The US market is closed on Monday for the Martin Luther King holiday. It will reopen Tuesday morning.
Countertrend (corrective waves)
The current corrective wave is a countertrend wave within a countertrend fourth wave — a most dangerous undertaking to trade it. Let’s take a moment to think about this.
The larger trend is still up. In the SP500 (and related indices), as I’ve stated many times, the overall trend to the upside is corrective itself (it’s a B wave). We’re not supposed to have those based on the work of Bob Prechter, but Ralph Nelson Elliott believed otherwise.
(There were a number of changes that Bob Prechter made to Elliott’s work, not always to good effect. There are many errors in the Elliott Wave Principle book, as I’ve highlighted in previous articles. However, it’s a great tool for learning the basics of Elliott Wave Theory).
|The Elliott Wave Principle: Key to Market Behavior by A.J. Frost and Robert Prechter (2005)|
|Ralph Nelson Elliott (1871-1948) spent much of the 1930s studying the way the markets moved. I often wonder what would have happened had Dewey, Elliott, and Wheeler spent some time together. Their theories all intertwine and for the most part, the cycles they discovered run in parallel. Elliott waves are how the market moves. They are heavily based in Fibonacci numbers, which run all through nature and into the cosmos. When the market are running in a trend, they’re highly predicable and measurable. This book can get technical, but if you’ve been in the markets for a year or two, this will make it all come together for you. (Click on the book image to go to Amazon to purchase)|
Fourth waves are corrective waves (countertrend structures) of a larger, five wave trend. The corrective wave that we’re nearing the top of this week is yet another countertrend wave — a countertrend of a countertrend of a countertrend. As such, they’re dangerous waves to trade, until they reach a top.
The problem with trading corrective waves, from an EW perspective, is that there are no rules as to the length of these waves, or their shape, other than the fact that they will be in three waves overall. Almost always, the C wave has a definite fibonacci relationship to the A wave. However, this can be one of seven different relationships (or wave lengths). So, it’s almost impossible to predict where they’re going to go, or for how long. This is particularly true of a corrective wave within a fourth wave.
When we’re in a full-fledged bear market (after the final cycle degree fifth wave to a new high) is in place, the major corrective waves, will most often retrace either at least 38% (fourth waves) or 62% (second waves). These corrective waves are difficult to trade, but not impossible, because upside targets are generally known.
Get used to seeing these dramatic countertrend moves, because they’ll be prevalent at predictable points within the impulsive decline that’s expected. In most cases, you’re much better to leave corrective rallies alone and “let them do their thing,” then look for a top (a first and second wave combination is the setup pattern after a trend change).
Corrective waves in fourth waves do not have these parameters and this makes them almost impossible to predict. So, keep this in mind in your trading.
To capitalize on the next wave down (starting this week) to a new low, the entry point, from an Elliott Wave perspective is after a first wave down to the previous fourth wave and a second wave up to at least 62% of the first wave down. You should enter after the turn down, or better still, once we reach a new low below the previous fourth wave.
Elliott Wave Basics
There are two types of Elliott wave patterns:
- Motive (or impulsive waves) which are “trend” waves.
- Corrective waves, which are “counter trend” waves.
Motive (impulsive) waves contain five distinct waves that move the market forward in a trend. Countertrend waves are in 3 waves and simply correct the trend.
All these patterns move at what we call multiple degrees of trend (in other words, the market is fractal, meaning there are smaller series of waves that move in the same patterns within the larger patterns). The keys to analyzing Elliott waves is being able to recognize the patterns and the “degree” of trend (or countertrend) that you’re working within.
Impulsive (motive) waves move in very distinct and reliable patterns of five waves. Subwaves of motive waves measure out to specific lengths (fibonacci ratios) very accurately. Motive waves are the easiest waves to trade. You find them in a trending market.
Waves 1, 3, and 5 of a motive wave pattern each contain 5 impulsive subwaves. Waves 2 and 4 are countertrend waves and move in 3 waves.
Countertrend waves move in 3 waves and always retrace to their start eventually. Countertrend (corrective waves) are typically in patterns — for example, a triangle, flat, or zigzag. Waves within those patterns can be difficult to predict, but the patterns themselves are very predictable.
Trend waves move in 5 waves and partially retrace. The difference in these waves is not covered in “The Elliott Wave Principle” book. There are two types:
- Simple 5 wavers are found in zigzags, flats, and other nondescript corrective patterns. They have 5 waves, and sometimes the third wave has a recognizable 5 wave pattern, but most of the time, they don’t.
- Impulsive waves require each of waves 1, 3, and 5 to have recognizable 5 wave patterns in their subwaves
Fibonacci ratios run all through the market. They determine the lengths of waves and provide entry and exit points. These measurements are really accurate in trending markets, but more difficult to identify in corrective markets (we’ve been in a corrective market in all the asset classes I cover since 2009).
To use Elliott wave analysis accurately, you must be able to recognize the difference between a trend wave (motive) and a countertrend wave (corrective). There’s very much more to proper Elliott wave analysis, but this gives you the basics.
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US Market Snapshot (based on end-of-week wave structure)
Here's the latest daily chart of ES (emini futures)
Above is the daily chart of ES (click to enlarge, as with any of my charts).
The current huge countertrend rally has lasted four weeks; it now appears to be in the final sub wave. I don’t have a clear indication of exactly where the top might be, but it’s relatively close. We’ll be looking early next week for a first/second wave Elliott wave entry point.
I put us currently at the top of the third wave of the fifth wave of the corrective C wave up. Wave counts in corrective waves are always extremely difficult, because often, the waves are not clear (and there is no commonality in their structure — corrective waves can be vastly different from each other, not like impulsive waves).
The final pattern to the downside is still up in the air. I would expect a zigzag to the downside, but with such a large rise, and with only two patterns determined so far in this large fourth wave, there are other possibilities. However, with currencies, the US Dollar, and Oil all expected to turn at the same time, the odds are that the wave structure to the downside will be a fairly solid drop of almost 400 points.
The downside target at the moment is the previous low at approx. 2318. We could drop lower, but this level is a fibonacci level which is a common stopping point for a fourth wave, and I have nothing to support a further drop (doesn’t mean it can’t happen).
So … we continue to watch and wait. Part of the issue is that many indices are in the same position internationally; it’s not just the US indices we’re waiting for. When the market is good and ready, we’re going to turn down … and I expect it to be very soon.
Summary: My preference is for a dramatic drop in a zigzag (5-3-5) pattern to complete a triple zigzag with a wave at least to the previous low that could start as early as Tuesday. The rally may have a bit more life, but it’s quickly coming to an end. The culmination of this drop should mark the bottom of large fourth wave in progress since January 29, 2018 – almost a full year of Hell.
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