More Warning Signs for Bulls

On Tuesday, I outlined some of the reasons why I felt the market was undergoing a fundamental change of character, and discussed why I believed the power had shifted to the bears.  Since then, even more warning signs have cropped up for bulls.

The most obvious is the fact that most indices have now broken their intermediate uptrends.  Additionally, the decline in the S&P 500 (SPX) appears to be a five wave impulsive move, which suggests that the trend has shifted, and the next highest degree trend is now pointed down.  Whenever we see a new five wave leg forming in the opposite direction of the prior move, we can generally anticipate this first leg will be followed by at least one more leg of similar length, or longer.  There are other warning signs as well.

The chart below shows the 5, 10, and 20 day exponential moving averages of SPX and the Dow Transportation Average (TRAN).  This is based on a trend-following system which was popularized by Gerald Appel, who rose to stardom by developing the now-ubiquitous MACD indicator.  Okay, maybe "stardom" isn't the right word, since us traders belong to a pretty specialized subculture -- it's probably unlikely that your barber or landscaper has posters of Gerald Appel hanging in the garage, and I doubt he's ever hounded by paparazzi.  

Anyway, the last signal from this indicator was a buy, back in November 2012.  As we can see on the chart, TRAN has already given bearish crosses, and SPX is now extremely close to joining in.  Of course, there are no "magic bullet" indicators, and this one can be prone to whipsaws around tops, which is another reason I use multiple indicators and charting systems.  Nevertheless, this is one more potential red flag in the making for intermediate traders of the bullish persuasion.
  

  
The short-term wave structure in SPX is open to a few different interpretations, but I'm presently inclined to favor a path similar to the one shown below.  We'll have to see what today's session brings, but I suspect we'll see a green close today.

Tuesday's "best guess" projected path has since tracked nearly perfectly, but as mentioned above, I'm not certain if it will continue to do so.  I have left it unchanged on the chart below, but right at this exact moment I don't necessarily feel that I can see two turns down the road for the market.  I do somewhat prefer the path outlined above, which would see a rally for today, then a decline into Monday, then a bounce for Turnaround Tuesday.  Let's get through today's session first, then we'll take another look at the near-term path in Monday's update.

Do note that the red iii/C is not presently intended as a "final target," it's merely a general outline of expected direction at this stage.  Note that the trend line off the November lows has been broken for the first time since then.

SPX and Gold: Song Remains the Same

In the last update we looked at some of the reasons why lower lows are likely to follow Monday's low, while I noted that a snap-back rally could begin immediately.  The market spent yesterday's session in rally mode, and closed near the high of the day, which fit the pattern -- so as yet I have no reason to alter my thesis that lower lows await. 

It's currently unclear to me if yesterday's high will mark all of the (assumed) corrective rally, or if the rally will turn into a two-legged ABC -- in either case, I expect SPX to close in the red today.  There's no material change in the outlook for the S&P 500, so my best-guess projected path remains exactly the same as it was yesterday (though the price action did allow me to delete the rising blue line which was previously drawn in the place where Tuesday's rally has since occurred).

 
While I expect lower lows, we can't ignore the fact that SPX and the Dow Jones Industrials (INDU) both remain in technical uptrends.  A breakdown of the rising green trend line on the chart below is the next step for bears to gain confidence. 

Incidentally, for those who still doubt the value of technical analysis, I would like to note that I charted the blue channel (below) a pretty long time ago -- yet the rally was rejected immediately upon running into the upper boundary of that "imaginary" channel, and the same occurred in reverse when it fell back to the rising green trend line.  The next break of either will be telling.

Finally, given the recent volatility in gold, it's time to update the long-term chart.  Once again, simple trend lines worked their magic, as the recent decline found support at the rising blue trend line.  Given the wave structure, I would be surprised if gold does not ultimately break through that support level.  I've outlined next support and some potential targets -- trade above key resistance is required for me to re-examine that outlook.  Given the numerous failed retests of the all-time high and the subsequent breakdown of the topping pattern, it's hard to view the last couple years as anything other than a significant top.

The Market May Be Undergoing a Fundamental Bearish Shift

As long-time readers know, I have been primarily bullish on equities since November 2012 -- but for the first time since then, I truly have no desire to "buy the dip" for anything longer than a short-term trade.  There are some disturbing early warning signs that the market may be undergoing a fundamental change of character.  

I don't presently know how long this will last, but when I see signals like this from the market, I don't screw around and risk gambling away my financial future.  One of my trading mottos is "when in doubt, get out."  I have often likened trading to poker -- and one of the mathematical concepts required to become a winning poker player is an understanding of "pot odds," which is the ratio of the current pot to the cost of calling a bet.  Simply put: if the pot is $100, and calling costs $10, then the pot odds are 10:1.  Trading is all about odds as well.   

While I'm simplifying this analogy by overlooking concepts such as implied odds, etc., the next mathematical requirement in poker is to calculate the odds your hand has of actually winning the pot.  Then one compares those odds against the pot odds, and folds or calls (or raises) accordingly.  For example, if your hand will win 1 in 5 times, and the pot odds are 10:1, then calling a bet is a winning play over the long term.  But if your hand will only win 1 in 20 times while the pot odds are still 10:1, then the correct play is to fold if someone bets, and wait to try again next round.  (Incidentally, this is also why you want to bet aggressively and don't want to "check" a winning hand; if you don’t bet, you are giving your opponents infinite odds to draw to their long-shots for free against you.) 

