SPX Update: Intermediate Upside Potential Still Appears Limited

Markets like this can make it a challenge to keep the updates interesting and not overly repetitive, redundant, and redundant.  There's very little to add on a material level -- in fact, I considered simply republishing the last update, but I accidentally spilled coffee on it.

Big picture, the S&P 500 (SPX) still appears to have fairly limited upside potential.  In Elliott Wave Theory, five waves forms a complete fractal, at which point a trend reversal becomes higher probability.
 

The near-term is ambiguous -- if the bear count is in play, then the top is probably in.  If the market is going to form five waves up for the fifth and final wave at higher degree, then it needs another small wave up.  At higher degree, both counts are basically bear counts, since the wave patterns suggest upside is limited.  From a classic TA perspective, that expectation may not fit with the potential cup and handle double-reverse v-bottom "papa bear, my soup is too hot" pattern, as it's sometimes called (when I'm trying to keep the updates interesting, anyway).  That pattern potentially targets 1900-1910 -- so in the event there's a breakout with increasing momentum, the wave counts may need to be revisited.  Presently I'm not anticipating that result, but any new signals would need to be respected as and if they occur.

There are two ways to view the current price action:  Bulls would say SPX is consolidating the recent rally; bears would say SPX is retesting a resistance zone (the all-time high).  Both descriptions are accurate, yet one of them is more correct -- pick your poison.  

The Dow Jones Transportation Average Unexceptional and Mediocre (TRAN) required some minor adjustments after the expanded flat count found a bottom at the previously-noted inflection point:

In conclusion, this market may to be trying to lull everyone to sleep.  I'm suddenly reminded of an old cheesy and cliche movie line: "It's quiet out there.  Too quiet."  It seems like most everyone is expecting new highs at this point, but, personally, I have very little desire to buy SPX near the all-time high, and I'm starting to see topping signals appear on some of my indicators.  Unless and until there's a convincing breakout, short -- or stand aside -- look like more reasonable positions to me.  Trade safe.

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SPX and TRAN Updates, while US Bonds Try to Build a Base

In the last update, I noted it was do or die time for the bear count, and yesterday the bears managed to turn the market where they needed to in order to keep hope alive -- for the time being.

Before we look at equities, I'd like to update the chart of the US 30-year Treasury bond (USB).  I haven't updated this chart in about 6 months, because there's been no reason to -- back in June and July of 2013, I was bearish on the long bond and remained so until recently.  However, the wave structure here has now reached an inflection point which could have long-term implications.  The long bond has formed a nice ABC decline into 127, and is trying to build a base.

The inverse correlation between stocks and bonds has been reasonable for the past few years (stocks up/bonds down), so if the long bond is successful at building a base here, this could also have intermediate implications for equities.  If the long bond was forming a simple ABC correction, that would mean new highs are in store -- and in that event, there are potentially long-term implications for equities.  We'll burn that bridge when we come to it, and the first thing is for bonds to complete this base-building attempt.  The pattern does suggest higher prices for bonds after the current correction completes, and next key resistance is near 135.  The only way I can see this pattern as a complete bearish wave is if the market formed a somewhat-uncommon running flat; I've noted the levels to watch.

Looking at the S&P 500 (SPX) at the intermediate level, I continue to have a difficult time envisioning the market heading much higher.  In the event we reclaim the all-time high, the most probable count still appears to be that SPX is completing a fifth wave -- meaning that another correction will follow on the heels of new highs. 

I should note "Target 1" is only in the event that the all-time highs are reclaimed -- i.e., the alternate bullish count.

I've outlined a few zones to watch on the SPX 30-minute chart:

One of the gross laggards recently has been the Dow Jones Transportation Average (TRAN), which has continued to behave like its in a corrective rally.  TRAN performed in line with the expectations of the preferred count (an ending diagonal) as outlined on February 14.

Not shown is the head and shoulders topping pattern that's formed on TRAN's daily chart, and which projects down to 6500 if 7000 fails.  If TRAN can instead break out here, I may be forced to become more bullish on the broad market.

