Thoughts for Thursday, May 31

I have been meaning to look up an old report that I wrote in October 2002, and finally found it tonight. The image below is one chart from that report. It is based on a quarterly line chart that I was using for very long-term analysis. The projection I made was for a low of around 750 at some point in 2003. The S&P 500 wound up reaching a low of 788 in March of 2003.

More importantly, I was speculating what would happen after we made a new low. The results of my analysis raised a few eyebrows at the time, and was actually quite a big deal for me because it represents a departure from Robert Prechter's long-term view. Now that the S&P 500 is rallying to new highs, I thought it would be a good time to revisit this report.

If you take a closer look at the last paragraph on the chart, you can see that I suggested that the S&P 500 would rally approximately 1468.35 points to a high of around 2218.35. I expected this top to be made in 2010. We have now officially rallied over half-way to that projected target since the March 2003 low. It will be interesting to see where the S&P 500 winds up in three years.

Thoughts for Wednesday, May 30...

The rally today invalidated the wave count that I have been proposing here. This means the trend remains up, and returns my bias to bullish. 1375 remains a distinct possibility for the future, but it will have to wait for now. Our first task should be to locate the next probable area of significant resistance.

To locate the next level of resistance, we will begin by comparing the length of our current wave to previous waves. It was the length of the wave up from October 2005 to May 2006 that yielded our initial price target of 1522. As the chart above illustrates, that would have given our current wave a length roughly equal to the October 2005 to May 2006 wave. Since this level has been broken, the next probable level will be a length 1.382 times the length of our initial wave. This suggests that our current wave will assume a length of 218.51 points. If we add that amount to the March 2007 low of 1363.98, then we obtain a probable target of 1582.49.

Another way to calculate the next probable level of resistance is to use the initial thrust up in March as the basis of our projections. This initial wave up assumed a length of 74.91 points. Interestingly enough, if the final wave up assumes a length equal to the initial thrust up, then that would put the S&P 500 at 1580.89. This gives us two fundamental methods of calculating probable resistance pointing to roughly the same area.

This suggests that the 1580.89 - 1582.49 level should be our primary target for the current wave higher.

Thoughts for Tuesday, May 29...

Last night I mentioned some intraday and closing price levels on the S&P 500 that would serve important roles in determining the current course of the market. The S&P 500 rallied up to the 61.8% intraday retracement level at 1522, and then wound up closing at the 61.8% closing retracement level at 1518. This has given us a nice proportional retracement of the initial thrust downward last week.

Given the five-wave structure of that initial thrust downward that appear on the hourly chart, it would seem probable that another downward thrust remains. My reasoning for this is one of the more basic principles from Elliott Wave Theory, which tells us that an initial five-wave formation will always be followed by at least one more five-wave formation. Elliott Wave Theory would suggest to us that the very least we can expect from our current structure is a 5-3-5 zigzag pattern down.

Should the second thrust down equal the length of the initial thrust then it will have a length of 23.53 on an hourly line chart. If the Tuesday high should prove to be the end of a corrective wave higher, then the next phase of downward movement should extend to around 1496.71. We might also look toward the low set on the open of May 11 at 1491.47 as significant support.

I would look at the 1496.71 number as important. If this downward movement is just some sort of short-term correction, then that will be the important number. This is because in corrective zigzag formations the lengths of the two thrusts down tends to be equal. If we see the S&P 500 extend down to the 1491.47 level, then that would be more suggestive that thiese waves are part of a larger structure.

Thoughts for Monday, May 28...

I thought that I would talk a little bit about what I will be looking for tomorrow. Last week, the S&P 500 declined from an intraday high of 1532.43 on Wednesday, May 23 to a low of 1505.18 on Thursday, May 24. That is an intraday decline of 27.25 points. If we use closing prices, the S&P 500 declined from a closing high of 1525.10 on Monday, May 23 to the Thursday close of 1507.51. This is a total decline of 17.59 points on a closing price basis. The rally on Friday took the S&P 500 to an intraday high of 1517.41 and a closing price of 1515.73. Neither one of these perspectives surpassed the 50% retracement mark.

I have expressed my concern about the lack of volume with the downward movement on Thursday, May 24. At the same time, I have expressed ample evidence that the recent rally has become technically weak and vulnerable to a decline back to the 200-day moving average and March lows. The rally on Friday was not enough to change my opinion that an important top has been formed.

