Now that we can safely assume that the series of waves from the highs of 2007 are part of an Intermediate wave C of a Flat, we can also assume that wave C is an impulse. A such, it must have 5 waves, one of which is “extended” or the larger one of the three components that go with the DOWN trend. The severe decline between May and October 2008 is the impulse Minor wave 3 (nothing minor about that, right?). The reversal we saw between November and January 2009 was quick but powerful, but as experienced traders will tell you, bear markets are characterized by very strong bear rallies that may caught you by surprise and make you react by buying the markets and thus fall into a bear trap.

Fortunately, the impulse series are much easier to define than corrective waves, and knowing that, we can wait until the markets have made a higher low before committing large sums of money. Nevertheless, the bear traps are quite tempting and using short-term options in a highly volatility market one can profit substantially, at least in some high performing stocks. I am partial to the use of Butterflies in this market with no more than an month to expiration in a select group of highly volatile stock with liquid options.

The common question among investors and trader these days is: have we formed a bottom? there are plenty of skeptical traders who have seen these strong rallies in the past, only to be disappointed in the end. I say that even if the bottom has been reached and the current rally is the beginning of a great bull market, one must be cautious in the understanding that every wave 1 must have a wave 2. Second waves correct up to 99% of the first wave, but generally no more than 61.8%. That does not mean that we cannot take advantage of both ups and downs.

Let’s compare my two proposed counts: Once more hopeful says the bottom is already in place. The impulse wave series is completed with a lower low compared to the lows of 2002-2003. Minor wave 3 is clearly the extended wave, and Minor waves 1 and 5 have an approximated symmetry. Minor waves 2 and 4 are also very similar in duration, but sufficiently different to satisfy the alternation rules. There is only one problem, which is by no means a small one: the proposed wave 5 is neither an impulse nor an ending diagonal, therefore it is not really a Minor wave 5. Until a final impulse or ending diagonal occurs, then we have to believe that the Minor wave 4 is still in progress.



So. what is the alternative? look at the next chart below. I would appear that the market is still in Minor wave 4. My problem with this count it, although it is an acceptable FLAT progressing through its Minute wave B, the Minor wave 4 is significantly larger and more complex than Minor wave 2. Once decided that these 2 choices are possible, then we can perhaps forecast how the SPX will behave going forward. In both cases, the resistance above is at the January peak of 943.85. Also, this is where the 200dMA is likely to be in a couple of weeks, and that alone could prove to be a strong resistance. This correspond to the high of Minor wave 4 in both cases. This is a reasonable place for wave 1 to end (if the first analysis is the correct one). If Minor wave 4 is still in progress, then we should expect also a peak at the same resistance point were wave A of 4 completed. Ironically, therefore, it is almost inconsequential to be “right” about the count.

We can then focus on the targets for the correction. In both cases we can expect a test of the lows. If the S&P500 makes a new low, then we’d have settled the question, if the 5th wave forms an impulse or an ending diagonal. If instead the SP&500 retrace about 60% of the rally that started in March, then we could say with more authority that the bear market has been over since the lows of early March. Then we could expect a strong rally after than. Hopes of new highs in the coming years may not be unreasonable. In my next article, I will describe the situation for the Nasdaq composite.