In conclusion, given what's in the charts as of this exact moment, I'm still having difficulty finding any patterns that would make me mega-bullish on an intermediate basis.  I ran into this same issue at the beginning of the year.  Certainly things can change heading forward, though, so I'm keeping an open mind to the idea that the patterns could shift into something more promising.  As one example: The usd/jpy currency pair also seems to be trying to build a base (chart not shown) -- if that's successful, equities could see more a sustainable rally. 

The bottom line is that there is a degree of fracturing among markets right now, and I'd prefer to see more agreement before committing to an intermediate bull case. Trade safe.

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Why Traders Erroneously Assess Risk/Reward -- Plus Extended Fifths, and the Moment of Truth

Friday saw the rally continue, and there's not much to add in that regard, so today's update is going to focus on a couple of (hopefully) educational things which go beyond the charts of the moment.

To lead into the first of those, I'm going to refer back (once more) to something I wrote on February 10:

There is only one thing bothering me for bears here, and that's the fact that my preferred count has us presently retracing an extended fifth.  Extended fifths frequently form impressive "double" retrace patterns -- if that happens here, the current rally will retest the all-time high before dropping to new lows.

Today I'd like to share a chart example of a double-retrace, so readers can understand why (despite all the bullish signals) I've continued giving the bear count airtime.  Below is a Forex chart of US dollar/Japanese yen, and it shows an extended fifth wave (in this case, an extended fifth wave to the downside), followed by a complex double retrace.

We can see the first leg of the rally retraced back up to roughly 101.400 -- from there, the bottom was retested (and broken slightly) before the second leg of the retrace formed, to new highs.  We can also see that the retest of the low was faster and seemingly more powerful than the first leg of the rally.  We can also extrapolate that a number of traders were whipsawed at that double bottom -- which then helped provide fuel for that second leg up.

The potential of a similar chart pattern on the S&P 500 (SPX) is literally the only thing that's kept me from committing whole hog to the bull case.  My main regret for readers is that I didn't immediately focus on the fact that a retest of the high was reasonable and probably even likely (I regret it because, early on, I did give strong consideration to going that route publicly).  Considering the strength and speed of this rally, pretty much any call since February 5 that even entertained notions of selling turned out to be the wrong call.

(Here I should insert a segue to the next topic, but I don't have one -- so this sentence serves as the segue!)

There are many ways to approach trades, but let's quickly discuss two of those ways:  One approach is what I refer to as "confirmation trading" -- an example of confirmation trading would be shorting a breakdown of a head and shoulders pattern.  The pattern breakdown in essence "confirms" the trade, and suggests the direction of the market.

Another approach, and one that's loaded with pitfalls for new traders, is to try and be a bit ahead of the market.  I utilize both approaches, depending on what the market gives me, but use the second approach when my wave counts support action against a resistance/support level, and the next two criteria are also met:

1.  There are clear ways to mitigate risk via stop levels.
2.  The reward is significant vs. the risk.

The most recent real-life example of this second approach would be February 5:  The wave counts suggested a fifth wave bottom was potentially at hand, and there was a nearby support zone which could function as a stop level.  In that update, I both specifically warned newer traders against front-running, and also suggested experienced traders might take a crack at it, as long as they approached with extreme caution.  So why did I warn off inexperienced traders?

The front-running technique tends to be harder for new traders, for several reasons:

1.  Many have a difficult time letting go of losing trades.  (Some trading wisdom from the movie Rounders: "Throw away your cards the moment you know they can't win.")
2.  Many tend to let go of winning trades too quickly.
3.  Many tend to erroneously assess risk/reward -- both theoretically and practically.

The third tendency can stand alone in the theoretical sense; but in the practical sense, it's frequently the result of the first and second tendencies combining.  Many newer traders consistently under-assess their actual risk -- since they hold onto losing trades longer than they "know" they should, the true risk is actually higher than it looks on paper.  At the same time, they frequently over-assess their reward -- since they let go of the winners too quickly, the intended reward goes unrealized.

