One Technical Argument for a Long-Term Top in Equities

In this article, as promised, I'm going to talk about the potential that 1687 was a long-term top.  Over the past few months, I've occasionally alluded to the fact that I was tracking the current rally as a potential extended fifth wave.  In layman's terms, extended fifth waves are generally called "blow-off tops."  I've felt a number of markets have shown the characteristics of such a wave. 

On and off for several months, I've toyed around with extended fifth wave counts for the S&P 500 (SPX), though I haven't published any of them, since I didn't feel they were near completion previously -- and thus a moot point.  In this update, we're going to look at the long-term wave count for SPX which details an extended fifth.

One thing I've always enjoyed about Elliott Wave Theory is the psychological component which underpins each wave.  Extended fifth waves serve a purpose in mass sentiment, and they function to pull the last of the disbelievers into a move -- just before reversing.  When extended fifths reverse, they often do so quite dramatically, and this serves to trap unwary traders on the wrong side of the trade, which gives the subsequent decline steam.  Extended fifths can be extremely difficult to spot in real-time, because they don't die off slowly, the way a normal rally does.  They die at near-peak readings, which lulls bulls into a complacent sense that there's still more upside left, due to the momentum of the move. 

The current rally fits these characteristics, though it also fits the characteristics of a third wave, which would in fact have more upside left -- and this is what makes it so difficult to sort out the two options.  Let's discuss some of the merits of this count.

The chart below shows that SPX actually counts quite well as a fifth wave extension.  I haven't seen this wave count anywhere else (though that really isn't saying much, since I generally entirely avoid looking at other people's technical work.  I find I do my best work "in a vacuum" so to speak, and other people's work tends to bias me).

This count has several features which I find quite appealing, and which actually fit the structure better than most of the wave counts for SPX (including my own long-term count); we'll discuss the appeal in a moment.  First the chart:

(Note the typo: "blue v" should read "red v.")

Here's what I like about the extended fifth wave count:

1.  The October rally in 2011 was almost certainly a three-wave rally.  Every Elliottician on the planet knew it at the time, and we all expected it was a corrective wave.  After the October peak was exceeded, we all scratched our heads and tried to figure out where we went wrong.  The count shown above explains this quite well:  We didn't go wrong in counting that wave; it was indeed three waves.  We went wrong in not realizing it was part of a triangle.  (I actually hypothesized this via NYA back in late 2011, but the expectations of that count got a bit fuzzy as the rally continued, and I eventually put it on the back burner).

2.  The same is true of the rally in the middle of 2012.  Also note how well this count explains the rest of the move throughout that same time frame.  This is the only count I've ever seen that fits that entire wave this well.

3.  This count eliminates the need for endlessly nested first and second waves at the beginning of the move, because all the waves are sub-waves of the extended fifth, and thus there is no technical issue created from the price overlap at the beginning of the structure.

4.  This makes the rally from 2009 a simple, common ABC rally, without reaching into extremely rare triple zigzags and such.  Personally, I don't feel the triple zigzag counts fit very well anyway, since, in my opinion, the waves are too disproportionate to each other.

5.  The RSI readings are perfect for the count.  In fact, RSI fits this count better than it fits any other count I've developed or seen.  Peak RSI during the third wave, second highest during (3) of v, third highest during the blow-off fifth.

Given the signs we're seeing in the credit markets, bonds, et al; and the strength of the sell-off so far, I'm going to give the extended fifth wave even long-term odds with the fourth wave corrective count I've previously detailed -- for the time being.  The market of course reserves the right to cause me to adjust these odds going forward (it's foolish not to adjust to the market's future input).

For the near-term, the count below details the least bearish potential.  The wave may be considerably more bearish than shown, but I'm still not seeing the strength of the sell-off echoed in certain key markets, which is making me hesitant about the mega-bear counts.  Play it safe for the time being though, because there is definite waterfall potential here.

One market which has continued to refuse to commit to the bear case is the Philadelphia Bank Index (BKX).  BKX finally broke key support yesterday, but it did nothing afterwards.  This leaves a few possibilities, and I've detailed one bullish option, as well as the more bearish option, on the chart below.  Both options suggest lower prices still to come, but the ending diagonal is a bear trap.

