The Bull Market Proceeds

From the ashes of the bear market, a bull market has sprang following the completion of the Primary Wave 4, which was a flat that lasted from 2000 to March 2009. The primary wave 5 that is forming, early indications are, that will form as an ending diagonal, which is not uncommon among 5th waves. This means that although is going to be a strong bull market, it will have steep or long corrections that could take the bulls by surprise. The best approach in such an environment is wise.

My explanation of the FLAT bear market that has just concluded is not new, I have been talking about this for a couple of years, now. Feel free to look back in this blog to look for my previous forecasts.



My contention that the bear market was concluding with the formation of this accelerated downtrend that started in October 2007 is not new. The completed intermediate wave C is an impulse wave as one would expect in the case of a FLAT. The next interesting and most important questions would be, what now?

Once an Elliott pattern is completed, one expects a counter trend, that would go back to test the highs, unless the FLAT is only the first part of one more complex pattern, such as a double three. With that in the back of my mind as a possibility, I will start with the most simple forecast: Primary wave 4 has completed, and Primary wave 5 is now underway. Early analysis of the bull market shows that the pattern is NOT developing as a classic impulse series, but rather as an aggressively up trending but corrective double zigzag. The simplest explanation is that wave 5 is developing as an ending diagonal, which is a series of 5 ABC waves. There is some ambiguity to this structure, thus one must be cautious in trading as well as investing for the long time, because there are likely to be steep and/or long corrections in the years ahead, until the pattern completes.

Since my forecast last weekend, the market continued to rally within the channel that I will use as my guide in the months ahead. The breakout from the June high has completely eliminated the possibility that intermediate wave C was still in progress. Minor wave Y of intermediate wave 1 of Primary wave 5 is in progress and this should go test the upper band of the channel.
I can almost hear the skeptical voices that are usually raised against those who appear to be market contrarians. On June 5th, 2009, at the trader’s expo I sat in a speech by Larry Katz who also called the bottom of the markets and called for a multiyear bull market. He was attacked with the most vociferous arguments implying that the economy could only get worse.

Today, the bull case is more easily made. I have searched a for companies that have reported earnings and exceeded expectations, while having a significant increase in stock appreciation. These are not few. You can look at any of them as potential candidates for trades:

CNW BDK OI ACE LLL IBM OXY BNI STR GWW STT SLAB NOV AMZN ZMH CTXS CERN CELG VZ ECL GS CF NTRS MA ISRG SRE RTN JPM CB COP SHW EMN ETN ITT NSC PPG DD MMM VFC MRK ADS ITW PX GILD AGN KMB HON WHR WLT ECA AAPL NBL NE NFX CSX RAI UNP PM CNI RRC APD AFL SAP AMT PCAR MHS UPS TROW BG BTU CAT DO BIDU TYC ALXN MET VAR FFIV FAST APA WDC TWC HES LIFE CMI SU SWN ROK AEM X FCX CVX MOS PCZ WY HP ABX AVP VSEA ADP RDSA MT MCK KLAC GG LRCX BEN CNX COF PCP

Although the forecast for the next few months is quite positive, there are those that might say that the market is overbought. To be sure, markets do not go up in straight lines, and I would not advocate to enter bullish positions at the top of the market. That is, I do not chase rallies. I had been buying the S&P500 in small amounts starting in December. I have since then stopped doing so, and will only buy again after a good correction. Still, one must look at the list of candidates above and use selective options positions. Here is what I am doing: Stocks with low volatility, I consider the PCCRC. Stocks with high volatility, I am considering biased butterflies with >3 month expiration. Although I am giving sufficient time for the markets to rally, I am also taking profits if the positions pay off early. This is my money management strategy.

Let’s take for example CNW which reported earnings of $0.64 while analysts were expecting $0.51. This is a considerable amount in excess of expectations so it qualifies as a surprise. If the company had raised guidance, I would have also considered an important entry point. When a stock jumps 10% or more after earnings, that triggers an alert in my trading platform (ThinkorSwim). Usually within minutes of the opening, I have read the earnings report, look at the volatility profile of the options and entered a butterfly or a PCCRC. This is what I did in this case:



Since the volatility of the ATM options was above 40%, I entered this biased butterfly. Although I am using December options to assure sufficient time until the next earnings season, I also make sure that the break even point in my trade is just above current market action. The biased butterfly has the additional feature of “unlimited” potential profit, if the stock in question goes well above the strike price of the butterfly’s higher strike price ($50). In this case, I am risking well below 1% my account’s available capital, so be sure to adjust accordingly.

In just a few days, CNW has exceeded the strike price of my shorts. If I had entered a plain butterfly, I would be concerned that the price would soon exceed the butterfly’s range without much profit for me. With this set up, and expiration months away, I can look forward to added profits if the stock continues its momentum. However, only days after my entry, I already have 70% return on investment, which annualized is huge. I elect to exit the trade and place my stock in a watch list, in case it corrects, giving me another entry opportunity. If volatility decreases, I might consider a PCCRC as well, since this stock is now a momentum stock.



My justification for this type of trading is my believe that the bull market is on, that in the immediate future (as Minor have Y is in effect) corrections will be shallow, so we can afford to place bullish trades while still protect against those shallow corrections. Butterflies and PCCRC’s are ideal for such markets.

Finally, I would like to present my current count on the /ES or e-mini S&P500, note that the market is making a zigzag from the lows of June. Wave A of that zigzag was completed on the overnight trading on Sunday, July 27th. Although the most recent high was on Thursday, this is really part of the B Minuette wave correction currently in progress.



I am expecting sub-minuette wave Y to retrace back to the level of sub-minuette wave W at about 965, but then the market should begin to rally again. We will see...