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How Bearish Should We Get?

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While lower prices appear likely, the bigger question is: How much lower?

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So 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 1590s mark one such zone. Other times, the market begins to form patterns that 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 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.


Click to enlarge

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 1400s. I'm holding off judgment until I see how some other markets begin to shape up, specifically the KBW Bank Index (INDEXDJX:BKX) and the Russell 2000 (INDEXRUSSELL: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.


Click to enlarge

The long-term chart of the Dow Jones Industrial Average (INDEXDJX:.DJI) 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.


Click to enlarge
No positions in stocks mentioned.
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