In order for me to change my current opinion, I would need to see a retracement beyond the 61.8% retracement level of the thrust down on Thursday. That means I would not begin to become concerned about any upward intraday movement until it surpassed 1522.02 or, more convincingly, above 1526 on the S&P 500. More importantly than that, I would want to see a closing high above 1518.38 or, more convincingly, above 1521. The numbers represent the 61.8% retracement levels, along with the more extreme 76.4% retracement levels. Such significant retracements would exceed those typical of proportional retracements.

It is important to remember that these levels would not represent an invalidation of the analysis that I have been presenting. They would, however, represent a prudent point to step aside from any aggressively bearish positions until a clearer picture becomes evident.

Thoughts for Sunday, May 27...

I have been discussing the possibility of that the S&P 500 has reached a position where we have a high probability of a top. We have a five wave structure up from October 2005. We have a five-wave structure up from March 14. We have a large amount of proportionality between all of the waves. We have experienced a throw-over above the upper trend-line of the trend channel. All of these add to my suspicion that we are nearing an important top.

Another factor that adds to my suspicion is volume. I use a 10-day moving average to track recent volume trends, and to let me know if recent volume was relatively strong or relatively weak. Our recent volume trend peaked out with the highs of February. At that point the 10-day moving average was around 2.05 billion shares. Our highest intraday point came on May 23. By that point, our 10-day moving average had declined to 1.80 billion shares. This point adds to our evidence that the rally on the S&P 500 has lost its steam.

By the same token, our decline on Thursday was not accompanied by strong volume. As the chart above illustrates, the 10-day moving average was at 1.71 billion shares but the volume for that day was 1.33 billion shares. If the price movement on Thursday was a significant change in trend, then we would have preferred to see volume greater than our 10-day moving average. This tells us that volume did not confirm our downtrend, and suggests that we remain cautious in our bearishness.

There are some other tools suggesting that we are in the process of reaching a top. I have offered the Relative Strength Indicator as an example of a momentum oscillator that is not confirming our recent highs. Above is a chart with a 20-day Momentum oscillator, a 60-day Commodity Channel Index, a 14-day Relative Strength Indicator,and an Ultimate Oscillator. I used a few different time frames to show how prevalent the divergences are from many different perspectives. On each of these, you can see that the oscillators are not making new highs to confirm the recent highs. This suggests that the market has become technically weak.

I also wanted to add another point to my comments on Thursday night. During that post, I speculated that a corrective formation on the S&P 500 would take us down to around 1375. The chart above shows the 50-week simple moving average. As you can see from this chart, it has acted as significant support at several points since 2004. I think it is interesting to note that the 50-week moving average is currently at 1380.54. So, there is some evidence that there is important long-term support around 1375 on the S&P 500.

Thoughts for Thursday, May 24...

The market began a trust downward on Thursday. It is my belief that this completes the formation of a significant top. First of all, It is my belief that today's decline confirms the completion of the five-wave structure up from the low of March 16.

I say this because my primary concern in the progression of this upward wave was that it would expand into a complex wave formation. As I have stated on more than one occasion, this would have been inconsistent with the typical wave formation, but it was a possibility to consider. The decline today took the S&P 500 below the level that would be allow a valid expanded third wave within the formation up from March 16. This fact, along with the wave counts that I have discussed previously, were enough to turn me bearish on the S&P 500.

On Tuesday, we discussed the possibility that the recent rally performed what is called a throw-over above the upper limits of the trend channel that began with the rally from October 2005. We might debate about which highs to draw this line across, but they all make the same general suggestion. If the market rallied above the upper limit of this channel, then it will most likely drive below the support at the lower end of this channel.

If we use the trend-line that I have drawn on the chart above, then that would suggest a throw-over of 28.1 points. A similar decline below the lower trend-line drawn on the above chart would put the S&P 500 around 1376.83. This is significant because it is also in the same neighborhood as the low of March 16. It would also put the S&P 500 between the 38% and 50% retracement levels of the rally up from October 2005 to present. As a result, 1375 does not seem like a bad place to make our initial price target.

Thoughts for Tuesday, May 22...

Little has changed from the trading on Tuesday. The S&P 500 once again failed to reach 1530 and fell back below the critical 1525.70 level. This leaves the five-wave formation up from May 10 intact, and the possibility of a top remains a valid consideration. There is not much else that I can add to this point at this time.

Instead, I would like to point to a development on the longer-term chart. The concept of trend channelling tells us that price patterns tend to travel within a parallel channel. When the prices move beyond the boundaries of that channel, it has important implications. In fact it was a similar situation that prompted me to predict a severe downward move on September 9, 2001.

