(Editor's Note: this has got to be one of the coolest, cleanest, most interesting guest posts ever; wow! Thanks, SJ! – Tim)
After the amazing day yesterday I have spent a lot of time reviewing
various charts. The first thing I have looked at is the wave count on
SPX. After yesterday I don't think there can be any real idea left that
the low on May 6th was just a 'fat finger' error. It was a powerful
third impulse wave down, and the wave count so far looks pretty obvious
from the SPX daily chart, even though I definitely wouldn't regard
myself as an EW expert.
Whether we are in the first wave down of an ABC correction, or of a five
wave bear market move, doesn't really matter at this point. I favor the
first scenario for longer term reasons that I'll explain in a weekend
post soon, but until we reach the end of the third wave down, it doesn't
make a lot of difference.
For this first wave down though, it seems obvious enough that the first
subwave bottomed at 1181.62, and that the third subwave bottomed at
1065.79. Subwave 4 was almost exactly a 76.4% fib retracement of wave 3,
topping out
out a few points below the bottom of wave 1. The subwave 3 low was taken
out on ES last night in what is obviously the current subwave 5.
Occam's Razor tells us that the simplest explanation is often, if not
usually, the correct one. I've seen a lot of EW counts over the last few
weeks, but this count looks to be the simplest and most obvious
explanation, and more than likely it is the correct one:
Where will this first wave end though? The third subwave down was 143.57
points, and the fifth subwave will probably be shorter, though not
necessarily. From the subwave 4 top at 1173.57, that would give a likely
wave range down to 1030 SPX for the completion of the first main wave
down.
The target of the broadening bottom that I posted yesterday was 1044 ES,
which is very close to the February low and would be a good subwave 5
target. If we do bottom there, it would strengthen a pattern setup that
would be pure chartist poetry for the next two waves of this bear move.
It would confirm that there is a right angled and ascending broadening
formation on SPX (66% bearish) and would also finish the head for a huge
head and shoulder pattern within that broadening formation. Both
patterns would indicate to the July low at 870, at what was (or is) the
most important support and resistance level for the bear market. We
would reach the top of the right shoulder on the next main wave up, and
then the third main wave down would carry us through the neckline to the
target:
The strangest thing about yesterday was the powerful move up in EURUSD
at the same time as the powerful move down on ES. This may signal that
the usefulness of this positive correlation between the two is at an
end, but I suspect it just means that ES is lagging EURUSD by a few
days, and that after making an interim bottom on ES shortly, we will see
that return to normal. I hope so, as EURUSD has been a very good
indicator for equities for quite a while now, and if the correlation
fails completely, that will be a great loss.
In the short term, the IHS that I posted yesterday has now formed,
broken the neckline and started to play out. The target is 1.282:
That's what I would expect from EURUSD, which bottomed where I expected
it to this week within the current broadening descending wedge. These
wedges are very good performers on EURUSD, as I mentioned earlier this
week, and as you can see from this weekly chart of EURUSD over the last
few years.
The only wedge that failed to make target on this chart was the
broadening descending wedge that ended in late 2008, and that target
failure was signalled both by the pullback in early 2009, and by the
boundaries of the subsequent rising wedge. Another interesting thing to
note on this chart is the rising wedge into mid-2007 that broke up, as
rising wedges do 31% of the time. I mention that because EURUSD is
currently in a broadening descending wedge, and these break down 45% of
the time.
Barring imminent apocalyse though, EURUSD is due to correct up to the
top trendline of the current broadening descending wedge, currently at 1.33 and
declining rapidly. We may see a period of sideways trading where EURUSD
slowly moves towards the line at a lower target of 1.282 to 1.30, but we
are due a bounce here and one seems to have started already. During
such a period, we would expect to see SPX trading up or at least
sideways. It is disturbing that we haven't seen that since EURUSD
bottomed early on Wednesday morning:
The right-angled and ascending broadening formation is perhaps the
characteristic pattern for where we are right now on equities. There are
quite a few of these as well as broadening tops across various indices.
Here is another example of one on the FTSE, and seeing these is a large
part of the reason why I think that if we don't bounce soon, then we
may fall a great deal further over coming weeks.
As you can see from this chart, we are right at the bottom of the
pattern, and it is an ominous sign that after a partial rise, the FTSE
has returned to retest the lower trendline. That signals an imminent
downward breakout 81% of the time, but until we see SPX break support at
the February low with conviction, I would regard it as subordinate to
the SPX pattern, as the FTSE is really just one tail on the SPX dog.
If SPX does break support there though, and then takes out the November
low at 1029.38, then this subwave 5 would be longer than subwave 3 down,
and the potential would open up to go a great deal lower in the coming
weeks.
In that event the recent action on the daily chart for 30 year US
treasuries would also look very ominous. For the past year, these
treasuries have been trading in a large rectangle, and have broken up
from it this week. These aren't always reliable when they take more than
a few months to form, and the eight month rectangle on XLF that broke
up in April failed to make target at 18, but FWIW, the target is 134,
which is what I would expect to see if we get a very major flight from
risk over coming weeks.
So there we have it. We bounce very soon, or equities continue falling
into a chasm of unpredictable depth. Should be fun either way, but it
will be a lot easier to trade this if we do bounce, so that's what I'll
be looking for here.
