Eldinril's Perspective

Thoughts for Sunday, August 17...

2008-08-17T17:52:00.000-07:00

Last week we saw the S&P 500 rally up to challenge resistance at the 1305-1315 level before pulling back. The manner in which this rally reached this resistance suggests to me that further upside remains ahead for this index. One of the traits of this rally that I find interesting is the trend channel that formed with our recent upward movement. We can use the way prices move within this channel to gain greater understanding of the future movement for the S&P 500.

Thoughts for Monday, August 11...

2008-08-11T19:13:00.000-07:00

As the S&P 500 has gradually moved higher since July 15, I have been feeling some concerns that we might actually see one last thrust down before the longer-term downtrend may be considered complete. I considered a few different techniques and perspectives before settling on the 1305-1315 area as my primary target to the upside.

The S&P 500 closed today at 1305.32, but I do not see any of the technical factors that might signal to me an end to the recent uptrend. It is entirely possible that the 1305-1315 area will prove to be a significant point of resistance, we will have to wait and see how things unfold. Nevertheless, the way that we rallied into this area of potential resistance suggests that the market will continue its uptrend and head even higher.

Thoughts for Sunday, July 20...

2008-07-20T19:11:00.000-07:00

So... in yesterday's post, I discussed the deterioration in momentum that has been developing with the recent price declines in the S&P 500. This deterioration suggested that the recent declines in the U.S. equity markets may be drawing to a close. I think it is important to note that momentum was not the only technical factor suggesting that a change in trend is due.

We can find similar indications by looking at the breadth of the recent decline. Both the Breadth Advance-Decline Indicator and the McClellan Oscillator provide us a measure of the number of stocks that are actually moving in the direction of the larger market trend. The chart above shows that as the S&P 500 continued its trend downward through June and July, then number of stocks declining began to decrease. This suggests that the overall breadth of the decline became narrower as the trend continued, that the trend was losing its strength, and that a change in trend was becoming increasing likely.

This gives us a second technical indication that our recent breakout from the downward trend channel was not simply an upward correction, but that a more substantive change in trend was due. This supports my opinion that we are now in the early stages of a bullish, upward trend pattern.

Thoughts for Saturday, July 19...

2008-07-19T19:14:00.000-07:00

My last flurry of posts was back in May, when I was discussing a negative divergence that had formed on the Relative Strength Index. We discussed at that time the bearishness that this divergence suggested. The initial area of support that I suggested was at 1375 on the S&P 500. We did see the markets bounce around at that level before beginning the downward trend that has persisted ever since. This downward trend has been longer in time and magnitude than I originally anticipated, but I believe it is coming to an end.

The chart above shows that as the price of the S&P 500 continued to make a series of lower lows into the month of July, the Relative Strength Index (RSI) began making a series of higher lows. This created a bullish divergence, and suggested that the downward trend had lost its momentum. When the RSI made a higher high as the equity market rallied this week, a failure swing was complete that suggests an upward trend will develop. It was this development, along with bullish indication on other technical measures, that prompted me to close the majority of my short positions and assume a bullish posture.

Thoughts for Thursday, May 22...

2008-05-22T19:52:00.000-07:00

I would have to say that the primary closing price target for the S&P 500 that I have discussed in recent weeks was that of the 1420-1425 area. I was not certain if the high on May 6 of 1418.26 was close enough. The eventual closing high of 1426.63 set on May 19 would suggest that it was not. That said, the failure swing created by divergent RSI after the May 6 peak was never negated in any manner. We have since seen the markets sell-off to again test the 1390 area.

I believe that it is also important to note violation of the trend channel formed by the closing lows of March 17 and April 14. The S&P 500 broke down below this support level on Tuesday. It would not be uncommon to see the markets meander higher for a day or two to test this trend-line, which now runs around the 1405 area. Should this resistance hold, then I would expect another thrust downward. 1390 remains the significant support, but I find myself intrigued by the possibility of a low around the 1375 area.

Thoughts for Sunday, May 11...

2008-05-11T17:23:00.000-07:00

I think that we have reached a good point to revisit the wave structure that unfolded since the lows of March 2003. There is a great deal of debate over the future course of the S&P 500. The bearish argument asserts that we have completed a long-term corrective wave higher and resumed the bear market cycle begun in 2000. The bullish interpretation sees the decline from October as Wave 4 in a five-wave structure that began with the lows of late 2002 or early 2003.

