Sometimes things happen which call into question the foundations of one's preconceived notions. The market action yesterday and today makes me want to rethink some of my assumptions about the rally and this correction. The chart above shows the ratio-adjusted McClellan Oscillator for the NYSE. It is readily apparent that market breadth as measured by the oscillator is as oversold as it has been since the resumption of the bear market in October 2007, which raises several questions.
Am I wrong about 2010 and is this the kickoff to a violent 3rd wave down as Robert Prechter has been forecasting for several years? Or is the market already so oversold that this will be one of those shakeout kinds of corrections like March of 2007? At the moment I don't know the answer, but I do think it would not be wise to add to short positions at this time, as the most probable outcome is a violent short-term rally beginning as soon as tomorrow or within a few days.
One thing I do feel confident about is that the kind of selloff we have seen the past two days is entirely consistent with market behavior after completing an ending diagonal triangle, and the probability that markets will retrace the entire EDT back to the July lows is very high at this point. We can only watch as the market action unfolds to determine if that will be the extent of the correction or whether the correction continues even lower.
Given that the October high completed a 3 wave rally from the March low, it is entirely possible that we could see a retest of the March low or even lower prices, which could be part of a very large bearish flat correction. In that case, the March lows would be another excellent buying opportunity as the October highs would most certainly be revisited in wave Y up. One clue that could help determine the extent of the decline will be how quickly we reach the July lows. If it occurs well before the expected completion of the 10 month cycle bottom, then lower prices would be probable.
Looking back at the top in the Qs on October 31, 2007, we see that the initial decline lasted 8 days. So far, we are on day 5. This is another reason to expect a near term bottom and a rally into the middle of next week. That rally, should it occur, would be a good time to add to short positions.
If the markets continue in a free fall, then we will have to reconsider whether or not we are in the beginning stages of primary wave 3 down and all that implies.