For example, if I take a trade thinking I'm risking 5 points to potentially make 50 (an excellent 1:10 risk/reward ratio), but instead exit after I make 5 points (due to anxiety or otherwise), then my risk/reward wasn't really 1:10, it was 1:1.  And on the other hand (when that trade goes bad), if I fail to honor my 5 point stop and don't actually exit until I've lost 10 points, then my risk/reward is, in practice, nowhere near my intended 1:10 -- it is, in reality, an abysmal 2:1 (risking 10 points to make 5). 


As Yogi Berra once said, "In theory, there's no difference between theory and practice, but in practice, there is."

If you're a new trader who's struggling with the usual "Why isn't anything working?" this might be one area to examine.

My point is that trying to front-run turns (in either direction) only works if one has a system for it, and then remains consistent and disciplined -- and often those are skills new traders struggle with.

Moving on to the charts:  Before I address the current SPX chart, I do need to mention that the Russell 2000 (RUT) broke through its apparent pivot zone (as discussed previously) which thus creates a potential thorn in the bear counts.  While I remain skeptical of the sustainability of this rally, outside of the discussed double-retrace, there is nothing in the charts that's actually bearish at the moment (one reason for my earlier discussion on front-running -- do with that what you will).  To the contrary, SPX has powered through every resistance zone it's encountered so far, and is now staring down the important zone: intermediate resistance at the all-time high.
  

On the SPY chart, there's some additional discussion of the (B) wave potential.  While there is (unfortunately) no hard and fast invalidation level for a (B) wave, there is still common sense.

In conclusion, in Friday's update, I discussed some of the more bullish options and potential targets, and nothing has changed in that regard.  SPX is into the zone where it's time for bears to make a stand if the ABC count holds any water.  So it's time for patience at the moment of truth -- but looking down the road, in the event bears can't get it done here, then we'll be wise to put away the bear claws until such time as the next bearish signals arrive from the market.  Trade safe.

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Looking at Both Sides of the Trade

Elliott Wave Theory is forward-looking, while much of classic technical analysis is backward-looking.  And as the S&P 500 (SPX) continues to power through resistance and moving averages, classic TA is giving buy signals left and right.  The final arbiter, of course, is price, and price currently still hasn't reclaimed (decisively or otherwise) the all-time high -- which thus says the market hasn't given the "all clear" just yet.

That said, bears dropped the ball during Thursday's session.  They had a chance to push through a number of key levels, but failed to even sustain the opening gap, which was quickly bought up and filled -- and SPX ultimately closed at new highs for this leg, directly inside Wednesday's 1827-1832 target zone.


Frankly, top calling in a bull market is a nightmare and possibly the toughest analytical gig there is.  Tops almost never look like tops, except in the rear-view mirror -- otherwise, who would be buying them?  As the old expression goes, "They don't ring a bell at the top."  So it can be a bit of a trap trying to call them at all, since you almost have to ignore certain bullish things.

In the last update, I promised to eat crow if the bullish signals ended up trumping the bearish wave count, and that's beginning to look like (an even more) distinct possibility.  But we're not quite there yet.  Biggest problem is, a few months ago I promised to eat crow if the near-term preferred count was wrong, and it ended up being right -- but I made the mistake of preheating that crow, then threw it back in the freezer.  Which means that now it's freezer burnt, and I'm quite certain it will be particularly bitter this time around.  I've definitely learned my lesson in that regard, and from now on plan on stocking only Mrs. Paul's Microwavable Crow.

Not too long ago, there was a lot of talk of the January Barometer -- essentially the theory that "as goes January, so goes the year" for equities.  An interesting study by Hennion & Walsh concluded that, since 1986, the January Barometer has worked 77% of the time.  The flip side of that coin is that the average total return for the 23% of "signal failure years" was 16.5%.  Something to keep an eye on.

