An Elliott Wave Resolution?

(click to enlarge)

The above two charts represent my current working elliott wave count for the rally. I have played somewhat fast and loose with the nomenclature in the past few weeks, but I have attempted to reconcile the labelling with Frost and Prechter's scheme from the "Elliott Wave Principle" (EWP) in these charts.

Arriving at a satisfactory count has been frustrating, to say the least. Several less than ideal factors have hindered the interpretation: 1) the April/May up move is not a text book impulse wave, although it appears to be impulsive, 2) the Qs made a higher low in July, while the SP500 did not, 3) the July/August upmove appears to be impulsive, but may not be, and 4) the market action since August has resulted in overlapping waves that subdivide into 3 waves.

Whenever we encounter these types of problems, it often pays to step back and look at the big picture and other information. My preferred count for this bear market is that we are in Supercycle wave (IV) and cycle wave x to be followed by cycle wave y. Cycle wave w completed in March 2009 (red w above). X waves are almost always 3 waves and usually zigzags. Given the size of wave w (9 years), we would expect wave x to be longer than just 6 months. My analysis of stock market cycles, and independent analysis by others, supports the view that the current rally will persist into the summer or fall of 2010. Therefore, we can expect that wave x will be a double zigzag. A double zigzag is composed of two abc zigzags that each have a 5-3-5 wave count. If we consider that the current zigzag is nearing completion, and if we require a 5-3-5 wave count, the only reasonable count that fits both the Qs and the SP500 is as shown above with intermediate wave (C) being an ending diagonal triangle that is yet incomplete.

While it may be possible to arrive at a much more bullish wave count by supposing that the move up from July is a still developing impulse wave that will lead to a huge 3rd wave breakout in the next few weeks, the waning breadth (as I measure by my own weekly breadth indicator) and the current position within the 10 month cycle do not support this view, which leaves us with the ending diagonal triangle (EDT).

From this interpretation, it is clear that the markets will make a new rally high in October after an intervening pullback. For an ending diagonal to be valid, wave 3 cannot be the shortest wave, and in this case that means wave 5 cannot be longer than wave 3. Therefore, as long as the SP500 remains under 1121.59, the wave count will be valid. For the Qs, the upper limit is 45.43.

While these are the upper limits, in all likelihood, these levels will not be seen. Often times, wave 5 for an EDT is 61.8% of wave 3. This gives us targets of 1082.76 and 43.63, respectively for the SP500 and the Qs. Amazingly, 43.63 is the upper target that I calculated weeks ago using trading steps, or boxes. A move above the upper trendline of the EDTs for both markets would put them between these levels. On that basis, we can project the highs for the SP500 to be somewhere between 1080.15 and 1121.59, and for the Qs to be somewhere between 43.17 and 45.43. Given the fact that we will probably see a pullback followed by another rally high, the high will most likely occur sometime toward the end of October and the first of November.

The one fact that follows from the above analysis is that the ensuing correction will be sharp and deep. From EWP pg. 38 we read, "A rising ending diagonal is usually followed by a sharp decline retracing at least back to the level where it began and typically much further." My experience has shown this to be correct on several occasions. Only once do I remember a stock with an EDT falling short of the origin. It has also been my experience that the time of the correction typically lasts about 1/3 the time of the EDT. So we should be prepared for a correction back to the July lows that lasts about 6 weeks. Which also amazingly would put the end of the correction at my projected end dates for the 10 month cycle of December 9-11 to December 24.

We are talking about a correction on the order of 20% or more. So October is the time to be exiting long positions in preparation for the impending down move. A reversal from a new high would be an opportunity to get short, and a break of the rally trendline would be an opportunity to add to short positions.

We can now also make a preliminary projection for the x wave targets based on a measured move. Using the 43.63 and 1082.76 levels above and the July lows, we arrive at target of 52.30 and 1285.29, respectively, a nice 50% gain for wave (Y) of x.

I am sure that the above analysis may not agree with everyone, but until something different develops, this will be my working count for the duration.