In conclusion, the decline has been playing out strongly, and that necessitates consideration that things may be more long-term bearish than I originally anticipated.  BKX is still hesitating to commit, however, and we'll simply have to see how this plays out over the next few sessions to begin connecting the long-term dots more decisively.  Trade safe.

How Bearish Should We Get?

The market's job is to get you looking the wrong way, and to try to get you to do the exact wrong thing at the exact wrong time.  It wants you to short when you should go long, and it wants you to go long when you should be shorting.  Back in November, I began leaning bullish, but hesitated to commit to a long-term bull outlook until January, when I became exceptionally bullish -- probability the most intermediate bullish I've ever been publicly.  My updates were all about the rally continuing to new highs -- and the signs of strength I was seeing.  Nobody read the darn things. 

I started trying to throw in some bearish stuff so as not to lose readers completely, since most everyone thought I was nuts talking about the S&P 500 rocketing upwards in a "nested third wave rally" to the 1500's and 1600's, and possibly even the 1700's. "What are ya, stupid?  The world is a mess, dontchaknow."  Believe me, I know.  I've been fundamentally bearish for years.  But I don't trade my fundamental bias -- my fundamental bias underpins my understanding, but it doesn't help me time the market.

Near the end of May, after the SPX had rallied more than 200 points from January's prices, the mass psychology has reversed.  Everyone "knew" it was stupid to ever take on a short position, just like everyone "knew" it was stupid to go long back in January.  I assume most thought I was nuts when, on May 28, I suggested it might be Time to Sell the Bounce.  I myself thought I might be nuts (and I said as much), especially after the SPX had reversed directly in the middle of May's target zone of 1680-1690.  Unlike most people who become more confident after a string of good calls, I become more cautious and start challenging my assumptions all the more rigorously. 

I take this approach because the market will eventually rip your face off if you start assuming you are way smarter than it is.  I learned that the hard way -- in fact, I'm not ashamed to admit that a bit more than a decade ago, I all but completely wiped out my trading account by going "max leverage short" at exactly the wrong time, after a string of good calls.  I started thinking I had it all figured out, and decided (since I could do no wrong!) that it was time to knock one out of the park with a massive put options trade.  When the trade started going against me, I stubbornly held to my previous views in the face of evidence to the contrary... and I clung to the trade until it was too late.  It was an incredibly painful experience.  This taught me that we always have to see both sides of the trade -- at least, if we want to survive.

This is why I offer my preferred interpretation, but also try to see the other possibilities and provide levels which hopefully act as waypoints to indicate when the market is breaking from my projections and onto one of the alternate routes.  I probably tend to caveat too much sometimes, but I feel this is a better approach than the alternative.  People who've read me for a while eventually learn my language and grasp where I feel we're headed through all my "but watch out for this and that" warnings.  I don't present alternate counts so that the outlook is "always right" -- in my mind when an alternate plays out over the preferred count, then that means I assigned my probabilities wrong -- I present alternate counts so readers can adjust on the fly and protect themselves where appropriate. 

A few times over the past couple months, I've talked in brief about the fact that the recent rally has shown some of the characteristics of an extended fifth wave.  I haven't focused on that option however, because up until May 23, the larger wave structure had (in my opinion) remained pointed upwards for the most part.  Sometimes it's hard to sort out the options too far in advance, which is one reason I'm a firm believer in staying nimble, and recognizing when the environment may be changing.  For reasons discussed above, getting married to a long-term outlook can be an account killer.  Everyone can see how the "let's marry our convictions" approach has killed the bears this year, as many kept shorting all the way up, convinced that the rally was "just about to end!"

In tomorrow's article, I'll talk a little bit about extended fifth waves, since they can be big money-makers for traders and we may be unraveling one now. 

One approach I take is to build a thesis in stages.  I look at the near-term, and try to determine what's likely, then I project that out to the intermediate-term.  From there, I envision how the charts will look if both projections play out, and I begin building a long-term thesis.  Sometimes I can see how things will play directionally to a point, but there's an inflection zone at that point and I can't see in advance how the market will react to it.  The high 1590's marked one such zone.  Other times, the market begins to form patterns which suggest that the move will be stronger or weaker than I originally projected, and I have to adjust on the fly to what I'm seeing.  This is what's happening now, which is one of the reasons I wrote, on May 23 (See:  The End of the Road for Bulls, or Just a Healthy Correction?):

In conclusion, the long term presently remains pointed higher, but that may be irrelevant at the moment. We can't see around every bend in the market, but most times we don't need to: The near term appears to be pointed downwards, and the intermediate term, while too early to confirm, also looks likely for further downside. This is not a bad time to behave defensively.