While there are some elements to this wave structure that support the notion that the last four years were merely a corrective formation, I believe that there are some subtle points that are consistent with the five-wave, motive formation. It is my belief the notion that we have been witnessing a corrective formation up from March 2003 has been invalidated.

One aspect of the longer-term rally appears consistent with a corrective formation. The rally up from March 2003 can be viewed as two primary waves higher. The first wave began in March 2003 and ended in December 2004. The total length of this wave was 370.77 points over a 21-month period. The second wave began after October 2005 and ran until October 2007. This wave assumed a length of 342.37 points as it unfolded over a 24-month period.

If this were a three-wave Zigzag formation higher, then we would expect to see Waves A and C assume a roughly equal length. The two waves higher differed in length by less than thirty points and in duration by only three months. This proportionality is consistent with what we would expect within a corrective formation.

The evidence that suggests this wave is not corrective can be found in the actual structure of the waves themselves. If we strictly count all moves higher and all moves lower using the closing price at the end of each month, then the rally after October 2005 unfolded in nine waves higher. This gives the wave an extended structure.

This point is of crucial importance because R.N. Elliott wrote in his book "Nature's Law" the following: "Extensions occur only in new territory of the current cycle. That is, they do not occur as corrections." If we accept this strict nine-wave interpretation of the October 2005 to October 2007 rally, then we must also accept the reality of this extended structure. If we accept Elliott's observations in their original form, then we must also accept that this structure invalidates the possibility that the rally from March 2003 was corrective in nature. We must also accept that this formation invalidates the assertion that we are in a larger, long-term correction.

Please understand that I write these words with a great deal of respect for Robert Prechter and his entire body of work. Everything that I know of the Elliott Wave Principle comes from his publications. Past clients have laughed at me when I have pulled out one of his texts in the middle of a discussion. I am that much of a devotee to his work. Nevertheless, I became convinced in late 2002 that the cycle had one more wave higher before completion. It is my opinion that we now stand near the beginning of the final rally in that fifth wave higher.

Thoughts for Thursday, May 8...

2008-05-08T05:19:00.000-07:00

The selloff that we saw on the S&P 500 presents us with what appears to be a classic reversal situation. We discussed previously the notion that we were in the third wave up of a rally from March 17. We also discussed the 1420 to 1425 area as a potential area of price proportionality and resistance. In addition to this, we have also considered the possibility of a divergence on the 10-day relative strength index. It appears to me that all of these issues have been relevant over the last few days.

If we look at the chart below, we can see what might be described as a narrowing trend channel . We typically see trend channels narrow as a price move nears completion. We can see that the S&P 500 closed at the upper limit of this trend channel on Tuesday, and then broke down below the lower range of this narrowing channel on Wednesday. This represents a potential completion of what I have been calling Wave C.

It is not insignificant that this price pattern completed around the area of proportionality and resistance that we have discussed previously. Among other things, this area represents the 50% retracement level of the decline from October to March. It also gives us a fair amount of proportionality between the initial wave up from March 17 to April 7 and the final wave up from April 14 to May 6. I would have preferred to see the S&P 500 close above the 1420 level, but what we have seen may be good enough.

The final issue of interest is the 10-day relative strength index (RSI). Last week, we discussed a possible divergence that was forming on the technical indicator of price momentum. We have seen this divergence continue to develop over the last week. The sell-off on Wednesday dropped the RSI below its previous lows. This was what Welles Wilder, the man from McLeansville, NC who developed many of our technical tools, called a failure swing. Failure swings are not always reliable predictors on their own, but they can prove helpful when coupled with other tools. I view the failure swing that completed on Wednesday as a bearish occurrence.

All of this lead me to believe that we may be due for a week or two of downward price movement. My initial primary targets are 1300 to 1325. We will see if this plays out.

Thoughts for Thursday, May 1...

2008-05-01T20:33:00.000-07:00

The S&P 500 is finally showing some signs that the recent rally is drawing to a close. I have previously expressed my skepticism about the strength of this rally. Those feelings have not changed, though it has required a bit of patience to wait for things to unfold. Nevertheless, there is some evidence that the underlying momentum of this rally is failing.

If we look at the chart below, we can see the 10-day Relative Strength Index for the daily chart of the S&P 500. The high set on April 28 for the S&P was accompanied by a peak of 84 on the RSI. This is a decidedly overbought level. Sometimes overbought levels mark the end of a move, but often times it is worth while to wait for a divergence to occur. Such a divergence began to appear today when the S&P 500 rallied to a new high, but the RSI did not. This failure to confirm the rally suggests that a possible price reversal lies ahead. Should we see the S&P 500 rally on Friday without a corresponding increase in this short-term RSI indicator, then my bearishness would increase.