When prices break above of the upper limits of a trend channel, we call this a "throw-over". It is important to note the magnitude of move above the channel, because it is commonly followed by a similar price movement below the trend channel. We call that this reaction a "throw-under". The fact that we have seen just such a breakout on the S&P 500 is what fuels my anticipation of a significant downtrend to correct this "throw-over". It is the tendency to see a reactive "throw-under" that should eventually take this index back below the March low.

Thoughts for Monday, May 21...

On Thursday night, I presented the possibility of a five-wave formation up from May 10. I calculated this formation using a line chart of closing prices. As I discussed Thursday, in order for this to remain valid the S&P 500 cannot close above 1525.70. The index closed at 1525.10 on Monday. This leaves my current count valid, even though I could attack it on more than one point.

The alternate count would be that the current wave is assuming some form of complex formation. This would not be a typical wave formation because Wave 3 was complex. That is, it took more than five waves to complete the formation. Typically, only one wave within a five-wave formation does this. This would suggest that the formation up from May 10 should be comprised of only five waves. It is for that reason that I will stick with my current wave count.

Thoughts for Sunday, May 20...

The S&P 500 did wind up rallying to complete the five-wave formation as we discussed in my Thursday night post. This rally wound up stopping right at the 1522 price target that I have mentioned on more than one previous occasion. This implies that a potential top is in place. I would prefer to have some downward price movement to confirm this analysis. Additionally, the S&P 500 can move up to 1525 or so without invalidating this count.

The number of 1522 was arrived at by using a standard technique of Elliott Wave analysis. I believe that the recent rally off of the March lows represents Wave 5 in a formation that began in October 2005. The first wave in this formation rallied 158.11 points before completing in May of 2006. The next rally began in July 2006 and ran up to the highs of February 2007. The length of this rally was 237.81 points. It just so happens that 237.81 is roughly one and one-half times the length of 158.11.

This proportionality was no coincidence. It is common for the lengths of the waves in a five-wave formation to unfold in a such a manner. It is also common for two of the waves to be of equal length, while a third is extended. Given that Waves 1 and 3 were proportional to one another, with Wave 3 being extended, it is only consistent with common Elliott Wave Principles to expect Wave 5 to be roughly equal to Wave 1.

As the chart above shows, a rally from the March low of 1363.98 of 158.11 points would place the S&P 500 right at 1522. The exact target was 1522.09. Friday's high was 1522.75. Should this level hold, then that would create a perfect Elliott Wave formation in terms of price proportionality.

It would also imply that a sizable decline awaits over the next few months. It would not be out of the question for this to reach down to the March 2007 low of 1363.98, but should not go below the May 2006 high of 1326.53. So, this is roughly 10% from our current levels. I will discuss probable targets more specifically should this prove to be a top.

Thoughts for Thursday, May 17...

Sometimes the market does not make a lot of sense. Take the current situation. The real question is whether the S&P 500 remains within the fourth wave of a five wave structure, or whether it has already entered into that fifth and final wave. If the S&P 500 declines and closes below 1505.85, that would confirm that we remain in wave 4. This remains my primary count. If I had to guess, this is what I would say will happen.

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If we rally from this point, then it will suggest that the market has reached an important top. I try not to go through life making grandiose or flamboyant statements. Nevertheless, if the S&P 500 rallies to close over 1520 (but less than 1525) on Friday, then I would view that as a major shorting opportunity.

If you take a look at the chart above, you can see that the S&P 500 continues to hug the lower side of that trend-line extending across the March 14 and April 12 lows. This trendline extends up to 1525.05 on Friday. At the same time, the Relative Strength Indicator (shown above the price chart) has developed even more sever divergences that when I mentioned it last week. When divergences get this severe, it is either because we are in the middle of a corrective formation or approaching a major top. If we close below 1505.85 on Friday, it will confirm that we are in a corrective formation.

Let us assume for a moment that I am wrong. Let us assume that the S&P 500 completed Wave 4 with its low on May 10. If this is the case then we have already completed the first three waves of Wave 5, and could be ready to make the fifth and final wave up. I have illustrated this hypothetical count above. Wave 1 began on May 10, and ended on May 11. It assumed a length of 14.38 points, using closing prices. Wave 3 began on May 15 and ended on May 16. It assumed a length of 12.95 points, also using closing prices.

This means that the fifth and final wave should not exceed a length of 12.95 points. There is alway the possibility of an extended wave, but there is usually only one extended wave per five wave structure and the rally from March 28 to May 9 served that role. This means that the S&P 500 cannot rally above 1525.70 in this scenario. So, any rally above 1520 could be considered a potentially major top. I would seriously consider an immediate bearish position, should this scenario unfold.