In order to become a winning poker player over the long-term, one doesn't gamble, but plays each hand with discipline and according to the odds.  Oftentimes, inexperienced players will stay in the game despite the odds stacked against them -- usually this is because they either don't understand the math, or because they like "being in the action" and lack discipline.  Sometimes, in spite of their poor play, they'll win in the end -- odds are only odds after all, so even bad odds are mathematically required to win occasionally. 

Unfortunately, the thrill and reward of these occasional wins encourages bad players to continue playing incorrectly, and -- worse -- often leads them to conclude that their lack of discipline was actually pure, unadulterated brilliance.  The problem is, over the long haul players who have no discipline will, without exception, eventually end up 100% dead broke -- and that is a mathematical certainty.  I view trading in much the same light, and traders who lack discipline and overplay their weak hands will certainly end up broke as well.

All that to say, while the market always reserves the right to prove me wrong and go on to new highs immediately, I feel the odds are very good that there are ultimately lower lows still ahead.  Note that a near-term reaction rally could begin as early as today's session, but unless the market does something to shift the ball back to the bulls, given what I see today, I would expect the next rally will be sold.  Since the best we can do is attempt to play the odds correctly, here are a few statistics and observations to consider:

1.  The Volatility Index (VIX) rose more than 30% in the last two sessions.  Nearly 90% of the time this has happened previously in the past 20+ years, the market has subsequently gone on to make lower lows before making higher highs. Interestingly, the ferocity of the recent VIX rally also argues for a near-term snap back rally in equities, beginning as early as today's session.

2.  Precious metals have been absolutely slaughtered lately (I'll work up some PM charts over the next few updates), which means the market is at least considering the thought of a deflationary environment.  Further, the extreme volatility in PM's can often be a warning signal that things are about to become more volatile for equities as well.

3.  The momentum lows we saw yesterday are rarely reached in exact tandem with the actual price low, and generally we'd expect to see a bullish divergence before price finds a meaningful bottom.  Additionally, the up-volume to down volume ratio was high enough that we would expect to see further downside and new lows in the reasonably near future.

Let's start off with the S&P 500 (SPX) chart.  I've outlined my best-guess for a market path that presently appears reasonable to my eye, but do please note that predicting an exact path with the market in this position is exceedingly difficult, so don't be surprised if it deviates. 

As I mentioned yesterday, there is currently the potential of five complete waves up from the November lows, which usually means we can expect see a correction begin.

(If you're new to Elliott Wave Theory, I have written a primer article on the subject.)

I spent several hours working with the Philadelphia Bank Index (BKX) last night, since BKX has been a great leading indicator.  The chart below outlines one of the remaining bear options for the long-term: If BKX is forming a massive triangle, it will ultimately go on to new lows beneath the 2009 low -- though it would first grind around sideways/down (relative to the size of the pattern) over the intermediate term.  The chart below outlines the next important long-term levels.

BKX is one of the markets I've been keeping a very close eye on for several months.  A few weeks ago, I made reference to the possibility that a number of markets may be completing extended fifth wave rallies, and BKX was one of the markets I had in mind during that discussion.  I have never been satisfied with the summer-2012 rally as a complete five-wave structure, and the decline into November also did not overlap the potential red wave (i) peak, which keeps the extended fifth wave viable.  Though it's too early to say with certainty, the chart below does outline some signals and price levels.

SPX Finally Connects 2000, 2007, and 2013

A lot can happen in a week.  As some of you know, I have been dealing with a family crisis recently, so I'd like to thank those of you who continue to offer your kind words and support. 

A lot has happened in the market as well -- the S&P 500 (SPX) fell one point shy of my first downside target zone, then reversed strongly and went on to reach a new all-time high.  Interestingly, on Thursday, SPX pinged the trend line which connects the 2000 and 2007 highs, then reversed (as seen, zoomed in, on the chart below).  This is basically the last remaining horizontal resistance level, but it is a "doozy" as they say. 

The market has done its best to make us forget the potential of a long-term triple-top by ramming into it at high speed and looking invincible -- ironically, sometimes this means we should be on higher alert for a reversal.  I genuinely don't have a strong opinion as to what will happen next right here, since the market is basically at resistance but still above support -- but I feel neither side can afford complacency at current price levels.

There are a couple of signals in the chart below which bears may find encouraging:  Note the Bollinger band indicator in the lower panel.  These types of extreme readings are often found in the vicinity of tops.  Daily RSI (top panel) is also continuing to throw off bearish divergences.

   
The 10-minute chart notes some updated trend lines and support/resistance levels. 