I find this intesting to see a divergence beginning to occur at these levels, because the S&P 500 is beginning to reach several levels of potential resistance. One of these levels can be derived from the length of the initial wave formation up. This wave began with the closing low of 1276.60 on March 17 and ended with the closing high of 1372.54 on April 7. That gave the completed wave a length of 95.94 points.

The Elliott Wave Principle tells us that Wave C of a structure tends to assume an equal or proportional length to that of Wave A. Let us assume that the March 17 to April 7 rally was Wave A. Let us also assume that Wave C began with the closing low of 1328.32 on April 14. If Wave C were to rally 95.94 points then, that would put the S&P 500 at 1424.26. Interestingly enough, we are almost at a period when the duration of the rally from April 14 is also equal to the duration of that March 17 to April 7 rally.

So... I did not discuss breadth in this post, but it remains terrible. We have a potential momentum divergence in the RSI. We also have a considerable amount of resistance around the 1420-1425 level on the S&P 500. It could be that a rally on Friday just might be what the S&P 500 needs to place itself in position for a reversal.

Thoughts for Tuesday, April 22, 2008...

2008-04-22T19:02:00.000-07:00

I just wanted to share a few little items that continue to inspire my skepticism toward the ongoing rally in the S&P 500. The rally on Friday was certainly impressive. It certainly exceeded my prognostications of around 1382-4. At the same time, the underlying breadth and technical strength left me unconvinced of the bull argument.

If we look at the chart below, there are two technical indicators that fail to confirm the rally from the closing low on April 14 to the high on Friday, April 18. The first indicator the the Advance-Decline line. This indicator provides us with a glimpse at how many stocks are participating in any given market movement. We can see from this measurement that even though the S&P 500 rallied to a new short-term high, the breadth of the rally deteriorated significantly. This suggests that the price movement is losing strength.

Our second indicator of concern is the Relative Strength Indicator. I tend to look at this indicator using both a 10-day and a 14-day time period. The version displayed below is the 10-day RSI. This shows a similar situation to the Advance-Decline line. The S&P 500 rallied to new highs, but the indicator failed to confirm this movment. The difference is that the Advance-Decline line measures the breadth of a movement, while the RSI measures the rate of change of a price movement.

I would also like to note the price movement of the S&P 500 since the March 17 closing low. We saw this index rally up to April 7 before beginning any sort of meaningful pull-back. If we draw a line across the closing lows of that March 17 to April 7 rally we can see an interesting level of support/ resistance. The decline from April 7 broke down below this support level before bottoming out on April 14 and rallying into Friday. What I find interesting is the way that the S&P 500 rallied back up to this same trend-line before stalling out on Friday. It remains to be seen if there will be another test of this resistance. We may well see a rally up to the trend-line extending down from the highs of October 31 and December 10, which might also include a test of 1400.

Who knows what will happen next? The S&P 500 may indeed push higher and perhaps even test the 1400 level. What we do know for certain is that more than one perspective suggests that the strength of the recent rally has waned. Any further upside movement should be viewed with suspicion and as an opportunity to take short-term profits.

2008-04-16T20:16:00.000-07:00

I am not the kind of analyst who claims to be correct all of the time. I have found that my observations tend to be legitimate, but that the market sometime finds it own ways of playing them out. I spoke a last week about the similar wave length in all of the upward thrusts on the S&P 500 since March 17. My argument was that a rallly from that point would put us up near the 50% retracement level of the decline from October 2007. This did not happen.

This week I became significantly more bearish when three technical indicators made bearish cross-overs. This occurence was followed promptly by a sharp rally in the equity markets. I cannot say that the rally to this point changed my overall bearishness. Of the three technical indicators that I shared this week, the DMI is the only one to turn positive. We did break back above the 10-day and 50-day moving averages. The big question now is whether or not the S&P500 can hold above them. We usually see a reversal down within four days of such a breakout, if one is going to happen.

When I feel myself being kind of whipsawed around by market action, I like to step back a little bit and see what might be correct and needs to be abandoned. I could not help but notice that the closing low on the S&P 500 this week was 1328.32. If we see the 54 point rally that we discussed last week take shape from the Monday close, then that would put us above 1382. Interstingly enough a 38% retraceement of the decline from the October highs rise to around 1384.83. So, it could be that we see a final shot up to the 1284 area before we begin the bearish movement suggested by the technical oscillators.

We will just have to wait and see how things play out.

