Sunday, February 5, 2012

SPX Update: Do-or-Die Week for the Big Picture Wave Counts

On Friday, the Dow Jones Industrial Average (INDU) came within 6 points of its 2011 high.  If this high is broken, this would be an extremely significant event for the counts, since second waves cannot exceed the beginning of first waves.  Monday is a critical day for the Minor Wave (2) count, and if the market doesn't reverse lower pretty much immediately, it will be time to rule that count out and consider some alternates.

I continue to favor the Minor (2) top here, but there is now no room for error.  Since I've been wrong before, and Monday may be the bears' last chance for the Minor (2) count, I've looked at a number of alternate possibilities this weekend, and have now decided on my main alternate long-term count.

The Minor (2) count isn't dead yet, and it's still my preferred count.  But in the event that it's way off-base and Monday opens higher, I'm going to present my main alternate count below for reference.  This count considers the possibility that the 2011 decline was an (a) wave, and the current rally as part of a (b) wave.

On Friday, the S&P 500 (SPX) closed just below a significant overhead resistance zone, as did the INDU.  The bears need this resistance zone to hold.  If this zone can't turn back the rally, then it puts the 1370's, and even the 1400's in play.

This appears to be a critical pivot point for the market.  My preferred view is that the market heads lower right from Monday's open and doesn't look back.  However, if that doesn't happen, my main alternate count is shown below.  This count will move into the preferred role if the INDU trades above 12876. If there's no pause at this resistance level, bears may want to stand aside and wait for the market to break its uptrend before taking further actions.  I've said it many, many times before: cash is a position too.

There is really no need to fear "missing out," as I've also said before.  If a big decline is still in the cards, it's not all going to all take place in one day.  Certain posters on my blog have suggested a "flash crash" is around the corner.  I've never been of this opinion.  While anomalies are always possible, I see no signs of such an event in the current charts.  Even the flash crash came after the market broke its uptrend line and started trending down -- not while it was still trending up.  Sudden crashes almost never start from this type of market position.  Patience is a virtue in trading.

In any case, as I mentioned at the beginning of this article, the Minor Wave (2) count isn't dead yet... it's just on severe life support.  Below is the short-term SPX chart, which shows my preferred Minor (2) count. I will continue to favor this count unless the Dow makes new highs above 12876.

Friday's preferred targets were all hit nicely on the chart below -- in fact, the targets were originally suggested on Jan. 24 as an if/then equation, which is often how the market functions.  Those targets are still shown in the call-out box, which has remained on the chart since the 24th. The move can be cleanly counted as a complete five-wave rally, to complete c of (y) of Minor (2).  Whether this is indeed the case will be revealed by the market directly.

If we combine the two charts above, we can see there are three major upsloping trendlines that the bears need to break before we can have any confidence in a significant trend change.  The first warning shot to bulls will be a break of the short term channel shown above; the second and third will be breaks of the larger channels in the first chart.  No trend line break equals no trend change.  As I've also said previously, until such time as the market breaks down, the benefit of the doubt should go to the established trend.

My job, as I see it, is to project the potentials as best I can (including targets when possible), warn about the possibilities of a trend change when I see them, and suggest potential pivot zones so readers can be prepared.  Potential trend change zones are areas to consider taking profits.  If no reversal materializes, one can consider adding to positions if the market breaks through a resistance zone.  Actively betting against a trend is tricky business, and traders must realize that.

Personally, I attempt quick stabs at counter-trend positions and either make a few bucks, lose a few bucks, or get lucky with my best educated guess and nail the exact top or bottom.  Less nimble intermediate-term swing traders should generally either wait for confirmation of a trend change, or be able to close positions without hesitation if they front-run a reversal that doesn't materialize, and critical support or resistance levels are violated.

For example, in my opinion, this is another very good zone to attempt some counter-trend shorts, since the market is just below overhead resistance, and the risk/reward potential is good.  But in order for the risk/reward equation to work, one has to be prepared to close positions if resistance is broken and the market doesn't reverse.  If one is going to hold and hope forever, then the risk becomes astronomical, as the market could just keep right on rallying.  Trading is all about managing risk; and betting against a trend is always risky.

As another example, due to a number of indicators, I was looking for a top back when the market was below 1300-1310.  It's fine if you want to try and play that possible top, but once 1300-1310 was broken, and especially when it was back-tested and held as support, then it was time to look up, not down -- and the daily preferred count this week pointed to higher prices and targets the entire way up from that zone.

There are certainly lessons here for those traders who have front-run a top without using stops.

Anyway, back to the market.  There are signs that momentum actually increased on Friday.  For the short term, the bears primary hope is that Friday was an exhaustion gap similar to October 27 -- and this is indeed a possibility.  As is so often the case in the market, we simply won't have an answer to that question until the next session.

Something small the bears have in their favor is that on Friday, the VIX touched its lower Bollinger band for the first time in several sessions.  This first Bollinger band touch generates at least a short-term pull-back in the SPX more than 77% of the time -- although it isn't necessarily a trend changer, it just means lower prices from where the signal occurred in 77% of prior cases.  However, over the past several weeks, the market has not worked out according to most of the historical odds.  It has blown up indicator after indicator, despite past averages.  In fact, VIX touched its lower Bollinger band in a similar fashion twice already in this rally, and the market kept right on rallying anyway.

Below is a short-term version of the VIX chart to illustrate some examples.  The occurrences on this chart do not equate to the 77% figure -- that figure is based on a much broader market sample. The market's last chance for Minor Wave (2) is at hand.  If that count still holds any water, the market needs to decline more or less immediately at Monday's open.  The SPX and Dow are both facing significant resistance levels, so the bears have a potential opportunity here -- and even if Minor (2) gets knocked out on the Dow, this is still a significant resistance level and represents the market's next hurdle, with or without Minor (2).

The final chart was originally presented last week, and this study is still valid and something to consider; as is the fact that the Bullish Percent Index is at all-time highs (see Wednesday's article). In the study below, in 2007, the SPX continued higher for two more weeks after the signal triggered.  It has now been one week since the recent trigger. In conclusion, back on Jan 24 I warned that if the market held the 1300-1310 zone as support, then it was likely on its way to 1330 as the next test... and if it got through that, it would head to 1345-1350.  Those things have come to pass.  The market is now facing its next big test.  If the bears can't put something together here and now, and stop the rally from breaking through 1350-1360 SPX, then it's likely that the rally will continue for at least another week.

I continue to favor the Minor (2) top -- however, ultimately that's just my best analysis; it's not a guarantee.  The market poses the questions, and the price action provides the answers.  If my preferred Minor (2) top is valid, then the market should reverse almost immediately on Monday, and the current highs should hold for a long time to come.  With only 6 points of upside left before the Dow knocks out its count, we shall have our answer shortly.  Trade safe.
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