How I Traded JPM

In March of this year, JP Morgan offered a rare opportunity to trade a very low risk/high reward pattern. I had been following the stock since the broader markets rolled over in October 2007. JPM peaked months earlier in May 2007. The wild swings offered traders a lot of opportunities, but I chose to stay on the sidelines as there was no discernable intermediate trend until November 2008, and by that time I was trading the SKF.

After the failed rally attempt in December 2008, the pattern began to come into focus. An ending diagonal triangle was developing which was heading toward a confluence of support. Looking at the big picture, the median line from the 2000 high through the 2002 to 2007 rally was projecting an intersection with support at the 2002 low and the lower trendline of the ending diagonal triangle.

As markets seemed to be heading into the abyss, fear was rampant, but as I commented in this blog, the markets were nearing the completion of a major elliott wave pattern at projected targets at an expected cycle low. With reasonable confidence that a rally of significance was about to commence, I projected the lower trendline to be at 16.50 on March 4. I entered a limit order to buy JPM at 16.50, which was filled on March 5. I did not use a hard stop loss. My exit plan was to sell JPM if it closed below the 2002 low, rallied and then failed. It tested but never closed below the 2002 low, and the rally began March 9.

The target for this trade was the origin of the EDT (ending diagonal triangle) at 50.63. I realized that given the wild swings in the stock it would most likely not make it all the way to the target, so I focused on the target zone of the range of the high day.

JPM peaked in wave (A) of its rally in May well short of the target. The hardest part of this trade was sitting through the wave (B) correction, but it was rather muted compared to some of the other financial stocks. Wave (C) finally got underway in July. It closed in the target zone on September 22, but then promptly closed below it. I waited for a second test of resistance at 45.23. On September 30, it began to fail without making it back above resistance and I exited the position at 44.54 for a gain of 170%. Of course, the stock managed to make a new rally high in October, but it has now rolled over in earnest and a significant correction of the rally is underway.

What made this trade unique is the rare confluence of so many factors including 3 areas of support, a high confidence elliott wave pattern completion, a stock market cycle low and impending rally. In particular, my confidence in this trade was high because I stayed on the sidelines for almost 2 years as I observed and waited for the opportunity to present itself. When the time was right, I pulled the trigger without hesitation.

Sometimes we get so caught up in trying to capture every zig and zag, we miss the real opportunities. This is a perfect example that you don't always have to be in the market or trading every move of a stock to make big profits.

Impulsive Decline

A still imcomplete impulse wave in the SP500 is ongoing. Expect another sharp rally on Monday followed by at least one more new low for the decline. The subdivisions of wave iii are not clear so it could be wave (iii), but the decline definitely has the look and feel of an impulsive move. Once complete sometime next week I would label it as minor wave 1. We would then expect a substantial wave 2 rally to follow lasting several days or more before waves 3, 4 & 5 down to complete wave (A). This scenario is definitely subject to change as there are multiple valid paths that a correction can take, but the reason I am assuming an impulse wave for (A) is that it is the most likely form to trap the primary wave 3 down to Armageddon bears.

Oftentimes the target for a zigzag correction can be estimated by multiplying the length of wave (A) by 1.618. If we use the July lows as a target for the end of the correction, we can project the end of wave (A) by dividing the measure from the October 21 high to the July low by 1.618. This gives a target for wave (A) of 957.94 for the SP500 and 37.94 for the Qs. Both of these are around the June highs interestingly enough. A stop at that point may convince many that the correction is over.

It is also quite possible that the current impulse wave that began October 21 that ends next week is all of wave (A). If we assume that the July highs are the target for the correction, then we can estimate the target for wave (A) as 1011.66 for the SP500 and 39.75 for the Qs. These would probably also be good estimates for the end of wave 1 of (A) for next week as well.

If you're totally confused by the above, don't worry. The point is that the correction has a lot further to run and we can't know what the ultimate target for this correction really is. We can only project possible outcomes and watch as the market action unfolds to see what the most probable path is as we get more information.

I will be looking for a substantial wave 2 rally to add to short positions in the coming week.

Broken Trendlines

The Russell 2000 (IWM) and the Dow Transports have both broken their respective trendlines from the March low. While it is entirely possible that these could be bear traps, it is not the most probable outcome given all of the other factors we have considered in the last week. A retest of the broken trendlines is underway and may last until the middle of next week. Thereafter, expect a resumption of the correction that began October 21.

