Market Entering A Correction/Consolidation Period

We have distribution days piling up with another one today. We have a negative divergence MACD sell signal. And we have the 4/27 swing low coming under the 4/19 swing low. All we need now is a move below 1181.81 to confirm that the short term trend is down. However, the 50dema is just below at 1170 followed by the January high at 1150.

There are a number of reasons to believe that markets will attempt another high in May, but the 20 week cycle is due to bottom in late June. This suggests that we may see a flat correction develop over the next few weeks. I postulated that possibility after the January high, and it was summarily dismissed by the market, but sentiment has reached an extreme that will take some time to work off.

The RSI 14 has room to move to the downside so we should assume the correction will take more time to complete. Only after we see the form of the current decline can we make a more educated assessment of the nature of this correction. Of course, we could see just a small 3 wave pullback and then a burst to new highs, but given the extreme nature and duration of the rally since February 5 that would be unlikely.

An impending low next week would offer opportunities for short term longs, while a double top or lower top in May would provide the best opportunity for short term shorts. An expected low in June should give us the last chance for intermediate term longs this year.

The bears are now beginning to growl again, but I believe their noisemaking is premature. As I showed with the charts of the XHB and XLF on Wednesday, the markets have at least one more upswing to complete the rally. And as I showed in last Friday's big picture view of the SP500, this cyclical rally is probably far from over.

Unfortunately, technicians can get locked into singular viewpoints about future market direction. Corrections by nature can take many valid paths and the best that we can do is estimate the probable direction. It is rare that conditions are such that all but one outcome is determined. Consider the XHB and XLF. After completing a double zigzag upward correction later this summer, they could easily correct in another 3 wave movement only to move higher in another double zigzag to form a more complex combination, or in an impulse to form a very large upward flat correction. This would allow the broader markets to move back to the all time highs, while the housing and financial sectors remain down near the bear market lows. The entire process might take years to unfold. So don't get caught up in this notion that we have to fall off of a cliff with the Dow going to 4000 next year. It might happen, but we are along way from having enough information to come to that conclusion yet.

Amazing Channel

The Qs have traded around the median line formed by the November 08 and March 09 double bottom for over year. To me this is truly amazing and shows the overall strength of this rally. There has been only one brief test of the lower channel line, but I suspect that between now and mid-June we will see another. That will probably be the launch point for the final moonshot of this historic rally. However, since the current formation is occuring below the median line, it is less likely that we will see a move to the upper channel line. The median line should prove to be formidable resistance through the summer. Even so, the slope of the median line projects to 58 at the end of August when the top is expected, which would be another 15% gain from current levels.

The lower channel line will mark the transition from rally to correction when it occurs, and it will occur at some point.

Missing The Forest For The Trees

While there has been great debate over the elliott wave count for the major indexes, two sectors that have not gotten much attention in this debate are the two sectors that got us into this mess in the first place: housing and financials. Even though reasonable people, reasonable analysts, may disagree over the wave count for the major indexes, the wave count for these two sectors is about as clear as one will ever see. If we can't agree on these, then we should forget about elliott wave altogether. Both sectors are sporting a double zigzag upward correction.

In the XHB, wave (X) is a triangle, which is how we know that it is an (X) wave. Wave C of (W) = wave A of (W), which is how we can be fairly certain that (W) is a zig zag. Some technicians are calling wave (X) a 4th wave, but that really is stretching it. We would normally expect a third wave to be longer that a first wave, if this were the beginning of a new bull market.

In the XLF, wave (X) is a zig zag. Again, some may argue that wave (X) is a 4th wave, but this would give a third wave that is considerably shorter than the first wave, which just does not fit with our expectations of a new bull market.

In both cases, waves A of (Y) are approximately equal in time to waves A of (W), so we may expect that waves A of (Y) are complete. However, we might also expect them to be the same length in price and to approach the upper channel lines, which means they could have a little further to run.

Either way, both of these charts are telling us something very important, and that is that after an intermediate term correction lasting 6 to 8 weeks, we can expect one final push higher to complete the countertrend rally that began in March 2009. Afterward, both on these sectors will correct substantially if not move to new lows. We can also expect that the rally in the broader indexes to fail coincidentally with these sectors or shorter thereafter.

My current projections in time put the top of the overall rally around the end of August to the first of September.

Selling Finally Show Up

It appears that the SP500 is headed to at least the 50dema around 1167 if not the January high around 1150 by the end of this week or the first of next week at the latest. That should mark the end of this reaction. Afterward, we should expect a retest of the April high at a minimum, but more likely a move to 1260 by late May. The McClellan Oscillator still has not broken down, and I am still waiting for an oversold condition.