Eldinril

Thoughts for Monday, April 14...

2008-04-14T19:37:00.000-07:00

Last week, I spent some time outlining a possible bullish blowoff to the 1420 level. That pattern never developed, and since that time we have seen enough technical deterioration that I feel it is worth mentioning. The chart below provides a few of the occurences that prompt me to view the market from a bearish perspective at this point.

The first thing I would like to point out are the technical indicators at the top of the chart. If we look at them from top-to-bottom, they are the Stochastics Oscillator, Wilder's Directional Movement Index, and the Moving Average Convergence Divergence Indicator. We can see that all three of these technicals indicators experienced a bearish crossover in the last two days. These crossovers are given even more meaning by the fact that the same oscillators on the weekly chart remain bearish. This suggests to me that a downward trend has developed on the S&P 500.

We can also look at the waves formed since the closing high set on April 7 at 1372.45. Since that time we have seen a trend of higher highs and higher lows yield a lower high followed by a lower low. These progressively lower levels suggest that some sort of downward trend has developed.

We have also seen a breakout above the 50-day simple moving average retest and breakdown through the 50-day moving average support. That same trend-line also moved lower for the first time since March 18. I view these two developments as bearish in nature, as well.

My personal repsonse to this situation was to initiate a short position on the S&P 500.

Thoughts for Tuesday, April 8, 2008...

2008-04-08T18:40:00.000-07:00

I just wanted to share another quick thought about the recent rally on the S&P 500. The chart below is not the clearest explanation that I have ever made, but I think it gets across the general idea. If we look at a closing price chart of the S&P 500 since the closing low of March 17, we will see that this index has made three upward thrusts.

The first thrust took place on March 18, and assumed a length of 54.14 points. The second thrust began with the closing low set on March 19 and extended up to the high set on March 25. This thrust assumed a length of 54.57 points. Our third thrust high took place between March 28 and April 1. The length of this wave was 54.96 points. You might have noticed that this gives us three thrusts higher that have each assumed a length of roughly 54 points.

Just for the sake of speculation, let us assume that we begin a fourth thrust up from today's close, which was at 1365.54. If we were to use the median length of the three thrusts and assume that our final thrust will assume a roughly equal length, that would suggest that the S&P 500 might make one more thrust higher to 1420.11. As this chart also points out, that would run the S&P 500 up to a level just above the 200-day exponential moving average. It would also put us at an interesting level from the perspective of Fibonacci analysis.

If we back up for a moment and look at the decline down from the closing high set on October 9, 2007, then we can see that the S&P 500 declined 291.79 points to a closing low of 1273.37 on March 10. A fifty percent retracement of this decline would rally the S&P 500 to around 1419.26. That would put us in the same neghborhood as the thrust suggested by our first chart.

I have mentioned that I am not terribly impressed by the rally we have seen since March 10. At the same time, the markets have traded rather flat over the last few days, and I tend to agree with the old adage "never short a dull market." I have little doubt that a dramatic thrust up to 1420 over a short period of time would cause a great deal of excitement. Nevertheless, I would view that level as an excellent point for a reversal from more than one perspective of the Elliott Wave Principle.

Thoughts for April 6, 2008...

2008-04-06T18:43:00.000-07:00

There is a great deal of speculation over whether this market has yet reached bottom. I would say that we have reached "a" bottom, but we have not reached "the" bottom. Some of the reason for my thinking can be found in the chart below.

If we look at the most recent lows, we can see that the S&P 500 made a closing low for the week of March 14 that was 2.8% below the closing low for the week of January 18. At the points in time, the 14-period RSI of this index reached an equal low. Some people might call this a bullish divergence. I do not find it to be a particulary inspiring one. In fact, I find myself wondering if the closing low set on March 14 was simply "Wave b" of an expanded flat formation. It suggests to me that further downside may lie ahead.

If we look back at the closing highs of December 15, 2006 and February 16, 2007, then we can see a far more dramatic RSI divergence. The subsequent sell-off lead to a great deal of angst, but did not mark the end of the bullish formation. The peaks that formed between the highs of July 14 and October 12 were far more pronounced, and came with a definite deterioration in the overall relative strength of the S&P500.

Such RSI divergences are not necessary for us to reach a bottom in this recent bear market. Nevertheless, this is but one reason why I am not terribly enthused by the recent rally in the equity markets. There simply remain a great deal of relative weakness in the markets. I will admit to buying some financials and industrials for long-term investments on the weakness in March, though I am not concerned if those particular actions result in short-term losses.

Thoughts for January 2, 2008...

