View: WEEKLY ANALYSIS 0310 | The wave trading

RISK ON IS BACK

In the currency front: The JPY (proxy of global Risk On/Risk Off) has failed to confirm an almost accomplished reversal pattern. Neither the fulfilment of the Head & Shoulder target nor a potential Triangle, which was completed at the end of February, has allowed price to establish the bottom of the assumed wave (A) from the November 2011 top. Now despite technical indicators are extremely oversold the next support is at the 0.618 retracement of the June 2007-November 2011 up leg, which is almost 3% below last Friday’s eod print. Obviously the catalyst for a Yen reversal will come when investors will reduce their risk appetite, so far there is no evidence that suggests a risk reduction scenario.

In the bond front: There is an unquestionable inverse relationship between bonds and the equity markets. When the equity market is on the verge of establishing some type of a top there is always a flow of funds out of equity into bonds. If we take TLT as a proxy of the bond market, last Friday price by braking down through the February 20 low has aborted a potential short-term bullish pattern. EW wise instead of carrying out a wave (B) rebound (Black count), the wave (A) from the November 16 high is extending down with a likely Triple Zig Zag (Blue count). As in the case of the YPY, TLT is also extremely oversold, hence a short-term bounce is probable but the pattern is not complete yet. (We are in the wave A of the third Zig Zag)

Sentiment: The AAII Bull Ratio from the January extreme bullish readings, which were warning of a probable sizeable pullback of the equity market, during the month of February bullish sentiment saw a large decline. Now despite the Dow and several others US sectorial indices have established new all time highs, the current low bullish sentiment does not suggest probable a major reversal of the equity market.

What has happened last week?

Despite we had a lot of warnings from breadth and momentum indicators, price has deviated from the expected path and instead of carrying out a larger pullback from the February 19 peak; the 3-wave down leg has established an unexpected bottom at the February 26 lod.

In the case of SPX, in my opinion, the assumed Double Zig Zag form the November 16 low has morphed into a Triple Zig Zag, hence instead of carrying out a larger retracement of the November-February up leg, price is extending this up leg higher.

If the TZZ count is correct, price should be now involved in the late stages of the wave (A) of the third Zig Zag. Once the wave (A) is in place a wave (B) pullback will be followed by the last wave (C) up. The wave (B) pullback, probably, it will not breach the February 19 peak at 1530.94 (Retest of the break out) and if it does I don’t expect a move below the 20 d ma = 1520

Last week reversal has aborted my preferred long-term count since in an ED the wave (III) cannot be larger than the wave (I). Therefore the Double Zig Zag wave (X) is no longer valid.

Therefore instead of a Double Zig Zag (ABC=W; X; ABC=Y) = 7 -wave structure EW wise the last option left is a Triple Zig Zag (ABC=W; X; ABC=Y; X; ABC=Z) = 11 -wave structure

In a Triple Zig Zag the waves = 3, 7 and 11 have to unfold an impulsive sequence or an Ending Diagonal. Since in my opinion the current up leg (Assumed wave 11) is not impulsive, the wave (Z) should unfold an Ending Diagonal:

Conclusion: Given the corrective internal structure of the rally from the 2009 lows I maintain unchanged the scenario of a wave (X). Last week unexpected reversal has prolonged the “life” of the bearish wave (X), probably into the end of the fourth quarter of 2013, but EW wise once it is complete the next directional move should be to the down side.

Lets go back to the shorter-time frame

Despite the up leg form the February 26 low is quite stretched (The DOW now has 4 consecutive eod prints above the BB), Friday´s candlestick does not suggest that the up leg from the November lows is over.

If the ABC=Z scenario is correct (From the February 26 low) odds favour the wave (B) pullback during next week (Quarterly Opex next Friday) and the wave (C) rally the following week (FOMC on March 20).

The assumed wave (B) pullback will most likely be bought either at 1530.94 or in the range 1526-1521. If the pullback is larger then the wave (Z) should be already in place (Not my preferred count)

In the technical front:

As I discussed last week the Mcclellan Oscillator is overbought but the stochastic has not issued yet a sell signal:

The NYSE Adv-Dec volume is showing a negative divergence, which is suggesting that upside momentum is weakening.