Oil has broken back down into its trading range. It must hold above the $75 level or risk breaking down altogether. Gold has begun its last leg up in the double zigzag upward correction. I expect that gold will top at the same time that the stock market reaction ends.

BWLD is selling off more than 20% afterhours. There is a good chance that the recent high completes an ending diagonal triangle. If so, the downside target is 14.50. However, it would be best to wait for a countertrend reaction to consider a short trade.

Waiting For An Oversold Condition

The McClellan Oscillator is holding in a range. At the moment I am not entering new long positions until it becomes oversold at -200 or lower. I will exit my two remaining short-term short positions at that time, should it occur, and will be looking to add short-term longs.

The action today continues to be consistent with a developing blow-off top. Size positions accordingly.

The Big Picture

I think it would be a good time to step back and look at the big picture. The above chart is a monthly chart of the SP500. One of the things that stood out to me years ago during the 2002 to 2007 rally was how the market respected what I am calling the decadal pivot of 1160.75, which is just the midpoint of the decline from 2000 to 2002. This level was influential even before the market topped in 2000 as can be seen by the first red arrow. It was then support and afterward resistance during the 2000 to 2002 decline. Later during the 2002 to 2007 rally it proved to be significant resistance which led to a multimonth consolidation. After breaking through that level in November 2004, the market consolidated above it for many more months before the uptrend resumed. However, in January of this year, the market only paused briefly before punching through with vigor.

I've noted the previous range of the congestion zone during 2004 and 2005 (blue lines). Even though it does not appear to be significant at the moment. I believe this range will prove to be significant during the rest of this year. The top of the range is at 1260. The expectation would be for a pause near 1260 and consolidation above 1160 for the rest of the year with the worst case scenario being a return to 1060 at the bottom of the range. If 1260 is penetrated meaningful and sustained during this summer, then we should expect an assault on the all time highs by the end of the year as there will be no significant resistance above that level.

The yellow line at the bottom of the sell zone is the August 2007 low. This is not a strong resistance area as it was strongly penetrated in May 2008. Therefore, the line in the sand is 1260. The March 2008 low as 1256.98. Penetration of and reversal at 1260 with a monthly close below it should usher in a retest of at least 1160.

From the longer term perspective, a move approaching or exceeding the 2000 monthly closing high of 1517.68 should be seen as an opportunity to sell long term holdings, a rare gift. At that level, the SP500 would be tracing out a large expanding wedge, a megaphone pattern with the expectation that a restest of the 2009 low will follow in the future. If it pulls back in a corrective manner from that high level and breaks out then we would most likely be in cycle wave 5 up. Even so, that would only usher in another top that would most likely lead to a retest of the 2009 low. Either way risk will be high at that point.

The sustained move above 1160 this month has routed the bears. Until we see a sustained move back below that level, I will not be shorting this market and only very select stocks that are definitely breaking down against the trend. We should expect a brief pullback at 1260, perhaps one that lasts 2 to 4 weeks, and thereafter a rally into the sell zone. A move above the 2000 monthly closing high of 1517.68 would be a rare gift and a second opportunity opportunity to sell long term holdings. While it is possible that we are in cycle wave 5 up to new all time highs, that is not the most probable outcome. Even so, we are now clearly in a sustained cyclical bull market that must be respected.

7.25 Years Or 3.5 Years?

Bob Prechter has put out a new cycle analysis pointing to a 7.25 year cycle. I hate to disagree with him, but I don't think there is any such thing.

There are 3.5 year, 3.75 year, 5 year, and 7 year cycles which are subharmonics of longer cycles. The interplay of the 3.5, 3.75 and 5 year cycles gives rise to the illusory 4 year cycle, which seems to be very evident for several periods and then seems to fade out for a time, as it has right now.

I pointed out in March of 2009 that the 3/9/09 low was probably the beginning of a new 3.5 year cycle, which was why I believed that the rally would last well into this year, and why we should expect some sort of low in late 2012.

There is also a 20 month cycle which should bottom late this year, around November or December after the current rally tops in earnest. It will only be after we see the form of the decline that we can know whether or not the bear market has returned. The low late this year will have everyone talking about the 4 year cycle low and the continuation of the "bull" market. Don't fall into that trap. Yes, we will see a rally next spring, and maybe new highs, but it will still be part of a bear market rally that will eventually give way to a retest of the 2009 low.