2008-01-02T20:32:00.000-08:00

I hope that all of you had an enjoyable holiday season. Mine was very poignant given the presence of my two year old son who has learned about Santa Claus and the exciting presents he brings, alongside the absence of my father-in-law who passed away at the end of August. It was a nice time to share with my family.

I have little doubt that the recent gyrations of the stock market have left many people concerned about the overall health of the equity markets. I thought that I would share with you tonight why I have been having a difficult time getting too worried about things. To be perfectly honest, I have been using recent dips to add to my positions. The chart below provides a good example of why I have been doing this.

Let us begin with a look at the price structure since the November 26 low. Between November 26 and the highs of December 10 and 11, the S&P 500 rally assumed a five-wave formation. This suggests that at least one more five-wave formation lies ahead. Since that time, we saw a decline from December 10 to December 17 or 18, a rally from December 17 to December 26, and a decline that continued into today's close. What I find telling is the fact that all three of these movements since December 10 unfolded in three-wave patterns. This suggests that they were all corrective in nature. The current wave could be some sort of triple-three formation or it could be a 3-3-5 flat formation. Either way, it would seem that we are within a percent of a significant low.

We can find additional eveidence for this conclusion by looking at two gauges of market breadth- the McClellen Oscillator and the Advance/Decline Ratio. Neither of these gauges confirms today's downward movement. In fact, the Advance/ Decline Ratio is making higher highs as the S&P 500 is making a lower low. This suggests that the current downward price movement does not possess any real breadth at this point, and supports my notion that we are within one percent of this move's completion.

I might also add that the 50-week moving average for the S&P 500 is at 1479.83 this week. I have discussed in previous posts that it has proven quite profitable over the last few years to buy any dips below two percent of this support level. Two percent below 1479.83 is 1450.23. That puts today's close within a price range that would make a good buying level for those people who pride themselves in buying the dips.

It is for all three of these reasons that I am finding it too difficult to get ruffled by our recent price declines. Best of luck, and Happy New Year.

Thoughts for December 16, 2007...

2007-12-16T17:42:00.000-08:00

This week we are going to go back to some fairly basic Elliott Wave interpretation. Just about anybody who is familiar with the basics of the Elliott Wave Prinicple know that price tends to unfold in five-wave formations followed by three-wave corrections. When we look at price movement on the S&P 500 up from the low of November 26, we can see a fairly clear five-wave formation up into the high of December 11. The three-wave formation down from this high seems to be a fairly predictable example a typical Elliott Wave structure.

We can also find further confirmation of this interpretation by looking at the behavior of the Relative Strength Indicator (RSI) as these waves unfolded. The high set on the S&P 500 Index received confirmation by a corresponding high on the RSI. Conversely, as prices closed at a lower low for the close on Friday, December 14, the RSI actually finished higher than on Thursday. This suggests that the downward movement on Friday lacks any real momentum.

We can add to this information the fact that the correction from the highs of December 11 have retraced approximately 46.6% of the previous rally. This suggests that a decline to between 1450 and 1477 would reflect a retracement between 38% and 62%. Such a retracement would be consistent with the proportionality that we typically find suggested by Fibonacci analysis of price movement.

This combination of elements suggests that the current downward price movement possesses many of the characteristics typical of a standard Elliott Wave formation. The structure of the price pattern from November 26 assumed five waves up followed by three waves down. The downward price movement off the high of December 11 has retraced a proportional amount of the previous wave higher. The lower low reached with the close on Friday was not accompanied by a lower low on the RSI. All of this suggests that any further downward movement from this point will be limited.

A post for World AIDS Day...

2007-12-03T16:10:00.000-08:00

Yesterday was World AIDS Day. Once a week I post my thoughts on the market, but during the week I work with patients living with HIV/AIDS. Most of the folks I help are in the advanced stages of the disease. I am proud to say that every person with whom I have worked have seen improvement in their lab values. Unfortunately, not every person referred to me has chosen to accept my services. Equally unfortunate is the fact I am only one person, and the need for assistance far outstrips the resources available.

I was asked to speak at my church this past Sunday in recognition of World AIDS Day. After the feedback I received from those who listened, I decided to share my words here. I hope you find them worth your attention...

Today is World AIDS Day. Given that I work exclusively with individuals who live with HIV/AIDS, Beth and Jay asked me to say a few words for the occasion. I had a difficult time bringing my thoughts and feelings together into something well-developed and structured, so I just decided to share with you the ideas I wanted to impart.