Let's start off with the near-term and build from there.  I completed this chart after the close on Friday and posted it in the forums, and the futures action this morning has left both options still on the table.

The biggest question in my mind is whether we're seeing the smaller wave (2) of the larger black (3) (on the hourly chart) or if this is a fourth wave correction with wave (5) of black (3) underway.  I'm leaning toward the latter.
 

With that thesis in mind, here's the hourly chart.  Not shown on this chart is what happens if the more bearish count is underway.

If the rally we just witnessed was actually blue wave (2) of black (3), then the next black (3) target zone is 1470-1480, with a final target in the low 1400's.  I'm holding off judgment until I see how some other markets begin to shape up, specifically the Philadelphia Bank Index (BKX) and the Russell 2000 (RUT).  I'll firm up my opinion on the above matter over the next few sessions.

Be aware that markets often become very whippy around important levels, and the intermediate uptrend line on the chart below is one such level.  That trend line has held every decline since November, so the market may not be ready to let it go so easily, and may return to test it before moving much lower -- not shown on the chart below is what happens if wave (5) simply makes a marginal new low and then retraces 38-62% of the prior decline, perhaps to back-test the aforementioned trend line. 

The long-term chart of the Dow Jones (INDU) shows support in the 14,400-14,600 zone.  If the market is unraveling the most bearish count imaginable (the deeply nested third wave discussed above), then forget about support.  There's just no way to know for certain yet -- as I said, I want to see how some other markets react to the pattern in the next session or two.

SPX Update: A Dangerous Market for Dip Buyers

The market finally broke the 1598 low, which I've been slightly favoring would be the intermediate outcome for this wave.  In fact, while the last wave felt very whippy, it appears I had the preferred count dead right all along.  Below is the "best guess" market path I published on June 12, and this is one of the reasons I love Elliott Wave theory.  When properly applied, there is simply no other system that matches it. 

We can see on the current chart that the market couldn't have followed this projection much better than it did.  Now we hold our collective breath and see if T3 is reached.  Again, please keep in mind that if this count is correct at intermediate degree, this is a nested third wave decline.  Third waves can be tricky, because the smaller waves are usually compressed, which means bounces should be muted.  

During third waves, I usually stay short (or long) until I start seeing impulsive moves to the upside (or downside) -- I've found that otherwise I often cover way too soon and the market runs away from me.  Draw your trend lines and use those as guides.   Keep in mind that the idea of a third wave decline is to punish the dip buyers. It punishes them by not letting them out and not giving them any bounces to allow them to get back to even on. It will keep punishing them until they stop and go curl up in a corner... or until they decide to go short -- then it bounces.  This doesn't mean bears should get complacent, and there is an alternate count which could find a bottom directly -- but I wouldn't suggest front running anything during a third wave.  Until there are signs of a turn, this is a dangerous market for dip buying.

If my preferred intermediate wave count continues to track, we now have to give a bit more credence to the idea that 1687 may mark a long-term top.  I last published the count shown below back in May, and I'm still considering it a marginal underdog -- however, if the current decline continues to play out as expected, then this more bearish count may gain additional traction.  The long-term expectations for this wave count would be new lows beneath the 2009 low.

New Lows on Deck?

Yesterday, Bernanke let the market know that good news is bad, as continued economic improvement would mean the Fed is likely to start tapering asset purchases later this year, and could end purchases entirely by the middle of next year.  This is exactly what the equities market did not want to hear, since without the Fed's inflationary money printing, the actual cash value of the S&P 500 (SPX) is approximately twelve dollars and fifty-eight cents.

The dollar, on the other hand, was quite excited by this news, and rallied straight up in a rocket launch.

Interestingly, I suspect this scare will be the push needed to drive equities to the lower low I've felt the charts were suggesting was more likely to mark the wave iv bottom.  I think this press conference will embolden bears to step out of their caves for a bit, but the bottom line with Bullnanke's statements is that the QE money will still be flowing (for the time being), and that means continued liquidity for equities. 

