near-term potentials for the S&P 500 (SPX). Specifically, I'm going to elaborate on Friday's discussion regarding extended fifth waves. On Friday, I wrote:
The way I'm tempted to view the decline, though, is as all of wave 1-down. Instead of viewing the big drop as wave iii-down, I suspect it may have been an extended fifth wave. Calling extended fifths is difficult, though, because the technical indicators literally don't work -- so it's all about "feel." These are the types of calls I run with as a trader, but shy away from as an analyst, so do with this what you will. If this was an extended fifth, then expect a retrace rally toward 1879-82 (the chart says 80-82), followed by a retest of the 1863-70 zone, followed by another rally leg up toward 1888.
SPX came within 1-point of the 1879-82 target on Friday, so let's take a look at a near-term chart of SPX for further illustration (more discussion after the chart):
When an extended fifth wave forms, we know to expect a retrace to wave iv of the extension, which has already happened. This is usually followed by one or more retests of the wave-v low. Then, after the retests, the rally will typically retrace to wave-ii of the extension (zone noted on the chart).
The alternate count, shown in black on the chart above, was also discussed on Friday:
The conventional way to view the big drop as the belly of wave iii-down of 1-down. That would mean the bounce that began yesterday is merely a fourth wave consolidation that should be fairly short-lived. In that count, the market is still forming wave A or 1 down, with wave v-down of 1-down still to come.
Both counts remain viable, and 1862 is the dividing line. The key point is that, either way, I expect 1862 will break in fairly short order, so I'd be very cautious playing with longs here. Right now, I view this as a market where I'd short the bounces, not buy the dips. Ironically, bulls probably have better odds if the market declines directly toward 1850 than they do if 1862 holds and it continues to rally. (I'll discuss that in more detail in Wednesday's update if it becomes appropriate to do so.)
For more perspective on the bigger picture, let's take a look at the two-hour SPX chart:
The Russell 2000 (RUT) is one of the markets that kept me skeptical of the recent new highs in SPX. RUT is in an interesting position right now, because it appears to be coiling for a rapid move. This is a market in which to stay extremely nimble, because the next move is likely going to punish anyone who hangs on "hoping" while on the wrong side of the trade.
In conclusion, barring a breakout over 1903, the charts presently suggest we should remain bearish on equities until there are signs of a meaningful low. If 1862 SPX fails, watch for a drop to 1848-53, which would also be a potential reversal zone. Trade safe.