As long as the Qs remain under 42.79, a small degree 4th wave is probably in progress. Once complete, expect a 5th wave followed by a larger 2nd wave rally. There are many avenues this correction could take. We don't need to get too caught up in the wave count. It will become clearer as the next few days unfold.

The main point is that today we had a sharp countertrend rally off of a deeply oversold condition. That doesn't change the fact that a correction is underway, rather it is consistent with the type of market behavior that would be expected during this correction.

Is There Any Doubt?

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.

More Downside To Come

The initial leg of the decline remains incomplete. It may bottom sometime this week, perhaps even tomorrow. The decline in the SP500 looks the most impulsive and I will be using it as a guidepost for the correction. I believe I have resolved the count for the Qs, but I want to wait and see how it looks when the SP500 completes wave A or 1 down.

The Qs closed at 42.34 and below the trendline from the March low (around 42.50 today), which is another strong indication that the trend is now down. Volume was higher on most indexes, so it is hard to imagine that IBD will not call this a "Market In Correction" in tomorrow's edition. Support remains at the 50demas and October lows for most indexes, but the Russell 2000 and Dow Transports are below their 50demas and rapidly approaching their October lows.

Other indications that the correction is gaining momentum is the recent reaction to earnings and guidance by BIDU, SOHU, ILMN and APOL. These stocks have been crushed. Also, AAPL closed below the $200 mark on higher volume today and other market leaders are being sold hard, e.g. FUQI and DTG. This is why I highly recommended selling into the new rally highs in September and October. FUQI is down 33% from its September high. It will take weeks to repair the damage.

An interesting development today was the traditional McClellan Oscillator closing at -280.36. Such low closes have often led to sharp rallies in the past. The rally this time may correspond to wave 2 or B and will likely be a bull trap. As long as the October highs are not exceeded on higher volume, this would be a good opportunity for those who have not opened initial short positions to do so. Again, keep in mind, that I am not expecting an impulsive return to the March lows as many are calling for, but rather a choppy correction to the July lows. Adjust position sizes and stops accordingly.

At this point there is little doubt that the correction is upon us. The only question that remains is how long and how deep. In my opinion the probable answers to those questions are until December 2 to 24, most likely around December 9-11+/-, and down to the July lows. This is certainly not a time to be buying stocks, although many will try.

Double Top With Bear Flag

The Qs completed a 3 wave rally from the 10/22 low just after 10am this morning. A sharp selloff began just before noon today that bounced off support at the 10/22 low and then formed a bear flag. Coming under 42.79 will confirm the double top which projects to 41.76, however, in reality the likely target is the 50dema which is currently at 41.50 followed by the August high at 41.08. The trendline from the March low is currently at 42.40, so if the above targets are hit the trendline will be broken, adding to the growing list of sell signals. We now have renewed MACD sell signals on all of the major stock indexes as well.

While some sentiment measures are increasingly bearish, such a change in sentiment from bullish to bearish is not in and of itself a reason to believe the correction cannot be a deep one. This change in sentiment is normal as the trend changes. Most intermediate term indicators such as the weekly MACD and Stochastics are far from oversold and the 10 month cycle is now in its down phase into the first of December. We should expect that the correction will intensify over the coming weeks with sharp intervening rallies. A break of the rally trendline followed by a retest of the trendline and a move below the swing low of the break will confirm that a move to the July lows is underway.

At the same time, most stocks will not have had time to set up for short trades, rather they will be pulling back for a chance to enter the established uptrends at better prices. AAPL and AMZN come to mind.

Count Invalidated

The bearish count that I presented Friday for the Qs has been invalidated. As long as the 10/21 high is not exceeded, the correction may still be considered to be underway. Unfortunately however, as I have stated on several occasions, we are likely going to see a very choppy and difficult correction. Smaller position sizes and wider stops will be the winning approach.

If we do see new highs today or tomorrow, the next potential turn date is November 3rd by my approach. With a window of +/- 2 days, this puts a possible top at 10/30 to 11/5. But let's not put the cart before the horse, we haven't seen new highs yet.

Another clue that I will be watching to confirm that the correction is truly underway is AAPL falling and sustaining below 200.