Long cycles tend to have double tops. The biggest double top in history occured in 2007, but the actual 42 year cycle "high" was in March of 2003, appearing as the 21 year cycle low between the two tops. Part of the reason that even with the devastating decline that we had in 2008 the markets have been generally up is that we are on the front side of that 21 year cycle. It is due to peak around 2013/14, which should mark a low between two more tops of lesser degree.

So what does all this mean? It means that the stock markets will be making huge swings for another decade with the final decline not likely to occur until the end of the upcoming decade or the early 2020s. It means that Dow 4000 or lower is not likely to be seen for several more years. It means we have a lot of great trading ahead of us if we can learn to follow the trend and not get bogged down by a particular wave count that may or may not be right. It means that there is a great deal more economic turmoil to come, and we should be prepared for that in our personal finances and businesses.

What about the wave count? I'll have more to say about that after we see an intermediate top which is coming soon, but one thing is for sure. We have more rally to go this summer, and shorting this market has not worked for some time. Traders would probably be better served by not trying to short the coming top, but by taking a break and looking for new long opportunites for the summer rally.

The Amazing Levitating Market

This market is truly amazing. It refuses to correct even though most agree that it is overbought and due for a correction. The internals are not that great, but not that bad either. This makes it a dangerous market. It leads to a complacency that will likely catch many off guard. Even if it continues its upward trajectory, I think the prudent thing is to be taking profits on short term trades when possible, and not initiating new intermediate term trades until we see a pullback to the 50dema. The Wilshire 5000 looks as though it only needs one more push up to reach its upper channel line, which should be the terminus for the rally from 2/5/10.

There are reasons to believe that the rally might make another new high in May after the first pullback, but I think any test of the current high will be a (B) wave. We may see a repeat of last year's May/June correction.

Gold appears to be ready to move up in wave [c] of Y of (X). This will probably lead to some metal stocks breaking out. However, the move may not last more than another 8 to 10 days.

Oil is still holding up and oil service stocks are doing well. I expect oil to continue its move higher against general expectations.

A Few Observations

AAPL is up after hours, but not nearly so much as one might think given the earnings results. It's possible that the action over the last 3 days is a small degree triangle that projects a top under 260. This may very well be a 5th of a 5th wave top. It often happens that a company's best earnings results occur at the top of it's run. We shall see.

The McClellan Oscillator failed to rise above the zero line today continuing to indicate that all is not well with the market no matter how great it looks on the surface. However, the market may work off this condition by consolidating sideways for some time. The key will be a deep oversold level in the Oscillator.

I count 14 stocks in the Dow 30 that are breaking down or that have broken down. I count another 4 or 5 that appear to be in 5th waves, some of which are ending diagonals, which portends some sharp selling. Nevertheless, the head and shoulders pattern that I posted yesterday appears to be busted, but we will probably only see a sharp 5th wave thrust before more selling begins. It may be prudent to sell short term longs on this thrust higher, which may only last one day.

Gold and silver look toppy. They may try for another rally high, but overall the pattern appears to have completed or be completing a double zigzag upward correction that should resolve to the downside. Wave Y down should take about 2 months putting the expected bottom in gold and silver around the first of July.

Is oil in trouble? Possibly. I would like to see it get back above 86.40 soon or a sharp selloff may be coming. I still think the intermediate trend is up, but the risk is increasing. One alternate interpretation is that the pattern since the 7/13/09 low is a very large ending diagonal triangle. If so, oil should stay above 76, preferably 80, and then we would see a final 3 wave upward movement ending in a thrust above 90. Afterward, a very sharp selloff should ensue initially down to the 7/13/09 low of 58.32.

After two really great years, I am having a very dull year so far. Sometimes success can go to your head. The elliott wave count has been hard to work out, and my expectations have gotten in the way. However, I know if I keep working and controlling risk the situation will resolve itself.

Head & Shoulders Top In The Dow

The hourly chart of the DJ30 is sporting a nice head and shoulders top that targets 10757 to 10677. It is a good bet that a retest of the January high is likely, but that should provide a good entry point for new longs, at least short term. I would be surprised if the January high is broken on the first test. Money managers are in the black for the year and will defend that level vigorously. A break of the lower channel line from the February low will also bring in a lot of new shorts, which should add another layer of support.

Anatomy Of A Trade - ATPG

In my opinion the best trades come from being patient and stalking a good setup. I had been watching ATPG for some time for a potential setup. The stock is volatile, but has also shown strong trends. As oil consolidated its gains in March, ATPG moved sideways and formed an ascending triangle, but in addition to the triangle pattern, ATPG's moving averages were all stacked positively with the 50dema sloping upward and above the upsloping 200dema. Price tested the downsloping trendline 3 times in March. This can indicate strong resistance, but also the possibility of a powerful breakout. The MACD was above the zero line confirming the uptrend and setting up for a buy signal.