Since today is a service devoted to Joseph, I thought about what he and Mary must have gone through in their own experiences as unwed parents. It occurred to me how little we hear about their parents or their family. It made me wonder why they did not stay with an aunt or an uncle or a distant cousin when they returned to the city of Joseph’s origin. It made me wonder if they experienced the same reactions from their family and their community as many people who live with HIV/AIDS do today.

I wanted to share with you the types of people and issues that I see on a daily basis. There are the women who were infected by their husbands. Husbands whom were either stepping out or on the down low. There are the individuals who live with schizophrenia or some other diagnosis of psychosis, whose success with treatment depends more on their mental health care than their HIV care. There are the developmentally disabled, who are simply incapable of managing the complicated regimens that often accompany the treatment of advanced HIV. There are those who are dealing with substance abuse issues so profound that their addictions control them more than the patient’s own sense of self-preservation. There are some who live with one of these. There are some who live with all of these.

There is the patient who served hard time for a crime committed in his youth. Though he has served his debt to society and been out of prison without incident for seven years, he has been repeatedly denied full-time employment. Nevertheless, he reliably pays his bills by mowing lawns, cleaning industrial sites, and working odd jobs. This past week we got back one of his lab results, which was at desirable levels for the first time in years. When I told him how proud I was of his accomplishment, he looked up at me and said, “I just needed somebody to give a ____.”

We can focus on many different interpretations about the meaning of Christmas or how to win the fight against HIV/AIDS, but none can be clearer than this. It is now during this darkest time of our year that we celebrate a gift of light. God sent to us somebody who cared for us and loved us and forgave us for our flaws and our shortcomings, and who asked little more than that we do the same for one another. We may not be able to solve many of the world’s insurmountable problems, but sometimes all we really need to do is care.

Thoughts for December 2...

2007-12-02T17:54:00.000-08:00

I have kind of been struggling with what to post tonight. I have decided to be succinct. The S&P 500 traded down toward the lower range of the long-term trend channel that we have previously discussed, and which is illustrated in the chart below. It also declined to approximately 4.6% of its 50-week simple moving average, as we have also discussed. I should not the similarity between these situations and the depth of the thrust down in August.

These declines were all followed by a rally back up toward this same 50-week moving average, as illustrated below. Given the speed with which this rally has progressed, I would find it surprising to see the resistance of this moving averaged violated without some sort of proportional pull-back.

At this point, it is difficult to say how deep that retracement will be. I am of the opinion that the lows of the recent downtrend have been set. I would find it encouraging from a bullish perspective, if the 1460 level was not successfully penetrated. That said, it is entirely possible that we might see another test of the lower range of the trend channel without substantially altering the overall scenario that I have been describing over the last few weeks. It will be an interesting week to watch.

Thoughts for Sunday, November 25, 2007...

2007-11-25T17:31:00.000-08:00

We discussed another technique last spring that suggested we were near the end of the rally and the beginning of a corrective period. This technique couples the practice of wave counting from the Elliott Wave Principle with the Relative Strength Indicator developed by Welles Wilder. This technique proved its usefulness on multiple occasions over the years. 2007 has been no different.

If we look at the chart below, we can see that the Relative Strength Index (RSI) tends to peak during the formation of Wave 3. We can see examples of this with the highs set in March 2004 and with the highs set in February 2007. As prices rally to new highs during the formation of Wave 5, we tend to see the RSI fail to confirm these new highs by reaching new highs of its own. That is, a divergence forms between price and relative strength. It was just such a divergence that formed as the S&P 500 rallied to new highs through July of this year, and suggested a corrective period was near.

The Relative Strength Indicator provided further indication of future market direction during the rally into October, as the chart below suggests. The S&P 500 approached and exceeded the highs set in July, but the RSI failed to confirm. Not only did the RSI fail to rally to new highs along with the underlying price, it failed to get anywhere close to the trend-line formed by the peaks of February and July. This suggests that even though S&P 500 rallied to new price highs, the underlying strength of the move suggested that this move was corrective in nature.

This leads us to our characterization of the corrective wave that began in July. One possible corrective formation found in the Elliott Wave Principle is known as a flat. To quote Frost and Prechter, a flat formation "tends to occur when the larger trend is strong, so it virtually always precedes or follows an extension" (Frost, A.J. and Prechter, R.R.. "The Elliott Wave Principle." 20th Anniversary ed.: p 45.). There are few who would dispute the strength of the rally over the past few years.

