By Avi Gilburt
Multi-Year Inflection Point
The epic battle continues between the bulls and the bears. In fact, we are very close to the market giving us the signal as to which one will be victorious for the remainder of 2012.
Last weekend (on the Elliot Wave Trader subscription site), I said that “the topping region for this wave is between the 1351ES-1363ES region.” During the week, it did seem like the higher target may be hit, but the market actually made its top at 1357ES, right smack in the middle of the target zone, which is unusual as it usually hits one of the specified Fibonacci extensions levels. However, once the market broke down below the 1340.50 level of support we noted on Thursday, the larger decline began to play out.
I also said that, if the most bullish pattern we were watching were to play out, “after hitting the top of wave i, my expectation would be that we would decline in a corrective wave ii, which would potentially target the 1317 level at the .618 retracement level.” While the low this past week was 1317.50, I am still not certain that we have seen the bottom to this downside action. But how and to where this market does decline will provide us the key into whether this market will be a bear or a bull for the remainder of 2012.
Currently, the market is presenting 2 potential primary patterns (with an alternative to each), one of which is VERY bearish, and the other is VERY bullish – as both of which could kick off a strong move, but, clearly, in opposite directions. It is not often to see such an inflection point with strong ramifications in opposite directions, but this is where we now seem to stand.
Red Wave (2) – Bearish
As we hit the top target region for this pattern, and turned down quite hard, this could be the first indication that, as I said last week, the market has “kicked off a decline that would take us down to the 1100 region in a wave (3), which would not take more than a few weeks, as 3rd waves are the strongest waves in a 5 wave pattern.”
In order to see follow through in this count, as you can see from the 60 minute chart , we have yet to complete the 3rd wave of within this sub-wave of the decline, and if wave v of red wave (3) were to exhibit a 1:1 Fibonacci relationship with wave i, then it would be targeting a double bottom at the 1317ES level. However, it is also possible that we may see an extended wave v, which would target the 1.5:1 or the 1.618:1 relationship between the 1308-1310ES region.
Under Elliott Wave theory, in order to see a change of direction in the market, which would indicate a change in sentiment, the market would have to complete 5 waves in the opposite direction. Under this bearish count, the next drop would only complete 3 full waves from the top, after completing 5 sub-waves within wave (3). Therefore, we would need to see the market consolidate one more time (after making another low) below the 1332ES region (estimated .382 retracement of wave (3) and top of the wave iv of one lesser degree), and decline one more time, ideally to the 1296/1297ES region, which would be the larger .382 extension for red wave i of the larger wave (3) decline. As you may remember, the .382 extension is the standard extension that we look towards for a wave i target within a larger 3rd wave.
If this pattern does continue to fulfill, then a bounce from the 1296/97ES region will likely be seen, which would likely target the 1326-1333ES region (with 1342ES the high range possibility) for wave ii of wave (3), followed by a very sharp and strong decline that will take us down to the 1200 region at the 1.00 extension very quickly. This would be a 3rd wave within a 3rd wave, and they are the most powerful extensions within a 5 wave move. So, if we break through that 1296ES region on that drop from the 1326-1342 region, we would potentially see several days of decline similar to what was seen this past Thursday, wherein we would see multiple 20+ point drops over several days.
Note also how a red wave i and ii, as described, would also create a Heads & Shoulders pattern which would be targeting much lower levels.
If this pattern were to fulfill, then it would be initially targeting the 1200ES region before seeing a larger bounce, which could take us back up as high as 1236-1259ES, on our way down to ultimate targets between 1040-1080ES. This is the pattern that provides the clearest indication that the bear market is back and here to stay for the next several years, and would likely be targeting levels below the March 2009 lows.
Most Common Bearish Count – A Problem
As I have been receiving many emails regarding the prominent and most widely held bearish count proffered by most analysts, I would like to make a comment about a problem in the pattern which all these counts present. Every single count that I have seen has the top of the wave (2) as a truncated 5th wave from the 1338 to 1355 level in the futures. This same wave tops at just under the 1362 level in the cash index. This is the basis for almost all of these practitioners to view the larger red wave iii down as upon us. Our analysis has labeled that same top as a green b-wave or, alternatively, the top of the smaller red wave (2) within red wave i.
If you actually take that wave apart, you will see that it is formed as a 3 wave structure, in which the a-wave is exactly equal to the c-wave. I cannot count this as the top of a larger 5 wave move as it is not an impulsive wave, and definitely cannot count it as a truncated 5th wave. As it is, I think truncated waves are often labeled incorrectly, as they are not very common, and such a labeling, especially in this case, cannot be heavily relied upon. To consider labeling a truncated 5th wave with a 3 wave structure is simply beyond the probabilities I am willing to accept. This is a major problem with the most common bearish Elliott Wave count we see being proffered by most, which is maintained by almost every email that has been sent to me.