While no one can deny that the price action has been unabashedly bullish, I'm still not entirely sold on the sustainability of a bull move here -- but I've added more detail to the bullish alternate count nonetheless.  I'm also moving it up to 49% odds from its initial appearance on the chart (on February 7).  This does call to mind one of the values of Elliott Wave, even when not everything pans out perfectly -- the wave counts accurately identified the intermediate inflection point at 1737 well before the rally had made much actual headway.

Next up is a closer look at SPX via the 30-minute chart.  This next part is a bit premature, and hopefully doesn't get too confusing:  Until the all-time high is reclaimed, the most bearish count of wave i down (which has never been my preferred count -- wave A has been my preferred count) remains alive.  Wave A does not actually invalidate at the all-time high, due to the option of a large expanded flat B-wave rally.  Just north of the all-time high sits what appears to be another important inflection point, as noted on the chart.  If we make it that far, watch that zone carefully, as it could theoretically put an end to the rally and take us back down in a C-wave to new lows.  More on this discussion will be presented in a future update if it becomes relevant. 

Near-term, 1824 is the first key zone for bears to reclaim -- and while there's no official "sell trigger" in that zone, it could certainly be used as a pivot.  Incidentally, we're finally starting to see some negative divergences in RSI.

Finally, there are a few indices racing ahead of SPX, such as the Nasdaq Composite, and still a number of indices lagging significantly, including the Dow Jones Industrials (not shown) and the Dow Transportation Average (TRAN).

In conclusion, I'm well aware of the bullish signals which have dominated the action in SPX this week, and I'm certainly not blindly ignoring them.  Again I'm left deciding between favoring the forward-looking Elliott Wave, or honoring backward-looking TA.  For the record, I'm still giving marginal odds to the bear count -- but ready to eat my bitter crow directly if necessary.  Trade safe.

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Bulls and Bears Battle in US Equities, while Indicators Conflict with Elliott Wave Counts

Long-time readers know I'm not a "perma" anything when it comes to equities.  Outside of how it impacts my account (and yours), I really don't care whether the market goes up or down.  I let the charts dictate the probabilities, then trade in the direction that seems like it's going to pay the most.

We have an interesting situation now, because a lot of traders will have systems that have switched to buy signals on the recent rally.  That means the majority will be expecting upside follow-through, and many will be expecting new all-time highs (in fact, I've heard numerous perma-bulls gloating already, as if new highs are simply a given).  Some of my indicators are on buy signals as well, and I have to respect that -- but I also have to respect the wave counts.  These are the most difficult moments for me as an analyst, because I have conflicting signals between my preferred wave count, which is bearish, and my indicators, which are bullish.

So I've combed the charts extensively for clues, and in this update, I'll present a few things which may help as signals.

While the S&P 500 (SPX) has rallied basically straight up, a number of indices are lagging by a significant margin, and we're going to look at two of those today.   First up is the Russell 2000 (RUT), which has a bit different wave structure than SPX, as shown below:

    
Next is the Dow Jones Transportation Average (TRAN).  TRAN's rally so far appears quite anemic in comparison to SPX (shown in the lower panel).  Note that TRAN has run into resistance.  Also note that the first upside target (this is not a target that was discussed previously here, it was one I calculated near yesterday's open) for SPX (1823) has been reached.  Not shown on this chart is the fact that hourly RSI (for SPX) confirmed the 1823 high with no divergences. 

From a near-term perspective: If SPX makes a low below 1818.38 before it breaks above 1821.32, then it would suggest we've formed at least a small impulsive decline against the 1823 high -- which would favor that at least one more leg down (of similar length or longer) would follow the next small bounce.

Finally, the SPY chart.  As I mentioned a moment ago, many of my own indicators are now bullish -- so in order to understand why I'm still favoring the bearish wave counts over the bullish indicators, we need to revisit something I discussed on Monday:

There is only one thing bothering me for bears here, and that's the fact that my preferred count has us presently retracing an extended fifth.  Extended fifths frequently form impressive "double" retrace patterns -- if that happens here, the current rally will retest the all-time high before dropping to new lows.

