Where to Next?

With the “unprecedented”, “historical” events of last week, people are using terms such as “capitulation”, “oversold” and “extreme”. Granted, the fear was in everyone’s face, and the move of the last two days appeared more of a short-covering rally, rather than a willingness of beaten down investors to bring their money back in.

It is hard to say whether the panic in the Street is an indication of capitulation, as they would call it. Personally, I would make no commitments of my money one way or the other. I just keep on trading my PCCRC strategies, if a real candidate shows up. However, I would attempt to use my favorite indicators to try to make some sense of what has occurred and to make a forecast of what may come, and how to take advantage of the opportunity.

First, let’s look at the $VIX. The CBOE volatility index of the S&P500. Indeed the $VIX spiked well over 40, to settle down back to the low 30’s, in what appeared to be a climax in volatility the likes of which we have not seen in years, exceeding the previous peeks of Aug. 2007, and Feb and April 2008, and a minor peak in July. But this is hardly what you would call a historical event.

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If you go back to the early 2000’s you’ll see a few more dramatic spikes. Let alone the 1987 spike. Markets DO recover, and stability returns from the ashes of events like this weeks. However, this is not in itself an indication that “the worst is over”, for all we know it may only be the beginning, as the repercussions of the bail out begin to be felt in Main Street with inflation, fear, and collapse in consumer confidence.

As traders, we cannot rely on hope that things will get better, let alone “trust” in America, and other rallying cries. We have to look for opportunity, wherever it may arise, dust our selfs off from our loses (if any) and prepare for the next trading day. Only those that can keep a clear head and can have a confident believe in his/her system or approach to trading will live to trade another day, and perhaps even thrive when others despair.

As it is often the case in times like this, I go back to my roots as an Elliott enthusiast and try to make sense of the chaos that is the stock market. I am seeking some understanding of what is the real meaning of the events last week, from an Elliott wave perspective. I’d try to be as unbiased as I can be, using a time honored method of making the best case and worst case scenario Elliott counts and establish invalidation points for these two counts.

As Mr. Spoc (start Trek character) used to say, when all the possible alternatives have been eliminated, what ever is left, no matter how improbable, must be the truth.

I am assuming that the peak of the market in Oct 2007 represents a mayor high, and that the pattern that has developed since should be a discernible Elliott pattern that may or may not be completed, but with clearly readable, and complete patterns of a lesser magnitude. My policy with the Elliott wave theory is that the smaller completed patterns should be air tight and that they should give us reasonable indications of what the larger patterns would be. Below I have created my best-effort counts. I believe strongly on each one of the smaller waves, labelled here with cyan blue numbers or letters. I will use R.C. Beckman’s terminology and call this “Minuette” or multi-day waves. Completed Minuette waves give rise to Multi-week waves called “Minute” waves, which in turn give us an indication of the complete or uncompleted Multi-month “Minor” waves. We can only be certain that the bear market is complete if we can conclusively demonstrate a complete pattern. Still, even after having a complete Minor Wave pattern, we must be vigilant for an alternative count. Only if and when we can invalidate the best possible alternative count would we be able to forecast the continued decline or reversal of the market.

Day traders talk about pivot points, support and resistance. We can use two extreme road marks that I would call Elliott invalidation points. This are points that if broken would invalidate the count, and perhaps validate the alternative. There are not entry points, in fact one might even take profits at such points because the markets will tend to reverse at those points, but the invalidation of the count would indicate that a new multi-month “Minor” wave is in place, or the alternative, which is that the current Minor trend is still in place.

The bearish alternative, suggest that the downtrend is intact even as the 20dMA (red curve) is broken and the 50dMA (green curve) is being tested. The 200dMA is usually an indication of the larger trend until broken (blue curve). But we are not about to wait until the 200dMA is crossed over to make that decision. Instead we rely on the Elliott wave invalidation points.

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Only if the likely Minor wave 3 (currently in progress) is invalidated could we positively rule out a continued decline. Perhaps at that point, the 200dMA and the price action would meet. Once this alternative count is invalidated, we must then assume that the bullish alternative below is the correct one.






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Here again I have placed an Elliott invalidation bar in red. The count below is a double zigzag, counting from the top of the market in October 2007. This count implies that the pattern is now completed and a rally to test the October highs would now be in place. If this count is wrong, the market will decline and break through the red bar in the chart below, before the red bar in the chart above is broken.

Please do not rely on this forecast to make your trading decisions. I can only recommend that you trade delta-neutral strategies and only in situations in which such strategies are indicated. If you decide to trade directionally, be sure to limit your risk with options.

The market will do its thing, always catching us by surprise!