Therefore, the only way to count this decline properly is the manner in which the red count is displayed on our 60 minute chart, which still requires two more 5th waves to complete the structure – grey wave v of red (3), and then red (5) of wave i. However, this count is also problematic, as we need to assume that the 1st wave down from the high on the 19th in this bearish structure is a leading diagonal – another rather infrequent pattern. Based upon the structure, I think it does count better as a corrective a-wave rather than a leading diagonal, but am open to the possibility that it is a leading diagonal, especially if the rest of the pattern does fill in.
Furthermore, we know from experience that a wave i down within a 3rd wave will at least target the .382 extension, if not the .618 extension. So, without a fully formed 5 wave structure to the downside that targets at least the .382 extension in the upcoming week, I cannot wholly adopt the bearish count, despite the significant number of other Elliott Wave counts presented to me that say otherwise.
While there is an alternative bearish pattern that would take a little longer to play out in the same manner, there is a possibility that this last top was the top of a 4th wave of an expanding leading diagonal, which would target the 1200-1236ES region to complete a 5th wave of a larger wave (1) in the bearish count, but that would then provide us with a wave (2) bounce that would take us back up beyond the 1259ES level, and take us back up to the 1306-1331ES region for a larger wave (2). While this is a rare pattern upon which one cannot place a significant amount of reliance, it has occurred on occasion in the past, so we must keep this potential pattern in the back of our minds, and make it a prominent count if the market would be able to bounce from the 1200/1236ES region back over the 1260ES region.
Green Wave ii – Bullish
In the most bullish count on the chart, this past week has seen us top in green wave i within a 3rd wave that will ultimately target the 1420-1450ES region. The next upside target will be the 1383-1404ES region, and, based upon this pattern set up, we can get there quite quickly.
Last week, I wrote that if we topped within our topping target region of 1351-1363ES, “my expectation would be that we would decline in a corrective wave ii, which would potentially target the 1317 level at the .618 retracement level, which also coincides with a retest of the downtrend channel, from which we may have recently broken out.” Thus far, the market has played out exactly as we suspected. However, I am not thoroughly convinced that we have completed all of the downside at this time.
If the market were able to continue up to the 1340ES level on Sunday night into Monday, then that would be my first indication that green wave ii may have completed, and I would be looking for a 3 wave corrective pullback into the 1326-1331ES region, which would be a strong buying opportunity – again, only assuming it is a corrective pullback, and using a stop at 1320ES, just below the .786 retracement. If the market does start moving up strongly from that 3 wave pullback into the 1326-1331 region, then you will want to move your stops up to your break-even point, or even lock in a small profit, as any decline that even approaches this low again would be an initial indication that a strong wave iii to the upside is not in the cards.
However, based upon the primary count within the sub-waves, it would seem more likely that the market would provide us one more 5 wave decline into the 1308-1317 region to complete 5 waves in the green c-wave of green wave ii. I know this is a bit lower than we had initially expected, as we were ideally targeting the .618 retracement for wave ii within the 1317-1319ES region, and the 1308ES level is the .786 retracement of green wave i, but, we have to be prepared for all potentially reasonable possibilities at this time, and this one is quite reasonable based upon the current pattern, and the larger than expected size of grey wave iii. Furthermore, there is strong Fibonacci confluence supporting a low at 1308ES, with a Fibonacci complement target of 1404ES.
So, if you do choose to go long in the region of the next decline, then you would use a stop of either 1304, which is just below the .786 retracement, or 1313, which is just below the .618 retracement, depending upon which target low is hit by the next 5 wave decline.
However, if the market was projecting to move below the 1308 level based upon its sub-wave extension targets, then you must be mindful of the alternative bullish count and the larger bearish count, which revolve around 1296ES and 1293ES, and the pattern with which it hits those targets, BEFORE you consider a long position.
For those traders/investors that are more conservative-minded, you can choose to see how the market reacts after hitting the next low, and then buy the 3 wave pullback, assuming we see 5 waves moving strongly to the upside after the next low is hit. Any corrective moves to the upside should not lead to buying opportunities on drops.
So, ideally, for the primary bullish count to remain our main focus if the market will drop on Monday, the market should not drop below the 1308ES level, and should, thereafter, be moving over the 1332ES level in a strong move, which is indicative of a strong wave iii up that will target the 1383-1404 region quite quickly.
Bullish Alternative – A Fractal Perspective
I want to remind everyone that the larger multi-decade cycle still has us within a large 4th wave pattern. Therefore, we still need to keep all options open, as most anything can happen within a 4th wave, as it is the most variable-patterned wave of the entire 5 wave Elliott structure.
So, I am also leaving an option open to a fractal playing out that is similar to the fractal that we saw from the October 2011 lows. That fractal also began with a 3 wave move up off the lows, with the 3rd wave also stopping at the .618 extension of the initial wave off the lows, which is where we recently topped on the 19th. The decline which followed the top of that initial move off the lows completed at the .618 retracement of the entire 3-wave rally. That would give us a target of 1293ES (with the outside possibility of a 1277ES target, which is the .786 retracement, which also coincides with the 1.382 extension from the top on Friday).
