Summary

Markets all but confirmed that we are in minute wave 3 today.  This gives us confidence in an extended move down over the next couple of months, but the shorter-term count remains murky.  Trading the longer-term trend may be the higher probability tactic until short-term clarity improves. 

Markets on Tuesday

By any measure, a 268 point drop in the Dow represents a change in character.  A greater change was heralded by a return of volume to markets.  The two together gives us the sharp down move we had been looking for to help identify a third wave.  This doesn’t tell us which of the many short, shallow corrections we’ve seen since resuming downward moves on June 21st is a 2nd wave retracement.  In fact, it’s still possible that we haven’t seen it yet.  However, the negative strength of our technicals during Tuesday’s drop makes it most likely that we are now in a third wave down. 

Before we bemoan the lack of a good count that identifies wave [ii], let’s take a moment to observe the gift that the market gave us today: we all but ensured that the market has seen the end of minor wave 2.  In the Dow prices have retraced over 93% of the move up from $9,758 on June 8th further decreasing the chance that it is just a correction.  While we don’t currently follow the S&P 500 every day, we would be remiss if we didn’t cite that it broke to new lows down from its April high and managed to print its lowest close of 2010.  Removing That provides confidence that the S&P is likely to be in Minute wave 3 along with the Dow.   Merking this milestone allows us to consider 10,594 a likely lasting high on the Dow for some time to come.  Taking it out would require us to re-work major portions of the wave count.  Being able to count this as a durable high is much more valuable than knowing where we are within the smaller-degree wave structure.  At this point we have a high degree of confidence that we are in minor wave 3 of intermediate wave (1) of primary wave [3]. 

Unfortunately the price we pay for the added clarity in the minor wave count is murkiness in the wave count at minute degree and below.  Our best analysis suggests that some or all of Tuesday’s decline occurred within minute wave 3.  As we mentioned before, virtually all upward retracement in the past week has been short and shallow making it hard to discern wave structure.  So our view of Tuesday’s action is based more on technicals than wave count.  On all possibly relevant timeframes from less than a 5 minute chart to over a 60 minute chart, EWO and MACD recorded lower values during Tuesday’s decline than at any time since June 21st.  Until a better view of the wave structure appears we will use that as our best guide and it suggests that we are most likely in minute wave [iii].  It would be unwise to trade on this assumption without further confirmation. 

Absent a reliable count or much reason to discern between them, we’ll focus on presenting a single primary without alternates.  That doesn’t mean the count is right, it just means that we have high confidence in the higher degree count, hence showing only one.   And with no confidence in the lower degree count, it doesn’t matter which wave we’re in at lower degree since we can’t act on it. 

Notable milestones for Tuesday’s action include:

  • The Dow broke back below the second of our two trendlines down April highs
  • The Dow broke below our adaptive channel on the daily chart
  • The Dow registered a MACD crossover on the daily chart

If this wasn’t enough to signal the strength of the decline, we note that RSI(5) on the Dow reached its lowest level since Febrary, 2009.  It’s worth pointing out that while many of these short-term strength measures tell us that markets are very weak, they might also be telling us that the move could be getting ahead of itself. 

Outlook for Wednesday

Our lack of a confident count below minor degree makes it hard to predict exactly what will happen on Wednesday, but confidence in our larger degree count gives us a much better picture for longer term.  There’s no reason to deviate with our expectation of seeing minor wave 3 take the Dow  below 9,174 in the next few months with better targets around 8,800 and 8,300.  This will make short-term trading based on Elliott Wave Theory difficulty because oversold bounces in a rapidly moving bear market can be large and rapid.  The fact that drops may be faster and larger is little consolation if an unanticipated bounce wipes out a significant portion of equity and limits participation on drops.  A prudent approach might be to adopt a longer term posture that anticpates the greater decline over the course of minor wave 3 and that could tolerate a bounce that retraces a significant portion of the move down from the end of minute wave 2.  This might entail a longer timeframe and less leverage, but it is an attractive trace with what the market is telling us now.  As always, it’s wise to plan for contingencies should our broader count also be wrong.

This isn’t to suggest that one should completely avoid short-term trades.  However, know the risks.  If you have a way of getting out of trades quickly and with minimal losses, that’s great.  But the short term wave counts may not be able to help in chossing entries and exits.

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