R.N. Elliott actually described multiple types of flat formations in his original book on the subject. Frost and Prechter focused primarily on the variety that forms a 3-3-5 formation. If we look below at a weekly line chart of the wave formations since the July highs, we can see an initial, simple thrust down to form Wave A. The rally up into the October high could arguably be described as a seven wave formation higher. This would give us a complex Wave B. Since the highs set in early October, the market has declined in five waves to form Wave C. This provides us with the 3-3-5 formation consistent with a flat formation. It also suggests that we are currently in the final wave down of Wave C.

Once again, we can look to the RSI for an indication of what to expect from future price behavior. Even as the S&P 500 continues to decline on the weekly chart, the corresponding RSI has failed to reach equivalent new lows. This suggests that the RSI is failing to confirm these new lows and a divergence is forming. It also supports the notion that we are at or near the end of this decline, as the wave count proposed above also suggests.

Thoughts for Tuesday, November 20...

2007-11-20T05:27:00.000-08:00

This is not going to be an extensive post, but I did want to make folks aware of something. As of today, the 50-week simple moving average for the S&P 500 stands at 1472.94. The S&P 500 index, itself, closed at 1433.27. That places the index about 2.7% below the 50-week moving average. If we go back to 2004, then we will see that this has not been a bad place to think about entering the market.

I do not think the downtrend is over. I can actually envision two or three scenarios where we make a final thrust down to around 1400, or roughly 5% below the 50-week moving average. Nevertheless, those investors who pride themselves on buying the dips would not be unreasonable to begin looking for opportunities to do so at these levels.

Thoughts for Sunday, November 18, 2007...

2007-11-18T12:16:00.000-08:00

The market action of the S&P 500 really supported some of my recent comments. One point in particular that I would like to revisit is the significance of the 50-week simple moving average. This moving average has provided significant support for the upward trending of the S&P 500 for the past few years. We have not had a penetration of more than three percent of this line since 2003, until August 16 of this year. Of course, that penetration was only intra-day.

We can see from this chart that the recent downward movement penetrated this trend-line during the week ending November 9. This past week the S&P 500 rallied briefly above the 50-week moving average, but failed to finish the week above it. This is not necessarily an ominous sign, but it does suggest that a certain amount of weakness remains in the market. Further evidence of this weakness can be found by looking at a shorter-term trend-line on the daily chart.

You can see from this chart the relationship of the S&P 500 to its 10-day simple moving average. The low was set on Monday, and you can see that things had gotten very oversold relative to this moving average. The rally on Tuesday was very strong. It was a 2% increase over the previous day's close. Nevertheless, that did not get us back to the ten-day moving average. We gapped up above this resistance on Wednesday, but were unable to close above it. This is also consistent with my belief that a fair amount of weakness remains in this market.

I will say that the strength of the upward move on Tuesday makes me suspect that we will see a second test on the 10-day moving average before heading lower. That said, I remain of the opinion that the S&P 500 has some additional downward movement ahead of it. This could easily take us down to test the 1400 level before resuming our longer-term bull market.

Thoughts for Sunday, November 11...

2007-11-11T19:08:00.000-08:00

I have spoken recently about the importance of trend channels and of the tendency of the market to travel within two parallel lines. We have spoken about it primarily in terms of the trend channel that formed with the rally off the July 2006 lows. We might also find an excellent example of this from trend that began all the way back in March 2003.

We can see from this parallel channel how the highs of May, June, and July kissed along the upper trend-line of this channel, as well as the high of October. We can also see how the lows of August approached the lower trend-line across the 2003 and 2006 lows. I find it interesting to note that if the S&P 500 were to return to test the lower trend-line again, then it would find itself around the 1400 area. I do not find it a coincidence that we find significance in this same number from a variety of perspectives.

Thoughts for Thursday, November 8...

2007-11-08T18:18:00.000-08:00

There was some rather volatile price action on the S&P 500 today. The market declined throughout most of the morning, and reached a low of 1451.01 around 1:15 in the afternoon. From that point, the index began an almost thirty point rally to reach a late day high of 1479.45, before settling down into a closing price of 1474.21.

I recount all of this because it illustrates the recurrent importance of a particular source of support for the S&P 500. I refer to the 50-week Simple Moving Average, which is illustrated on the chart below. If you look back as far as 2004, you can see that this price level has provided an excellent source of support for at least five sell-offs. It is not as though the markets turn on a dime when they hit this moving average, but the S&P 500 has yet to penetrate more than two or three percent below it (with the one exception of August 16, 2007).

