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The Area on the S&P 500 That's Most Important for Bulls

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The market will want to take this area out with authority to continue the intermediate bull run.

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The S&P 500 (INDEXSP:.INX) has been in a potential 5 wave rally going all the way back to October 2011 lows of 1074. This type of 5 wave rally is common in a bull market, but must be watched closely as it could also signal another large correction just around the corner from current 1464 levels on the S&P 500 Index. Once you complete a 5 wave bullish pattern, there is commonly a 3 wave corrective decline, therefore determining where those key pivot points are is crucial for market watchers.

If we take a look at the length of the 5 waves in the Rising Wedge pattern from the October 2011 lows of 1074 below, and compare them with other waves 2-5, we can see several Fibonacci fractal relationships amongst all of them. This is one of the clues I look for when trying to analyze pivot points and knowing at least what I should be watching for further clues.

In most cases, wave 3 is commonly the largest of a 5 wave structure, but that does not preclude wave 1 from being the largest in the series. To wit, recall the nasty decline into October 2011 that spurred the next big market advance of about 350 points off the bottom. When you have a significant decline preceding the early stages of a 5 wave advance, often the first wave in the pattern is in fact the largest, which may be the case here.

Let's take a look at a possible 5 wave count just so we know what to be aware of:

Wave 1: That 350 point advance was a possible wave 1 off the 1074 lows of Oct 2011.

Wave 2: managed to retrace 155 points of that advance into June 2012, a common wave 2.

Wave 3: rallied to the 1474 pivot, which was a 207 point rally. 207 points is about 61% Fibonacci relationship to wave 1's 350 point advance, again another clue.

Wave 4: dropped as we know from 1474-1344, or 130 points. 130 points is also about 61% of Wave 3's prior advance on the downside.

Wave 5: Theoretically this wave 5 is now from 1343, and if we took 61% of wave 3 advance and add it to 1343, we come up with about 1470. 1470 would then be a double top in the market, stop wave 5 in its tracks... and be followed by a large correction.

So with the above in mind, we advise watching 1470-74 with keen interest as the market will want to take this area out with authority to continue the intermediate bull run. If not, we could be in for some downside trouble....


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Twitter: @activetrading

Editor's Note: David Banister is the chief investment strategist and co-founder of ActiveTradingPartners.com, a small-cap portfolio and market advisory service.

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