You might also notice that this would put the S&P 500 in the neighborhood of the 1522 target that I have discussed previously. It would also put this index back at the resistance formed by the March 14- April 12 trend-line. We are also reaching a time cycle point on Monday.

I do remain faithful to my insistence that the S&P 500 needs to finish the week below 1505.85 in order to create Wave 4 on the weekly chart. I also tend to think that the severe divergence in the Relative Strength Indicator on the daily chart is most likely due to an incomplete corrective formation. That said, I am mindful of the possibility that the market could rally, and have shared with you the important implications of such a possibility.

Thoughts for Wednesday, May 17...

The TRIN closed at 0.65 yesterday. That is not a resounding indication of a top, but it is low enough to serve as one. The S&P 500 closed at 1514.14. This places the broad market index squarely within the 1513- 1515 area of resistance that we have discussed previously. Furthermore, we have seen a three-wave formation up from the low of 1491.42 on May 10. All of these suggest that there is a good probability that the markets will give us that c-wave down to complete wave 4 of the rally up from May 14. This would simply give us a flat corrective formation prior to our rally to form Wave 5.

My primary target has been 1475.11. I still like that number for a few different reason, but the flat nature of this correct wave suggests that we should also consider the area around 1489.90 as likely target. I think that both of these numbers represent legitimate targets. Of course, we need to break below support at 1499.01 first.

To the upside, my primary target is 1522. I do not think I have discussed that frequently enough here. Nevertheless, there are a couple of sound methodologies that point to this number. I hope to discuss them further in the days to come.

Thoughts for May 15...

Around the beginning of May, we discussed the importance of a trend-line that extends up from the lows of March 14 and April 12. The S&P 500 tested this trend-line support on May 1, and then dropped through it on May 10. The chart below shows how this former source of support has now become resistance. We can see this trend-line serves as resistance on May 11, 14, and 15. In fact, this line extended up to 1514.54 on Wednesday. This was also the area of resistance between 1513 and 1515 that I have discussed previously.

There is no real reason to alter my anticipation of a further decline on the S&P 500. As I have stated previously, my primary expectation is for a decline to the 1475 area. This would represent the final wave within a larger three-wave corrective formation. If and when we do rally to higher levels on the S&P 500, I would anticipate that the March 14 to April 12 trend-line would serve as upside resistance to the ensuing rally.

Missed it by that much...

It is my belief that the S&P 500 will eventually have a down week. I will go out on a limb, and guarantee it. Sooner or later... at some point in the not too distant future... the closing price on the S&P 500 will be lower on one Friday than it was the previous Friday. Will it be Friday, May 18? Could be.

The S&P 500 only needed to close below 1505.62 to be down this past week. It finished up at 1505.85. That is fine. It seems probable to me that the rally that lifted the S&P 500 to that level was merely a b-wave in a larger three-wave corrective pattern down. It would not be unreasonable to see a final downward thrust over the next couple of days.

The area around 1475 continues to serve as my promary downward price target.

Best wishes,

Eldinril

Time for Wave 4...

The S&P 500 made an intraday high on Wednesday, May 9 of 1513.80. If you go back to my post on April 29, you might see mention of that exact number as a potential source of resistance to our upward movement. For whatever reason, this appears to have proven correct.

We have now entered into what I consider to be Wave 4 of the wave up from March 14. You can get a fairly good representation of this interpretation by viewing the weekly chart I posted on April 30. The only real requirement for this interpretation to be valid is that we close tomorrow below 1505.62 on the S&P 500. This was where that index closed on Friday, May 4.

Our next challenge is to determine how low our current decline will go. Elliott Wave Theory tells us that it is not uncommon for a correction to retrace back to the area of Wave 4. It would not be unreasonable to assume that the low set on May 1 was the low of Wave 4. This suggests that the S&P 500 could continue down to the 1476.70 level.

This level becomes increasingly intriguing when we look at things from the perspective of Fibonacci ratios. Let us assume that the low of Wave 3 was 1412.54 set on March 30, and the high of Wave 3 was the 1513.80 high set on May 9. This gives the total wave a length of 104.90 points. A 38.2% retracement of this wave would be 40.07 points. This would place the S&P 500 at 1473.73.

This gives us two different methodologies within the principles of Elliott Wave analysis that both point to the level around 1475 as potentially significant support. I would view this as our primary target for this decline of the S&P 500.