I mention this point today, because the 50-week moving average of the S&P 500 Index currently lies at 1471.66. This means that today's trading saw about a one and one-half percent penetration of this moving average before rallying to close above it. In case you are wondering, a three percent penetration of the 50-week simple moving average at its current levels would take the S&P 500 down to around 1427.55. A penetration as severe as the one seen on August 16 would take the S&P 500 to 1405.08. My point being that we do find ourselves testing some very significant, time-tested support. At the same time, it would not be out of the question to see a fifty to seventy-five point penetration of this moving average before the markets finally turn up.

Thoughts for November 7, 2007...

2007-11-07T19:39:00.000-08:00

One issue that I discussed on more than one occasion last spring was the concept of a throw-over. One of the underlying principles of Elliott Wave Theory is that markets tend to trend within a parallel channel. A throw-over occurs when price break above a previously established channel. We experienced just such a situation when the S&P 500 rallied above the upper trend-line of a channel that began forming in late 2005 or early 2006. You can see from the chart below that prices continued to rally above this upper trend-line until finally breaking down in July.

Throw-overs are important to recognize because they are almost always followed by an equal and opposite movement below the lower extreme of the trend-channel. We saw an example of such a reaction when the S&P500 declined below the lower trend-line of this same trend channel at the beginning of August. You can see this principle illustrated in the chart below. I find it interesting to note that this index continued to make a series of higher lows throughout much of the period that it remained below the lower trend channel.

We saw a subsequent example of the importance of the trend channel concept when the S&P 500 broke back above the lower trend channel in September. If you look at the chart below, you will see that this rally took this index back to the upper trend channel. It tested the resistance of this trend-line once, failed, and then fell back again to the lower trend-line.

One reason why I revisit this point tonight is to illustrate the significance of the breakdown on Wednesday, November 7. As the chart below illustrates, the S&P 500 fell down to the lower trend-line, bounced off of its resistance, and eventually penetrated below it. This whole scenario supports my belief that we did indeed see the beginning of a significant corrective pattern in May or July of this year. We completed the first wave down in August, formed the second wave into October, and have since been working on the third and final wave of this formation.

Thoughts for November 6, 2007...

2007-11-06T19:07:00.000-08:00

Most of this past spring, I talked about the need for a longer-term corrective pattern that would take us into the fall. It is my belief that we have been in this corrective phase for the last six months, if we use a monthly closing price chart. My guess is that we have completed the first two waves of a three wave pattern. October began the third wave of this formation.

Over the next few weeks, I plan to revisit some of my comments from this past spring, and discuss how many of them played out. Many of these same concepts will be important as we consider the future movement of the U. S. equity markets. These include the throw-over of the trend channel that we saw from May to July, the divergences of momentum oscillators that took place through much of this same time, and other technical tools that have provided meaningful information as things have unfolded.

I hope that you will find the discussion useful.

Thoughts for Sunday, July 15...

2007-07-15T17:02:00.000-07:00

There is a technique for wave counting that uses the Relative Strength Indicator (RSI) to assist with the identification of waves in a motive formation. The theory is that the Relative Strength Indicator peaks at Wave 3, or, in an extended formation, Wave 3 of 3. It is then followed by an RSI divergence as Wave 5 unfolds to new highs in prices without corresponding highs in RSI.

If we use this technique to characterize the rally up from March 2003, then we find an initial wave up from March 2003 that ended in December 2004. As the chart below suggests, the RSI peaked with a price peak in February 2004. This was followed by a three-wave flat corrective pattern, and a final surge higher from July to December 2004. As the S&P 500 rallied to new price highs at the end of 2004, we saw a divergence on the RSI that failed to confirm the new highs. True to form, this was followed by a ten-month corrective pattern that left prices a approximately the same level as they were in December 2004.

We saw a similar situation beginning to set up this year. As the chart above illustrates, the Relative Strength Indicator (RSI) peaked with the highs in February. We then saw a divergence on the RSI as it failed to make new highs with the rally into the end of May. All of this agreed with the many other indicators that suggested some sort of top was in order. Ultimately, equity prices are determined by the balance and imbalance between buyers and sellers in the market place, and not the tools that technical analysts use to predict future trends.

This was made abundantly clear as the S&P 500 and the Relative Strength Indicator both rallied to new highs. This suggests that the wave up from July 2006 is extending. Moreover, since this is the third wave up of the rally that began in March 2003, we might expect the RSI to rally to a peak above that made in February 2004. We can assume that the price of the S&P 500 will continue to rise with it. It is also possible that we will have another wave, after the one that began this week, in which the RSI diverges from even further price highs.