Advanced Technical Analysis - SOX
Note: the following analysis is formulated as an assimilation of Fibonacci, DeMark, Elliott Wave and other technical indicators. It is offered as education and not intended as advice in any way.
We have published two notes in the last few weeks on the SOX and each of them stated that the SOX was in a corrective bounce off the September peaks that was "90%+ complete". We said that when the SOX was at 396 on two occasions and we highlighted 410 as a key inflection point that would negate the near term bearish case. Despite the presence of divergences at these junctures, the Sox has labored higher in an overlapping and corrective fashion during the month of October, posting a peak yesterday at 424.
This example - of an index showing clear bearish divergences but continuing to plod higher - typifies a particular weakness in the Elliott wave analysis we use. Perhaps weakness is too strong a word: it typifies a characteristic of Elliott wave analysis. As we have stated before, we use these collective indicators (Elliott wave, Demark, Fibonacci support/resistance levels, and momentum divergences) to help us with probabilities. Specifically, we use them to help us identify points of price resistance or support that have greater or lesser probability to act as a trend reversal point (in the world of complexity theory and non-linear systems, such points are referred to as bifurcation points). Among long time Elliott wave practitioners, the most difficult task is widely regarded to be the proper analysis of corrective bounces against the dominant trend. Though an Elliott wave practitioner can feel confident in the larger degree trend, a move against that trend can take longer and carry further in price than is expected. Yes, the 38.2% resistance level can act as resistance or support for the counter-trend move and turn prices back toward the dominant trend. But so too can the 50%, 61.8% and 78.6% levels. And all the while, the move against the dominant trend can exhibit clear divergences and count as "complete" in terms of its Elliott wave structure, suggesting that an imminent return to the larger degree trend is nigh. So it has been with the SOX in the month of October.
You have seen from us a number of notes over the last few weeks suggesting that the move up from September is "near completion" but the SOX has continued to plod higher, creating larger and larger divergences and moving to the next Fibonacci resistance level. All the while we have maintained that the larger degree trend is in fact bearish. This can be very frustrating to regular readers and to traders wanting to position for the return of the dominant trend; it certainly is to us. But the fact that the SOX, or any other index or stock for that matter, can continue to "plod" higher in a corrective fashion and with deepening divergences despite our analysis for an "imminent" move down, should not (we hope) diminish the utility that Fibonacci/Elliott wave analysis has as a technical tool. Just know that corrective, mean reverting moves often frustrate all traders and are a characteristic of complex systems (like stock markets) that is inevitable. Patience (and stop loss discipline) is the antidote.
With that, we turn back to the SOX because yesterday's price action almost saw an outside down day in which the SOX put in a higher high vs. the previous trading day, a lower low and a lower close. Though the SMH tracking stocks did put in such an outside down day, the SOX index did not put in a new low yesterday vs. the previous day. Nevertheless, the spike up yesterday and then the lower close is certainly bearish on its face. For the SOX, the last time this took place (a higher high but a lower close than the previous day) was 7/21/04. We note this bearish pattern because we have been looking at the SOX index for the last several weeks and noting the bearish formation it has been taking.
Specifically, the SOX has taken on a wedge-like pattern off the October 15th lows and given the clear overlap between important peaks and troughs within that span of time, the proper Elliott wave conclusion was a bearish one that could resolve to lower prices in time. Yesterday's gap higher and then strong fade into the close may be then the beginnings of just such a bearish resolution.
How will we know for sure if this wedge formation in the SOX has now given way to the larger bear trend down from the Q1:04 peaks? 2 things: (1) a clear "5" wave decline on the hourly chart and (2) the SOX moves below 393. For now, the conservative approach favors awaiting such a confirmation of the larger trend change. You will recall that our original lower SOX Fibonacci targets were in the 300-210 area once the resumption of the bear trend got underway. Those remain the targets. Given the downside potential, conservative investors can afford to wait for confirmation of that trend change so as to not get whipsawed again by the gyrations of this index. The more aggressive interpretation however may allow for action sooner: with the analysis suggesting technical weakness from any bounces this index presents with a tight and definite hard stop at the peaks from yesterday: 424.26 ($33.35 SMH). How this bearish interpretation "fits" into the larger index counts (SPX, NDX, DOW) we are following is not clear to us at this time, but this analysis is independent of those for now.
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