In conclusion, the market has finally reached the very long-term trend line which finds its beginning in the same year the country was trying to figure out what the heck a "dimpled chad" was.  I'm not going to make any grand sweeping predictions about this being the end of the line for the rally, because I simply don't know -- but this is a long-term resistance zone, and the potential is there for a complete five-wave rally.  There are also a couple of indicator signals (shown in the first chart) which are often bearish.  This is one of those markets where bears have everything going for them but the actual price action, which has continued to run higher.  Some people refer to that as a bull market. 

Presently, there are no new targets, and this is more of a watch and wait position at the moment -- over the next few updates, the market will likely allow me to calculate some new targets. Additionally, we'll take a closer look at some of the long-term potentials and the signals to watch along the way.  In the meantime, trade safe.

Reprinted by permission, Copyright 2013 Minyanville Media Inc.

Publication Note

Unfortunately, I am dealing with a major family emergency right now, which has temporarily impacted the publication schedule.  I'm hoping this crisis will be resolved by Wednesday, but I'm uncertain if that will actually be the case.

Thanks for your understanding... and thanks again to those of you who show your support openly and generously -- I can't tell you how much that means to me at times like this.  You are surely the best group readers on the planet!  <3 

Good luck out there, and trade safe. 

Why Do Some in the TV Media Still Insist "You Can't Time the Market"?

The ending diagonal we started tracking in late March completed at 1573.66, about one-third of a point shy of the target zone.  On April 3, I wrote:

It is worth noting that yesterday's action did fulfill the minimum expectations for this pattern, complete with an overthrow of the upper trend line -- so while one more new high would look better, it is not required.

I was leaning toward the idea that there could still be one final thrust up still in the cards, but it never came.  It's rare that the market follows a projection that tightly, which is why most traders scale in and out of positions, as opposed to trying to time every move to the exact penny.  Considering that many of the TV talking heads will tell you that "you can't time the market" at all, I think hitting a turn within a third of a point on a 7-point target zone probably argues otherwise -- especially considering that we hit the two prior turns leading into that within a couple of points as well.

Before we get overly excited about the bearish prospects, we do have to recognize the reality that, presently anyway, only the short-term trend is pointed downward.  The intermediate and long-term trends are still pointed upwards -- for the moment.

In the last update, I outlined my expectations for the intermediate-term, so I won't repeat that here.  For the moment, we'll focus on the more near-term and see how things develop.  The first chart is the S&P 500 (SPX) 2-minute chart, and details my preferred interpretation of the wave structure, along with my first two targets.  Keep in mind that if my wave count is correct, we're now entering the small third wave within a larger third wave -- which often means a relentless down-trend for the near-term.  1549 will become key short-term resistance if this plays out. (Incidentally, I ran out of space on this chart...)

The hourly chart notes an intermediate bullish alternate count, which still expects lower prices for the short-term.  It also highlights the first target zone, and notes the second target zone in passing.  If it becomes appropriate, we'll discuss those options in more detail sometime over the next few updates, after the market reveals a bit more of the near-term wave structure.

The Pattern Nears Resolution as SPX Flirts with Its All-Time High

The preferred wave count continues to track extremely well and, as they say, "worked like a charm" again yesterday.  In this update I'll discuss the levels I'm watching for the short-term, and I'll also provide a bit more detail on my preferred intermediate outlook.

I remain bullish on the long-term, not because I feel the fundamentals support it, but because the central banks are still flooding the world with liquidity.  And as long as that continues, it will drive up asset prices.  The Fed seems to be trying with all its might to blow the biggest bubble it possibly can.  Somewhere down the road, I suspect this will all end badly (just as the last two bubbles have) and Bernanke will end up with a huge, unruly wad of US Mint-flavored bubble gum tangled up in his beard.  Then it will be time to break out the scissors.  In the meantime, though, the bubble is what it is -- and there seems to be no reason to try and fight it at the moment.

Let's start with the short-term charts and build from there.  The pattern I've been anticipating and tracking is called an ending diagonal, and so far it's done the "diagonal" part of the pattern perfectly.  Whether it will do the "ending" portion equally as well is likely to be revealed in the next session or two.

It is worth noting that yesterday's action did fulfill the minimum expectations for this pattern, complete with an overthrow of the upper trend line -- so while one more new high would look better, it is not required.  The key upside level to call this pattern into question remains 1582.82.  I have mentioned this next caveat in the past, but not recently:  when patterns such as this appear, if they turn out not to be ending patterns, then they are usually compression patterns which launch the market higher.  It's rare that they're anything in-between, so we should keep that in mind if the market sustains trade above 1583.  That's the caveat out of the way -- but because of the position of this wave within the larger structure, it is more likely that this is indeed an ending pattern.

To the downside, trade below 1558 would suggest wave v of 5 is complete -- or that the pattern was morphing into something entirely unexpected.

The hourly chart discusses the targets if 1582.82 is claimed.  Ironically, the only thing bothering me about the pattern is that it's tracked so incredibly well.  Whenever the market tracks this perfectly, I start suspecting that it's getting ready for a fake-out -- nevertheless, this pattern provides a clear trade setup that's hard to ignore. 

From an intermediate standpoint, the risk/reward is solid.  If the pattern completes cleanly, there's potential for a fair amount of downside.  Don't forget to keep the more bullish alternate count in mind when looking at the chart below, as I have not detailed it here.