Traditional TA Last night the S&P500 closed up 0.96% at 896.24. It has now moved up around 21% since the low on November 21 st at 741.0, a reasonable bounce by any definition. The chart below shows the market action of the S&P500 from the 1 st October to the 29 th November inclusive. It also shows likely resistance levels for the market in the near future. They are at the current level of 896 followed by 920 and 940. Look at these levels for likely direction changes. As can be seen by the 3 month daily candle stick chart of the S&P500 we have the upper boundary of the descending channel to contend with as well as the overhead descending trend line on the TMF. Both of these are indications of downward pressure in the short term. Page 1
XJO Like the S&P500 the XJO has been rallying in spite of the constant stream of negative fundamental news broadcast in the media. It has so far bounced a total of 16.3% since the low of the 21 st November. The chart below shows the market action of the XJO since the 29 th October to the 28 th November 2008. It also shows the likely overhead resistance levels which are at 3750, 3920, 3990 and 4150. Look at these levels for likely direction changes. Page 2
The 8 month daily chart below of the XJO shows that it too has the upper boundary of the descending channel bearing down on it however the overhead descending trend line of the TMF is further away from the current action than that of the S&P500. Page 3
Financials excluding LPTs Sector (XXJ) As was to be expected from the overall market action the XXJ has been staging a rally having bounced off the lower boundary of the yellow descending channel as shown in the following 10 month daily chart. Page 4
It should be noted that it does remain in a down trending pattern and hence is not yet a safe investment sector. Materials Sector (XMJ) The XMJ has staged a very powerful rally but is quickly coming up to the upper boundary of the descending trend channel. It will have to break through that to ensure that the rally continues with any momentum. The current pattern for the XMJ does look like it s in a much stronger position to that of the XXJ which has to dig itself out of a much deeper hole. Elliott Wave Primer continued Motive waves are the initial 5 wave component of an Elliott 8 wave pattern. It is the motive waves that propels markets and stocks forward and provides the direction of the trend of the next higher degree wave. It is the 3 corrective waves that that retraces some of the forward move created by the motive waves. The most powerful motive wave is the impulse wave and it is the most easily recognised by people having even the most basic understanding of Elliott Waves. The 5 wave pattern of the impulse motive wave is the one that propels the market the furthest in price action and this is due to the power of the hidden influence of higher degree waves that act a bit like a gravitational pull on the lower degree waves. There are two other motive waves which move the market forward but in each case the strength of the motive wave is not as strong as that of an impulse wave. One is the Page 5
leading diagonal wave and the other is the ending diagonal wave. The leading diagonal is usually a wave 1 in a pattern and is weaker than an impulse wave as it attempts to overcome the influence of the previous corrective pattern. A bit like waking up after a hard night out it needs time to build up its energy. The ending diagonal is usually a wave 5 and tends to be created after a powerful move in the 3 rd wave. It is basically running out of puff after the energy expended in earlier waves. The Ending Diagonal Triangle Wave For the sake of this market wrap I will concentrate on the ending diagonal wave. The general shape of an ending diagonal is shown in figure 1. As we are currently in a bear market I will show the bear market ending triangle. In a bull market the diagonal trends upwards rather than downwards. Note that the leading and ending diagonals are the only 5 wave patterns in the direction of the main trend within which wave 4 ALWAYS moves into the price territory of wave 1. In an impulse wave for example this would render the wave illegal. Throw Overs and Throw Unders Quite often wave 5 will break through the lower boundary (in the case of a bear market) prior to terminating and then reverse into the next corrective wave. This is known as a throw over. Occasionally wave 5 does not reach the lower boundary (in the case of a bear market) and this situation is called a throw under or a failed 5 th wave. Page 6
My Elliott Analysis of the XJO In last week s market wrap I made mention of the fact in my option 1 that there could be further downward movement in the final wave 5 of the XJO. One of the main reasons mentioned was that the S&P500 was still early in its wave 5 formation and for the XJO to wait for the S&P500 to catch up it would have to undergo a number of extensions to its wave 5. As the XJO and the S&P500 seem to be joined at the hip in terms of major turning points it seemed reasonable to believe that this would lead to extensions in its wave 5 creation. I felt very uneasy about this thought as it appeared to me that there was too big a differential in the phasing of the two indices. Fortunately another EW enthusiast shared an EW wave count for the S&P500 which appeared to more closely relate to the completion of wave 5 of the XJO. Whereas my previous wave count for the S&P500 had it early in its wave 5 creation this other option had it completing at about the same time as wave 5 for the XJO. For this reason I believe that newly offered EW count for the S&P500 had a greater probability of being correct than my original count so have therefore adopted it as being the one to run with. The following chart shows the pattern for the S&P500 which was completing its wave 5 creation phase. Note that wave 5 was an ending diagonal with a throw over. Page 7