Greed is a powerful emotion though, and I think it's more likely that the dip will still be bought, as there is yet no definite end in sight for the QE program.  There are hints it "may" end "if and when" the economy improves.  Of course, anything's possible, and maybe just the thought of QE ending will cause a rush for the exit, since no one wants to be the last one holding the bag.  But in my opinion, the charts still suggest the final long-term high isn't in yet.

But they do suggest that the much anticipated wave (2) high is.  I've seen a lot of confusion over how to label the recent rally, and I believe it represents another extended fifth wave, with a compressed (iv) and (v).  (When you trade Forex as much as I do, you learn to look for and recognize extended fifths.)

This wave looks like a textbook expanded flat with an ending diagonal c-wave in NQ (Nasdaq Futures).  In fact, in the private forums, I alerted everyone to this likelihood all the way back on Thursday, with the following statement:  "I think the new Globex lows in NQ in particular mark our ticket for a VERY high probability short after the market completely retraces the prior decline. Should make a marginal new high and then reverse to new lows."

The hourly chart continues to track well:

Updates to the Long-term SPX Projections

The SPX has reached the target zone, but the near-term is still a bit unclear in regards to what the market has planned from here.  Accordingly, I'm going to update the long-term charts.

It's always helpful to check how a count is tracking, so before we look at the current chart, let's take a look at my preferred count projection chart from back on February 7 and see how it's performed so far.

Below is the projection I published on February 7 (though for some reason I dated it "2/8/13" in the annotations -- though I'm reasonably proficient at tracking the market, apparently I have trouble using a calendar.).

Note: Right mouse click the chart and select "open in new window" to bring it up at full size.

If we compare that with the actual performance of the market, we can see that projection has tracked exceptionally well for the past four and a half months.  Note that for purposes of aligning charts across time frames, I've changed a few of the labels on the chart below (red 3 became red iii, for example).  I've also zoomed in a bit on the current price action:

The question in my mind is still whether red iv has completed or not.  I remain slightly in favor of the idea that it is not complete, and will become more complex, ultimately correcting lower before finding a bottom.

SPX Update: Unraveling the Near-term Potentials

The charts remain messy, but amazingly, despite the feel of hanging on the edges of our seats, the market has performed very much in line with the preferred count from June 12.  The pattern now can be viewed in a couple ways.  Bulls will look at it as a basing pattern, which projects to a retest of the all-time high.  This is entirely possible.  I have another way of looking at it, which I'll share in a moment.

First is the hourly chart, and the best-guess projection of June 12 has so far performed admirably.  I continue to marginally favor the bears on an intermediate basis, but it remains an exceptionally difficult call, which is typical of a fourth wave.  It remains possible that all of wave iv has completed at 1598, and I still feel that the bulls have the ball on a long-term basis. 

For the near-term, the pattern I suspect may be unfolding is shown below.  The other option is more straightforward, and is shown on the 10 minute charts which follows after the chart below.

Granted, the pattern I'm showing above isn't the "trade what you see" approach from a classic technical analysis standpoint.  One of the reasons I'm favoring the ending diagonal is the Philadelphia Bank Index (BKX) below:

The Charts Are Still a Mess...

I'm going to remain short on words again today, because there is still too much clutter in the charts to get a high-probability near-term read.  Intermediate term, I remain marginally in favor of the bears and do not believe the 1598 low will hold.  There's also no guarantee we reach the black (2) target, as there's potential of a nest of first and second waves lower.

One of the charts that bothers me for the bulls -- barring the fourth wave triangle in black.  Above the ii/B high and the triangle becomes very viable.

RUT is also a mess.  I'm having trouble buying into the bullish buy trigger... but I can't ignore it either.  992/993 is first resistance.

CVX is another chart suggesting there may be trouble brewing for bulls.  Not shown below is the fact that hourly RSI confirmed the low a week ago:

In conclusion, there are two places we find charts this confusing:  during fourth waves, and at important tops.  It remains to be seen which this is, and because of the sloppiness of the prior decline and the waves since, the near-term is exceptionally challenging to sort out.  I remain slightly in favor of the bears on an intermediate basis.  Trade safe.

(Ignore this next thing:  Added only for purposes of image hosting)