Tuesday, August 24, 2010

Small Caps Leading Decline

The breakdown this week in the Russell 2000 small cap index puts its back into correction mode. At the risk of sounding like a broken record, the first leg down from the April high is clearly a double zigzag. While some are calling it a leading diagonal, I think that is a much lower probability. Now we have an intervening 3 wave rally proven by the decline below the 7/19 low. If wave (W) down from the April high is a double zigzag, then wave (Y) down should be a double zigzag as well. This is most likely a complex combination correction and not the resumption of the bear market.

We should expect some greater intensity in wave (Y), which could cause it to extend in both time and price beyond the length and time of wave (W). Wave (W) down lasted 49 trading days and corrected 158.28 points. Using wave (Y) = (W) and wave (Y) = 1.618*wave(W), we can project the time and price for a low at October 5th to November 17th from 513.88 to 416.06. The 61.8% retracement of the March 2009 to April 2010 rally is 496.67.

The only thing we have to watch out for at this point is the current correction morphing and extending into an expanded flat correction. The probability for this outcome seems pretty low primarily because most of the cycle projections pointed to a high between 8/26 and 9/08. The market has used up its allotted time and now it is time for further declines.

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