Momentum Divergences...

On April 23, we discussed the technical divergences that were apparent on the daily chart from the perspective of breadth and volume. On April 24, we also mentioned divergences that were forming on the weekly chart from a momentum perspective. The measures did not signal the end of the upward movment, but they did act as confirmation of my belief that we are in the midst of a final wave up of a longer-term price structure.

Those divergences we discussed at the end of April still exist. In addition to those signs of technical weakness, we can now see similar momentum divergences beginning to appear on the daily chart of the S&P 500. This means that even as the market continues to rally higher, the breadth, volume, and momentum of this upward movement continues to deteriorate.

This can be a frustrating time for some traders. There is plenty of technical support for the argument that we are nearing a significant price high for the market. We simply have not reached it yet. We continue to make higher highs and higher lows within a well-defined trend channel. We are just below important resistance levels for the S&P 500 at the 1515 and 1520 levels. We also have incomplete wave formations. It can be difficult to maintain the patience necessary to ride this formation up to its top.

Trend Channels

Last week, we discussed the lower trend-line of our rally up from March 14 on the S&P 500. This trend-line was tested by the lows of May 1, before the index resumed its upward trend. The chart below depicts the channel formed by the upper and lower trend-lines as the formation continues to unfold. The upper trend-line of this channel was at 1516.20 on Monday. It has a slope of roughly 2.45, which will extend increase this potential source of resistance to 1518.65 on Tuesday.

One other potential source of resistance can be found in the rally from July 2006 to February 2007. If we draw a line across the lows of what represented Wave 2 and Wave 4 within that larger price formation, we can see a trend-line that extends up to the highs set last week on the S&P 500. This line extends up to 1517.01 this week.

This gives us a confluence of two important trend-lines for the S&P 500 that happen to cross near an important date from a time cycle perspective. Furthermore, we discussed the importance of the 1515 area from the perspective of proportionality and Fibonacci price projections in my post on April 29. We could even bring in some longer term price projections that suggest resistance around 1522. It will be important to watch how the S&P 500 behaves as it enters what must be viewed as an important area in terms of price, pattern, and time.

It's Street Sense!

Winning the Kentucky Derby takes a combination of a special horse, a skillful jockey, and a fistful of luck. All of these were exemplified in the winner of the Kentucky Derby, Street Sense, and his jockey, Calvin Borel. In the picture below, you can see Street Sense on the far right (his jockey is wearing the yellow and green silks) entering the final turn at Churchill Downs. Borel successfully navigated his horse through all of that traffic before turning Street Sense loose and winning by two and one-half lengths.

Betwixt and Between...

On Tuesday, the S&P 500 tested support at the lower trend-line we discussed yesterday. On Wednesday, this broader market index bounced up to test the upper trend-line, which we also happened to discuss yesterday. Will the S&P 500 break through the resistance at 1495, or will we revisit the lower trend-line one more time?

It is my personal belief that the S&P 500 should finish the week ending on May 4 at a lower price than it closed on Friday, April 27. This is because I think it would be most logical for the market to assume a formation like the one I posted on April 30. In order for this to happen, we need a down week.

This would suggest that Wednesday's encounter with resistance at 1495 on the S&P 500 will not be followed by a Thursday breakout. Instead, it would suggest that the market will somehow move lower over the course of the next two days.

This would make sense from a wave count perspective because it would create a three-wave corrective structure. The chart depicts that scenario. I think it is important to note that the lower trend-line that served as support on Tuesday has extended up to 1486.48 on Thursday. This may well serve as support again over the next two days.

Trendlines...

One of the most powerful methods of predicting future market behavior can be found in the concept of trend channeling. This is based on the concept that most price trends tend to happen within the confines of a well-defined channel. The recent behavior of the S&P 500 is no exception...

If we start a line at the highest price point of what I am calling the end of Wave 1 in May 2006 and extend it across the high point of Wave 3 in February 2007, we can see that the S&P 500 rallied right up to test this line when it made its highs of last week. We have backed off of that resistance for now, but I expect that this trend-line will continue to serve as significant resistance over the next few weeks

We can draw a similar line across the lows of 1363.98 set on March 14 and the 1434.01 set on April 12. If we extend this line up, we can see that it reached 1479.52 on Tuesday, May 1. The S&P 500 reached a low of 1476.70, but could not hold it. We might assume that this trendline offered some support to the downward movement seen on this day. If you are curious, this same support line will be at 1483.03 on Wednesday. We will see if this support holds for a second day...