The triangle developed two proper buy fractal pivots, and at the end of March I entered a Buy Stop Limit order at 19.90 above the high pivot of 19.81. Oil broke out to new highs on 4/1, but it was several days later on 4/12 before ATPG broke out.

The late breakout coupled with the triangle pointed to a short term trade. My initial expectation was for a gain of 2 ATRs (target of 21.30+). However, with the strong close on 4/14, I decided to wait and see if ATPG could breakout to new highs. On 4/15 it did breakout but closed below its previous high. The volume on the breakout day was much less than the volume at the previous high, and in the meantime oil had made a lower high on the daily charts. These three factors indicated it was time to sell.

Of course I was not expecting to wake up Friday morning and see oil down $2. I wondered how much profit I would give back at the open. I entered an order to sell AT The Market before the open and felt fortunate to exit at 22.91. This was a gain of 15.1% in 5 days.

ATPG may break out to new highs yet, but my trade objectives were fulfilled. If only they could all be that easy.

Update

Since my earlier post today on KKD, the market slide has accelerated. I think it is safe to say that the expected shakeout is underway. The pullback may last several days. I am looking for the traditional McClellan Oscillator to fall below -200, -300 would be better, to signal an end to the pullback. Until then, new longs are off the table. This should be a quick affair, so short positions should be taken only a hit and run basis.

Profit Taking In KKD

Krispy Kreme announced earnings after the bell yesterday, and while there is some concern about the decline in total revenues, other factors were decidedly positive. The turn-around plan seems to be working and plans for new company and franchise stores are moving forward.

Nevertheless, there is some profit taking today. There are multiple levels of support, in particular, the 50 and 200 demas as well as the recent swing high of 4.25. In order for the stock to really take off, however, it needs to break the $5 barrier which will allow mutual fund and institutional support. That said, I am definitely encouraged by the lack of news coverage on this stock. It is showing positive changes while maintaining its underloved status. This is a great contrarian sign.

The expected shakeout in the broader markets may be underway, but it is hard to tell since this is options expiration Friday. I don't think today's decline is the beginning of a larger correction just yet. I think we will have to see a retest of this week's highs first, but this view could change if an impulse wave down develops.

One area of concern that has developed over the last couple of days is oil. Oil has failed to produce a completed impulse wave after the recent breakout from a running triangle pattern. If it falls below 78.86, we may have a busted pattern. I still think the overall trend is up, but a wait and see cautious attitude is warranted. The current pattern could end up morphing into something different with an expanded flat correction before heading higher. Critical support remains well below current levels at 69.50.

Feels Too Good!!!

The 5sma of the equity only put/call ratio just hit a 3 year low, and the PPO(5,50) did as well. This is extreme bullishness. It doesn't mean the rally is over tomorrow, but it is a major warning sign. In particular, it is telling us that the 5th ( or (A) ) wave may be in its final stages. Certainly this is not a time to be adding short term long positions, but rather, selling them.

I did buy VSEA on a breakout today, but I already had the order in place for the last few days. I will probably sell it tomorrow or Friday.

This type of market makes you believe you can do no wrong. This type of market lulls you into complacency. This type of market gets you to overcommit, and then pulls the rug out from under your feet. Watch out!

Shakeout Coming

Notice on the hourly chart how momentum as measured by the MACD has never comfirmed the breakout to new highs, and neither has volume. This cannot continue indefinitely. The most likely scenario at this point is a sharp but quick pullback to the January high of 46.64. At that point we can evaluate whether further declines may follow, but it is important to implement some kind of plan to protect profits soon. I suspect we will see one more down up sequence before a selloff, but I wouldn't count on it.

I am currently looking to take profits on short term long positions tomorrow and Thursday. I sold EXPE today for a quick (by quick I mean 11 days) profit after it's 3/29 breakout. I am holding intermediate and long term long positions through any correction, and have been building a few short term short positions over the last week. Profit expectations are in the range of 2 to 3 x 10 day ATRs on short term positions.

One interesting short setup is JBL, which has broken its February to March trendline and looks to retest its February low around the 200dema. A break of the March low to the 200dema is around 5 ATRs.