From an intermediate perspective, we are currently retesting the all-time high.

In conclusion, this is one of those times when you almost hate to make a call, because you know that if you're wrong, you're going to berate yourself for ignoring your own indicators.  Yet I have to honor my own system, and feel I owe it to readers not to be wishy-washy here (and I'm fully prepared to eat crow if necessary!). 

The toughest part of trading and analysis is when the probabilities don't line up with the actualities -- and although this happens in everything in life (as you know if you've ever uttered the words, "What are the odds?"), when it happens in trading, it costs us money.  Ultimately, we simply have to see that as "operating cost."  No venture in life is without risk -- and even something as simple as driving five minutes to the local drug store can turn into a life-altering event.  I use this example because I almost had a head-on collision on the highway last night, when I rounded a blind turn and came face to face with a car in my lane who was trying to pass in a no-passing zone.  I ended up coming to a full and complete stop in the middle of the highway (from 50+ mph!) in order to avoid hitting him.

Trading is sometimes no different.  This is one reason why risk-management is an integral part of any system (yet one that's often over looked by newer traders) -- when the probabilities don't go as planned, make sure you're at least wearing your seat belt.  Trade safe.

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Bulls Finally Get a Turn in US Equities

Trading requires us to have a both a shorter memory than we want to and a longer memory than we want to.  I've spoken about this before, but often at roughly the same moment the market convinces everyone it's headed one direction and one direction only, it reverses.  Markets rarely head straight up or straight down, so getting bullish or bearish based on the immediate past is exactly what the market "wants" you to do -- it wants you to buy when you should be selling, and it wants you to sell when you should be buying.    

Remember way back when it was the End of the World?  I had trouble remembering the exact dates myself, so I referenced an online historical calendar, but it looked like too many days to count -- so I broke out the calculator, and using a few esoteric formulas (calculating for leap years and such), I was able to figure out that it's been almost a whole week since then.  Yet I've already heard a great deal of talk about how the market's headed "straight to new highs."

And maybe it is, who knows for certain?  But one can't help but be amused by how quickly we go from complacency to omg panic!!! to complacency again.

VIX fell 23% over the span of Thursday and Friday, which represents a massive shift in sentiment, from fear toward hope (and complacency).  From a technical standpoint, historically a drop of this magnitude in such a short time in VIX suggests the equities market will encounter a pullback within the next one to two sessions.  

Along the lines of sentiment:  Even after roughly two decades of charting, one of the things that sometimes still "gets" me about Elliott Wave is that it's so often counterintuitive -- yet it works.  On Thursday night, as I was working on Friday's update, the wave counts gave me a first target of 1788 for the S&P 500 (SPX).  At the time, futures were trading slightly red.  I looked at the cash chart and saw gobs of resistance between Thursday's close and 1788, and I thought, "How on earth is this market going to get to 1788?"  But I went ahead and annotated the chart -- then later (after a wacky whipsaw pre-open) the cash market gapped higher through resistance, hit 1788, and reversed.  By the close, it even went on to best that level.  The the moral of the story is that Elliott Wave pointed the way higher through resistance, despite the fact that such an outcome seemed counterintuitive at the time.

In my opinion, the most probable wave count is still pointed toward lower prices over the intermediate term.  And that probably seems counterintuitive after Friday's strong rally.

In other news -- from the standpoint of potential market-moving events -- on Tuesday, in what is sure to become an exciting semiannual tradition, Fed Chairperson Janet "Gellin' Like Janet" Yellen gives her first semiannual testimony on monetary policy.  It's expected she will reassure Congress that she's planning on bringing QE in for a soft landing with a gentle slowing of stimulus, as opposed to suddenly abandoning ship and throwing bankers overboard into the frigid waters of a tighter Fed.  Be sure to bring the whole family to D.C. for this "can't miss" Winter event; hot dogs will be served, and there will be free balloons for the kids! 