Also, remember that the second decline we saw in November extended to the 1.618 extension of the first decline. If the market were to move up to the 1340ES level, the 1.618 extension would be exactly the 1277ES level. So, this scenario must remain in the back of our minds during any potential bullish set up this coming week that takes us up to 1340ES, but then does not hold the 1326ES level on a pullback. So, a move up to the 1340 level on Monday, under almost all circumstances, may be a nice short set up for aggressive traders.
So, if the market were to decline from the top it hit on Friday directly to the 1293 region, which would be the 1.00 extension from the market high, (or if it moved up slightly higher early in the week to 1340ES and did not maintain the 1226ES support on the pullback), it would make me seriously consider this as my primary count, as we do not have 5 waves down from the market high, and a move down to the 1293ES level from this region would make me strongly consider a long position.
As this scenario could potentially be a major bear trap, the decline to the 1293ES (or 1277ES) level would have to be supported by positive divergences on our 60 minute futures chart to maintain this alternative possibility.
Again, while this is not my primary count, I am simply keeping this option open in the back of my mind if any decline from the top on Friday (or further extended top on Monday) to the 1293ES level were seen, and especially if it were to not exhibit the standard technical properties of a 3rd wave decline, similar to what we witnessed in the decline of November of 2011, which caught many looking for the larger 3rd wave down at that time as well, only to be majorly whipsawed back into reality.
There is one last point I would like to make regarding the larger bullish potential within the market. On the SPX charts, there is a gap just below the 1370 level, which has still not been closed. Since the market usually likes to fill gaps before moving in the opposite direction, it does seem odd to me that it would complete a potential wave (2) just below that gap without filling that gap only a few points higher. While not dispositive of the fact that the market will go back up to fill this gap, it does give a bit more support to the fact that there is going to be more upside to be seen over the highs we made this past week. So, again, this is simply another factor that causes us to keep an open mind to the bullish case.
Wave Count – Bottom Line
To summarize the wave counts, we have several potential patterns we are watching, and the pattern that plays out will be crucial in identifying the bullish or bearish case:
- Green Bullish: Move up to 1340 on Monday, with pullback to 1326/31, and then over 1340 to target 1383/1404 – or – drop down to 1317/1308 from 1332 high on Friday, and then rally to at least 1331 andmaintain support at all times thereafter over 1317(even if the rally began at 1308) on our way to 1383/1404;
- Alternative Bullish(not yet represented on the chart): Stay below 1340, and drop straight down to 1293/1277 without completing the 5 wave structure outlined under the bear count – which would set up a strong rally from one of those levels, similar to what we saw from Thanksgiving of 2011 until April of 2012;
- Red Bearish: Move down to 1317/1308 early in the week, bounce/consolidate to as high as 1332, and then down again to 1296. This would then cause another counter-trend rally back up to 1326-1342 for red wave ii within red wave (3), which should be a major shorting opportunity, with an initial target of 1200, on the way down to 1040-1080.
I often receive comments, especially on Market Watch and Seeking Alpha, regarding the reliability of using Elliott Wave for determining market moves and targets. While there is no market analysis methodology that is an exact science or that is perfect, Elliot Wave provides a methodology for market analysis which will limit the possibilities within the market, and, in my humble opinion, after learning many methods, it seems to be the most reliably consistent I have found.
Furthermore, when we apply the Fibonacci retracements and extensions within the waves (Fibonacci Pinball), they must be applied to the correct wave (as each wave has its own applicable standard Fibonacci calculations), rather than a set of waves, otherwise, your calculations may very well lead you to inaccurate expectations. This is probably the most widely made mistake when attempting to apply Elliott Wave analysis, because it must go hand-in-hand with a Fibonacci ratio analysis, and this is the main reason most people fail when attempting to use this methodology. This is why I strongly urge clients and subscribers who practice Elliott Wave to do their Fibonacci extension and retracement calculations even within the sub-waves in order to maintain a strong level of confidence in the larger wave count.
When Elliott Wave is applied properly, it can often pre-determine market turns that are almost to the penny, as you have seen many times. But, please do not mistake the high probability set ups with absolutes. There is nothing that will provide absolute certainty in the markets, and Elliott Wave will only assist you in assessing high probability market situations, and, very importantly, will often tell you, rather quickly, when a potential pattern is either failing or validating. Expecting more than that from any methodology is simply not reasonable when dealing with a non-linear based market.
Therefore, at this time, based upon my Elliott Wave analysis, the market is still battling it out between the bulls and the bears. We are at the tail end of a major inflection point at this time, and the side which emerges victorious in this battle will determine the direction of the market, most likely, for the remainder of 2012. As you can see, the market is now setting up for a potential 10% move in either direction, so you must still mentally prepare yourself for a bit more volatility and jostling over the early part of the week, as a strong 3rd wave set up in one direction can potentially complete. But, our hope is that, by the end of the week, either the bear or the bull will have made themselves known to be the victor, and we will have an appropriate trend to trade for the remainder of 2012.
Please take note that I have moved from the June futures contract to the September futures contract, which is approximately 6-7 points lower than the June contract.
This column originally appeared Sunday, June 24 on the Elliott Wave Trader subscription site.