Krispy Kreme Breaks Out

My favorite underloved turnaround stock, KKD, broke out today closing above $5.00 for the first time in almost two years. I pointed out in my previous post on KKD that it is most likely in a 3rd of a 3rd of a 3rd wave, and true to form for such a setup, it has failed to pullback to allow traders to get in at lower prices since that post. Earnings are due April 15 AMC, so a poor showing could derail this entire scenario, but with prices breaking out ahead of earnings, I am expecting an upside surprise or other positive announcement. If not, perhaps I will get "kremed", but even so this long term holding has paid off well, and I intend to stick with it until my longer term targets are hit.

The current breakout targets $7.50 to $7.65 based on the trading range and head and shoulders patterns, but any move above $6.75 would suggest that higher prices are possible. Failure on volume below $6.00 would be a concern.

Two Counts

Preferred Count

Alternate Count

Wow! is all I can say. A year ago the world was coming to an end and markets were going to zero, and today guests on CNBC casually talk about buying stocks on pullbacks. I've been wrong in my views since December and it has cost me (small gains thus far this year), but I am not worried about that. It doesn't matter what approach you use, there will be times when you are on the wrong side, but if you are consistent in your approach and that approach is a valid one, it will work out in the long run. It is advantageous to use multiple approaches to smooth out the results, which I do.

However, I pursue elliott wave analysis because when my count is right the reward far outweighs the periods when I am out of sync with the market. I honestly was not looking for a 5th wave this spring. It just didn't seem to fit any scenario I had anticipated. But that is just what it appears to be at the moment. The move from the February low looks more impulsive every day which leads us to my preferred count at the top. I know alot of people have problems with wave 3 of (3), but there are ways to count the subdivisions that are valid, even if not textbook.

If the preferred count is correct, it really gives us some insight into what the future holds because we are approaching the end of wave (5) of [A]. Terry Laundry has a T with a terminus around May 20. I tend to think that wave (5) will hold up until then at this point with perhaps a couple of scares on the way. Laundry also has a longer T scheduled to top in August. He has been on target for the most part during this rally, so if we take those dates into consideration, it would lead us to conclude that when (5) ends, wave (A) of [B] will begin followed by wave (B) up into August. If Laundry is correct that this should be at least a retest of the May high, if not a higher high, then we would be looking at a flat or expanded flat correction that would be followed by a sharp selloff into October or November. Afterwards wave [C] up would follow, probably taking the market to new highs. If this view is correct, then we (A) should fall to the February low or below.

On the other hand, if the correction that follows in May holds well above the February low, then the alternate count is probably the correct one. In that case, the market will top in wave (C) of [Y] in late August and that will be the end of the bear market rally.

Obviously, it is critical to assess as soon as possible which outcome is most likely. Unfortunately there is really no way to arrive at a conclusion at this point. That said, it would be prudent to lighten up on the long side as we approach the top of wave (5) or (A) since the ensuing correction will probably be on the order of 10% to 20%.

Whether or not you intend to short the correction is something to consider now. So far in this rally shorting corrections has been a difficult and generally unproductive exercise, but this may be the time it works.

5th waves seem to be the ones that set up traders to cause the most damage to their accounts. The reason is that by the time you are in a 5th wave it seduces you into believing that the rally is not going to end, and you are heavily positioned in one direction just in time for a sharp correction. It is even worse when you are long market leaders as they always seem to be the ones to get hit the hardest.

I don't know if either of the two counts above are correct, but I suspect that a correction is looming in the near future that will catch many off guard. I also think that by June we will have enough information to nail down the count, which should help us navigate the markets for several months or more.

Important Trendlines

The chart speaks for itself.

Dow Breaks A Trendling

Today the Dow broke its lower trendline from the 2/5 low, but before we get too excited about it we should note that there is strong support at the January 2010 high and at the channel line drawn parallel to the trendline at the highs of the rally. Only if those two levels of support are broken would expect a more significant correction.

Negative divergences, deteriorating breadth and distribution days are pointing to an impending correction. The question that remains is how deep it will be. The Qs have support at the January high and the 50dema, so it may just be a shallow correction. The 61.8% RT of the rally is around 44.71, which would be the ideal terminus of a correction - just enough to really juice the bears and enough to provide a solid entry point for the next rally.

Oil Breakout Continues

The weekly Darvis boxes continue to clearly highlight the uptrend in oil. Last week's breakout continued today, and there is every reason to believe that the box objective of 98.40 will be hit in the next few weeks. This is determined by simply taking the height of the last box and adding it to the box high. We also had a weekly long squeeze last week and a daily long squeeze today.

I will continue to ride this trend until there is evidence that it might be ending or the high target is hit. The most bullish price target is around $128.00, which would take about 6 to 9 months to be reached.