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Here Comes the Santa Rally

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The market is perfectly positioned for a strong rally into the end of the year. Here's what to watch for which could negate that outlook -- plus, some education on Elliott Wave Theory.

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MINYANVILLE ORIGINAL Yesterday's update was unabashedly bullish across all time frames. I noted the market was likely to find a bottom directly, and wrote, "I am currently viewing the decline as a complete, or nearly complete, c-wave lower to wrap up yet another second wave. This suggests a strong rally is waiting in the wings."

While I felt I conveyed my bullish stance quite clearly, I later realized that I had neglected to detail (in plain English, anyway) exactly what I was seeing in the charts that caused me to turn bullish at Friday's low. I sometimes forget that, to those just learning Elliott Wave Theory, the whole thing can seem slightly more complex than trying to build a fully-functional suspension bridge entirely out of Spam and nachos. It has a language all its own -- but I use that language so often, I sometimes forget that readers don't necessarily understand what the heck I'm talking about.

So in this update, I'm going to discuss what I saw on Friday, why 1420 lost its significance for bears, what I'm watching going forward, and why.

One of the main markets that's given me the bull bug is the Nasdaq-100 (INDEXNASDAQ:NDX). Yesterday, I wrote:

The NDX has formed a fairly clean five wave rally off the November print low, and that does suggest trouble for bears. It's also now in a zone where a meaningful bottom could form. If the count shown below is correct, this represents a low-risk buying opportunity with the potential for a great deal of upside.

Hopefully, some readers took advantage of that low-risk entry. First let's take a look at the chart (for those following along at home), then we'll discuss why I wrote yesterday's paragraph and what it means to traders. I've added a number of educational annotations to this chart, to help detail my views.


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There were two simple, logical conclusions that led me to view this chart as quite bullish. In Elliott Wave, five wave rallies move in the direction of the larger trend, and they cannot exist in a vacuum (in other words, you must pair the five-wave rally to the rest of the pattern; it cannot stand alone). So The first factor in my analysis is the five-wave rally off the November low. That leads me to the conclusion that the market must complete at least one more five wave rally in the upward direction (at the minimum). Two five wave rallies, separated by a corrective decline, complete an ABC. Three five-wave rallies, separated by two corrective declines, complete a larger impulse wave (a larger five-wave form). One five-wave rally cannot exist on its own in this position, so the rally from 2494 to 2699 must be considered as Wave-i or Wave-a.

Next, I zoomed in on the smaller time frames and counted five-waves down from 2696 to 2620, and that led me to another conclusion: If that decline is only the first wave down and not the end of the correction, then it appeared likely that the decline would ultimately retrace beyond where the larger Wave-i/a began at 2494... and that would break a cardinal rule of Elliott Wave, which says the correction to the first five-wave rally (the correction is called Wave-ii, or Wave-b) cannot retrace beyond where the rally began. This led me to the conclusion that it was quite likely the entire downward correction was over.

At this point, trade below 2620 would create a problem for that outlook, so that's the key level to watch for anyone who positioned long at yesterday's open.

The room for error lies in the fact that the market rarely forms "perfect" waves -- so it's always possible that my interpretation of Wave-i/a as a five-wave structure is incorrect. If it's not a five-wave rally since the November low, then the above points are moot, my preferred outlook is wrong, and the market is free to decline below 2494.

For now, we're going to assume that my interpretation is correct. Let's take a look at NDX daily to illustrate why NDX probably presents a problem for SPX bears. The bottom line is, it appears likely that NDX is headed to another rally leg of at least equal length to the leg from the November lows.

And if SPX follows suit and builds another rally leg of equal length to its previous leg, it will break above 1474 -- which then takes the bear count completely off the table (because of the retracement rule discussed regarding the beginning of first waves).


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The next chart I'd like to examine, partially for educational purposes, is the S&P 500 (INDEXSP:.INX) bearish wave count. The scenario shown on the chart below is not my preferred read on the market for the intermediate term -- it's my first alternate outcome if I'm interpreting the higher degree wave structures incorrectly (in other words, if some of the waves I'm viewing as five-wave moves are actually three-waves, and/or vice-versa -- as I noted, the market rarely forms "perfect waves" and the majority of the work is left to the analyst to uncover and interpret).

Again, the market finds itself in a position where the bull and bear counts are both pointing in the same direction (up) presently, and this count also suggests higher prices still to come. Bulls do need to break the 1438 swing high to confirm -- hence the black "alt: (1)" annotation.

Now to cover why the market dictated this chart be adjusted in-between Wednesday and Monday. The overlap at 1420 created an issue for the old bear count -- which depicted a higher-degree c-wave rally -- and that issue is based on the fact that c-waves are always 5-wave moves. Within those 5-wave moves, waves 1 and 4 cannot cross paths (except in special cases, called ending diagonals). An ending diagonal appears highly unlikely, based on the shape of the move. So once the potential wave 4 moved into the price territory of wave 1 (below 1420), that told us the c-wave was off the table, and I changed the labels to reflect the next highest probability bear pattern. I have adjusted the labeling again slightly since yesterday (since the bear outlook remains my alternate, I am not really focusing on this chart in most updates).


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Now we get into the preferred SPX outlook, which remains intermediate bullish. Bears should consider that the seasonality right now is very bullish, and that bullish seasonality also matches the price pattern I'm seeing as the most probable outcome (a continued rally to new highs).

At one point, I warned about sustained trade below 1420 because 1420 appeared to be the wave 1 high -- but 1420 lost its significance on Friday, because I was unable to reconcile the rally as a complete five-wave pattern. Since waves 1 and 4 can't cross paths, this told me that the decline into 1411 could not be a fourth wave. The overlap of 1420 suggested that it was instead another second wave (a very bullish pattern).

If this count is correct, bears should be super-cautious and nimble if they choose to get in front of this market. Nested third waves are very strong rallies, because they represent a "point of recognition" for the masses, wherein traders who were previously bearish suddenly realize the rally has real legs and isn't slowing down, and they are forced to cover short positions and/or chase the market higher. This creates a loop that feeds on itself -- each correction is bought and drives the market back up, and each push higher creates more need to chase.


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Let's zoom in a bit on the 30-minute chart, which shows a breakout and back-test of a very bullish basing pattern (blue dashed line). The expectations of this pattern, at least as long as the market maintains the 1411 swing low, match the bullish wave count.


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Finally, a quick update on the Philadelphia Bank Index (INDEXDJX:BKX). On November 30, I published a bullish trade trigger, with a target of 50.25 (about 3% up from the trigger) and that target was reached yesterday. The BKX is another index presenting a problem to the bear case, because no matter how you count the rally since November, you still end up with five-waves up... and that says it's unlikely that it's over yet.


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In conclusion, on December 3, I wrote: "While there will surely be corrections along the way, I tend to think that bulls will probably get their Santa rally." It continues to look likely that the market is planning to continue its advance, and that it may actually pick up steam. I've focused on the bull outlook, but trade below 1411 would be the first indication that something more bearish could be afoot -- and the market always reserves the right to do something unexpected. But until then, I remain bullish, and presently believe the market is ultimately headed to new highs beyond 1474. Trade safe.

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No positions in stocks mentioned.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

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