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Sunday, November 16, 2014

Elliott Wave Analysis of the SPY (SPX)

I decided to get the book out and look at a detailed look at each of the characteristics of a 5 wave impulse wave and see if it fitted well to the move we have seen from the Oct 2011 lows. Its my belief that we are nearing the end to the trend from the Oct 2011 lows and a significant decline is setting up.

I initially thought we had a peak back in Sept 2014, you can read that here: http://wavepatterntraders.blogspot.com/2014/09/brk-vs-spx-where-buffett-goes-so-does.html

However with the last rally I have been forced to adjusted the idea. whilst its was a great move that I forecasted it was not the move I was expecting. I am expecting a larger move than 200 points on the SPX.

Lets take a look at the chart and see if we can cross reference the thoughts at the time to what we have now.


1) Wave one is rarely obvious at its inception. When the first wave of a new bull market begins, the fundamental news is almost universally negative. The previous trend is considered still strongly in force. Fundamental analysts continue to revise their earnings estimates lower; the economy probably does not look strong. Sentiment surveys are decidedly bearish, put options are in vogue, and implied volatility in the options market is high. Volume might increase a bit as prices rise, but not by enough to alert many technical analysts.

I think we can all agree, at the time it was very bearish, and the bounce was considered a "dead cat" the bears were expecting much more downside as the next bear market hard begun or so the bears thought. So we can tick the box on that wave.

2)  Wave two corrects wave one, but can never extend beyond the starting point of wave one. Typically, the news is still bad. As prices retest the prior low, bearish sentiment quickly builds, and "the crowd" haughtily reminds all that the bear market is still deeply ensconced. Still, some positive signs appear for those who are looking: volume should be lower during wave two than during wave one, prices usually do not retrace more than 61.8% (see Fibonacci section below) of the wave one gains, and prices should fall in a three wave pattern.

Well wave [2] did correct wave [1] and that would have got many bearish as that's what a 2nd wave does. Volume was lower as well, prices retraced around 61.8% of the prior wave [1]. So we can tick the box on that wave.

3) Wave three is usually the largest and most powerful wave in a trend (although some research suggests that in commodity markets, wave five is the largest). The news is now positive and fundamental analysts start to raise earnings estimates. Prices rise quickly, corrections are short-lived and shallow. Anyone looking to "get in on a pullback" will likely miss the boat. As wave three starts, the news is probably still bearish, and most market players remain negative; but by wave three's midpoint, "the crowd" will often join the new bullish trend. Wave three often extends wave one by a ratio of 1.618:1.

Well we can count a large 3rd wave, the news was getting better and more positive economic reports were seen, even earnings were getting better if you believe the financial bubble media. Hardly any pullbacks so that's a characteristic of a 3rd wave as well. By the mid point many are joining in and "buying the dip" aka BTD or was it BTFD. I cant remember these days, there is a new one as well which is BTFATH. Wave [3] is longer than a 2.618 extension of wave [1]. So we can tick the box on that wave as well. 

4) Wave four is typically clearly corrective. Prices may meander sideways for an extended period, and wave four typically retraces less than 38.2% of wave three (see Fibonacci relationships below). Volume is well below than that of wave three. This is a good place to buy a pull back if you understand the potential ahead for wave 5. Still, fourth waves are often frustrating because of their lack of progress in the larger trend

Wave [4] is clearly a corrective decline, its in 3 waves, so that's the definition of a correction, its not in 5 waves, hence we are seeing a new ATH. In a strong uptrend when a 3rd wave is far more than a 2.618 extension of the 1st wave, we tend to see shallow 4th waves around the 23.6% of the 3rd wave, that's an acceptable 4th wave target. The Oct 2014 low was almost a 23.6% correction of wave [3]. The only negative is there was no alternation between wave [2] and [4], although not a rule it would have been nice to have seen that. So we can tick the box on that was as well.

5) Wave five is the final leg in the direction of the dominant trend. The news is almost universally positive and everyone is bullish. Unfortunately, this is when many average investors finally buy in, right before the top. Volume is often lower in wave five than in wave three, and many momentum indicators start to show divergences (prices reach a new high but the indicators do not reach a new peak). At the end of a major bull market, bears may very well be ridiculed (recall how forecasts for a top in the stock market during 2000 were received).

Well the news is "almost universally positive"  Investors have now bought into the trend (see the last weeks readings )

Survey Results

Sentiment Survey
Week ending 11/12/2014   Data represents what direction members feel the stock market will be in the next 6    months.
Bullish 57.9%
up 5.2
Neutral 22.8%
down 9.5
Bearish 19.3%
up 4.3
Generally this is considered to be the reading of the public I believe its a new high since the Oct 2011 lows. so the "public is on board". What can go wrong?

Volume is showing a clear trend moving lower as price moves higher. We have many momentum indicators showing divergences, and the bears are well and truly being ridiculed, if you mention that the market can move lower you are labelled a pariah, i have first hand knowledge of this, i was suggesting (although telling members to expect a strong decline) to people that the market was setting up for a significant decline in Sept 2014, only to be abused. so we certainly have the bears being abused and laughed at. So we can tick the box on that wave as well.


I believe this is a standard text book 5 wave impulse from the Oct 2011 lows and I think the risk for a significant decline is very high. so i strongly suggest anyone that is invested, take appropriate steps to protect yourselves, You saw how fast these markets can unwind, the Sept -  Oct  decline was speeding down before anyone even thought about a correction and fooled many. The next decline may shock many.

Time will tell.