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Jason Haver: Projected New Lows Achieved in US Stocks, So Are We 'There' Yet?

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For the moment, the market is a game of inches across time frames. Plus some discussion on utilizing Elliott Wave in trading.

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On Monday, I mentioned I was prepared to eat crow in the event I was wrong on the preferred count, but it turns out I'll have to throw it back in the freezer and save it for another time (and there will be a time, I promise you that. I live in Maui, so I even keep canned crow in the pantry just in case a tsunami hits us and knocks out the supply chain). Yesterday's new low kept the preferred count's win streak unbroken, and it's now hit virtually every turn since November 14. In my experience, this is, ironically, where things can become a little dangerous for readers, so I'd like to discuss that briefly.

There's a tendency to assume that since everything has played as projected to this point, then the future projections will do so as well. In my experience, one of the dangers of Elliott Wave is that it can be used as a rationalization to justify poor risk management. The key to making it work is to remember that even when we think we know exactly where the market is headed next, we must still utilize proper entries and exits. Projections must always be treated as probabilities, never certainties.

To draw an analogy, we can think of the market's price patterns as pieces of a jigsaw puzzle; but it's a puzzle with a missing box, which means we're not 100% sure what the final picture is. Let's imagine we find a few pieces that join together to form a picture of a thorn, and our immediate assumption then becomes that the whole puzzle is something unpleasant -- but as we assemble more pieces, we realize this thorn is simply part of a beautiful rose (or vice-versa. Incidentally, in a way, all of life works this way; we often don't understand the true significance of events in our lives until we're further down the road.).

Anyway, for the past four weeks, I've been able to assemble the puzzle pieces so that we knew what was coming well ahead of time. Along with this, I've suggested one bigger picture view those pieces may fit into -- but there are plenty of other "big pictures" into which those same puzzle pieces would also comfortably fit.

If I could boil all that down to one thought, it would be this: The minute you get cocky, start thinking you've got it all figured out, and decide you can forsake your risk management for higher-risk entries, that's usually the exact same minute the market does something completely unexpected.

In this business, if you're good, you're right six times out of 10. You're never going to be right nine times out of 10.
-- Peter Lynch

Without proper risk management, even "the best of the best" projection systems will eventually leave your broke. Likewise, without a good system of positive expectation, even the best risk management will simply result in being stopped out repeatedly, and will also eventually leave you broke. The two disciplines must be combined for lasting success.

In my opinion, the key to effective use of Elliott Wave Theory is to utilize low risk entries, despite the fact that you "think you know" where the market's headed. For example, the retest of the 1813 high was a great short entry from a risk/reward standpoint. Even if you viewed new lows as a 50/50 proposition, the R/R made that a winning play (math hypothetical: 5% loss 50% of the time vs. 15% gain 50% of the time -- trade nets 10% over time). Risk management is still paramount to any trade strategy, and I believe if you combine good Elliott Wave analysis with good risk management, it's almost impossible not to make money over time.

So, referring back to the big picture, my current expectation is that this is a fourth wave correction prior to new highs. However, there is an intermediate alternate count, so I'd like to briefly refer back to some thoughts I shared on December 2:
We're now entering waters that, while not exactly dangerous yet, certainly call for added caution... I had high confidence in the last two fifth wave rallies; however, my confidence is not as high for another one. Given the charts as of this moment, I'm still leaning toward it, but be aware that it's a higher-risk proposition and act accordingly. Also be aware that the wave count suggests we may be nearing a higher-degree fourth wave correction -- this means that the coming correction is likely to be deeper and longer-lasting than the previous two.

The chart below is largely intended to show RSI, but also shows the intermediate alternate count's "next move" in black. One reason I remain in favor of the preferred count is the overthrow of the blue channel, which is typical of third waves. So for the moment, we'll maintain the idea that this is a fourth wave correction and keep the alternate in the back of our minds.

The next question is, assuming this is red (4), is it complete yet? This is an exceptionally difficult question to answer. The decline has (so far) come within about 2 points from the target zone, and (as shown below), hourly RSI confirmation of the 1772 low does suggest the target will ultimately be reached. On the 3-minute chart, however, one can theoretically find enough squiggles to call the wave complete (2nd chart). Two additional devil's advocate arguments are made on the hourly chart below.


Click to enlarge

Let's look at the 3-minute SPX chart. The first leg of the rally from 1772 does appear to be impulsive, suggesting at least one more leg up for the near-term. Upside targets are noted on the chart below, and we'll have to see how it develops from there to determine if we should give higher odds to the idea (4) has completed. For now, I'm favoring the view that it has not yet completed.


Click to enlarge

The 30-minute chart includes the added note of the "perfect world" target of 1765.33 for wave (4).


Click to enlarge

In conclusion, to sum up everything across all time frames, I'm inclined to favor the view that this wave will reach the 12/6 target zone, and I'm still inclined to believe this is a fourth wave correction which will lead to 1825-40 for the fifth wave up. However, we're presently within a game of inches on both counts, so caution is warranted across the board. Trade safe.

Follow me on Twitter while I try to figure out exactly how to make practical use of Twitter: @PretzelLogic.

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No positions in stocks mentioned.
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