Note that this completed the final wave 5 for the S&P500 of higher degree wave (3). As can be seen from last week s chart for the XJO (see below), the XJO was also completing wave (3). In the case of the XJO however, rather than an ending diagonal it was a pure impulse wave which is a motive stronger pattern. As it was a stronger pattern than the ending diagonal of the S&P500 then one could possibly deduce that any rally in the S&P500 would be greater than that which would occur in the XJO as the greater upward pressure for the S&P500 would have caused the creation of a weaker ending wave 5 pattern. This in fact is exactly was has proven to be the case so far. Page 8
The chart of the XJO following shows the labeling of the wave 5 impulse pattern and the beginning of the following rally. I have temporarily labeled the corrective wave following the termination of wave (3) as an impulse wave with waves i, ii, iii, iv and later v. This wave will more than likely require relabeling once more of the pattern is revealed. Page 9
Recapping Where We are in the Cycle The previous bull market and current correction is shown in the following chart. Note that we can see that we had 5 impulse waves up during the recent bull market and we have now completed 3 waves down (1), (2) and (3). We have now started a movement upwards as would have been expected as would have been expected in this stage of the cycle. Note that usually corrective waves are labeled waves A, B and C, not waves (1), (2) and (3). As a casual observation we could jump to the conclusion that the above pattern was a typical EW pattern and therefore waves (1), (2) and (3) should be labeled waves A, B and C. In EW analysis one can never jump to conclusions because if the current correction produced another 2 waves (waves (4) and (5)) then it would mean that the A, B, C labeling would then be proven to be incorrect. Under the EW rules a 5 wave structure would mean only wave A could possibly have been created and that waves B and C would come later. Further more in this case it would mean that the corrective pattern would be a Zigzag because wave A was an impulse wave. The other possibility is that the 3 wave move may also be a Flat pattern and still only be a wave A. So much depends what happens next. Page 10
We have now come to a point where there are 3 high probability patterns emerging. Option 1 This option is that the current correction has completed the first 3 waves of a 5 wave impulse and hence would be part of a wave A. The rally following would be corrective wave (4) which would eventually be followed by a further down move via wave (5). This 5 wave impulse wave would then complete wave A. Option 2 This option is that the current correction has completed wave A of a Flat pattern (ie, has 3 waves down only). The rally following would be a wave B which would also be a 3 wave pattern. This would then be followed by a down move via wave C which has a 5 wave structure. Option 3 This option is that the current correction has totally completed and has formed waves A, B and C. The rally following would be wave 1 of a 5 wave pattern basically forming a new bull market. I personally think that this option is least likely to succeed. So How Will We Recognise Which Pattern is Correct in Future? Firstly the time frames for each of the above options are different. The shortest time frame pattern is that of option 1 as corrective wave (4) as it is a lower order cycle. To get an idea of how long it could take to complete and how big it could be we need to look at corrective wave (2). Corrective wave (2) took about 2 months to complete and had a range of around 941 points. Whilst corrective wave (4) will probably have a different shape (EW alternation guideline) and price range it at least gives us some idea. If it moved up around 941 point in a short period however then the creation period could be shorter. So far it has moved through a range of 525 points in a bit over a week so the wave (4) period could be substantially shortened. However it is also conceivable that it could develop into a sideways moving wedge shaped structure which slowly moves to the higher level through a number of waves. By the EW guideline of alternation (ie, if corrective wave 2 is a sharp pattern then wave 4 will be a complex pattern) corrective wave (4) will quite likely be a complex pattern. I suspect that this will probably happen. Once wave (4) completed there would be a down move in the market as wave (5) formed. Wave (5) would more than likely take out the previous market low unless it was a truncated wave (5) which would then look more like a double bottom. This extended down move would rule out options 2 and 3. Page 11
In the case of option 2 where a wave B commenced forming we would be looking at a much longer time frame and possibly a larger move of the first wave in the wave B pattern. As it took wave A over 12 months to complete I would expect that wave Bin this option would tend to take longer than our corrective wave (4) to complete. Wave B would have a 3 wave corrective structure In the case of option 3 we would once again be looking at a longer term pattern as it would effectively be the start of a new bull market. Option 3 would be a motive 5 wave structure. I believe that this particular option is the least likely option of the three at this stage because of the nature of the crisis that we have in the global economy and the likelihood of a long term bear market prevailing. The information in this market wrap is provided for educational purposes only and does not have regard to any particular person's investment objectives, financial situation or needs. The information must not be construed as advice to buy, sell, hold or otherwise deal with any securities or other investments. Accordingly, no reader should act on the basis of any information in this market wrap without first having obtained investment advice from a suitably qualified advisor. Page 12