The first chart I'd like to share is a ratio chart, of SPX to the Proshares Short S&P 500 fund (SH).  Notice the difference between the most recent bottom, and every other bottom of the past two years:  Price broke the last swing low.  You will see this same theme repeated across the charts in most major markets, and this type of occurrence is usually a warning to bulls that the party is ending.

Next is the long-term monthly chart of the Dow Jones Industrials (INDU).  To say MACD is a little overbought is like saying Miley Cyrus has "a few" emotional problems.

It's also time to revisit our canary, the NYSE Composite (NYA).  NYA counts best as an impulsive decline, and while there are bullish options in the form of a similar expanded flat as was discussed for SPX on Friday (an expanded flat is an irregular waveform where the B-wave high exceeds the start of the A-wave -- it's one of the only patterns in which you will find an isolated five-wave structure that isn't followed by another similar wave), the probabilities currently still favor another leg down.

NYA has retraced 50% of the decline; the 50% retrace is frequently a resistance zone.

Finally, the SPDR S&P 500 Trust (SPY), which is effectively a 1/10th scale version of SPX.  There is only one thing bothering me for bears here, and that's the fact that my preferred count has us presently retracing an extended fifth.  Extended fifths frequently form impressive "double" retrace patterns -- if that happens here, the current rally will retest the all-time high before dropping to new lows (shown as "alt: (B)").  Note the chart is a little smaller than usual -- this is because Stockcharts was giving me grief and wouldn't let me save the edited chart, so I had to take a screenshot of my work-in-progress.

In conclusion, a snap-back rally was expected upon completion of wave (5), and that's what we've gotten.  While there are a few early signs of encouragement for bulls, the rally has not yet done any significant technical damage to the intermediate bear case, and there is thus no reason to abandon the preferred count.  In a way, becoming bullish here would be the "easy" trade; and more often than not, the easy trade is the wrong trade.  Trade safe.

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Near, Intermediate, and Long-Term Outlooks for SPX

Wednesday's update contained more caveats than a prescription drug commercial, but the wave counts suggested a final thrust lower in wave (5), followed by a snap-back rally.  The snap-back rally is underway now, and my current suspicion is that this rally will end rather abruptly and unexpectedly.  Before we discuss that in more detail, let's center ourselves with a look at the big picture S&P 500 (SPX) daily chart.

In the last update, I shared a chart which noted the fractal similarity of the current Dow Jones Industrials with the 1929 market; however, the odds presently still favor the idea that we're not quite to the end of the road for the entire bull market yet.  The alternate idea of a massive corrective rally which started in March 2009 and completed at 1850 still has to be considered an underdog to the idea of new highs after the current correction completes. 

At intermediate degree, presently this structure is suggestive of a two-legged decline.  This will ultimately form an ABC (wave C down is still to come) -- if it instead turns into an impulsive form (five waves instead of three), then we'll give more weight to the idea that 1850 was a long-term top.  That's the long-term outlook and alternate. 

At intermediate degree, there is an alternate count that wave (4) completed at 1737, but I'm viewing that as a heavy underdog, at 30% odds.  Nevertheless, on the hourly I'll detail the wave count which allows that option.

   
The hourly SPX chart outlines my preferred target, along with the first alternate option.  Again, the idea that the entire correction completed at 1737 is presently being viewed as a heavy underdog, but I'd be remiss not to mention the possibility.  Please note the majority of the text annotation is at the bottom of this chart, including the price targets.

Finally, an update to the SPY chart, which followed Wednesday's preferred path quite well:

In conclusion, I've discussed a lot of alternates in this update, so to avoid confusion, the preferred counts across all time frames is as follows:

1.  Near-term, higher prices appear probable.
2.  Intermediate-term, lows beneath 1737 are still likely.
3.  Long-term, it presently appears that the bull market has some life left in it.

While I project the market across several time frames in most updates, I have to admit I always feel a bit humbled trying to anticipate the market's every move on all scales from micro to macro -- so don't be shocked if some of these projections need real-time adjustments somewhere down the road.  

Enjoy the weekend -- and until then, trade safe.

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