Weakness in the Market--A Sharp Contrast to Friday

1 minute chart of the S&P 500

After Bernanke's speech Friday, the market rallied sharply to close more than 25 points off the session's low.  The tenor of the market was much different today however.

The tone became decidedly bearish particularity after 1056 was broken to the downside.  As the chart shows, support near that level became resistance as prices failed to break higher on two occasions.  The sell-off then accelerated to the downside.

The downward channel formed today was actually breached to the downside near the close at the day's selling climax.  This development is of particular interest to Elliott Wave traders; a break out of a base channel (the channel formed by initial waves in the direction of a new trend ) usually means a 3rd wave of an impulse is underway.  So in today's case, it appears that a downward impulse is unfolding since Friday's highs. We will talk more about channels used with Elliott Wave theory in the future.

Finally take note of the head and shoulders topping pattern that has already nearly reached the 1047 price target.  This price target is determined by finding the distance from the neckline to the head, then extending this length from the point neckline support is broken.  The head and shoulders pattern suggest a reversal in trend which is to the downside in this case.  Read more about head and shoulders patterns here.

Elliott Wave Degrees

Elliott Wave Theory proposes that waves come in several "degrees" and are themselves fractals of larger waves. The basic structure of motive and corrective waves applies to all waves. Practitioners of Elliott Wave use labels for different wave degrees, from those wave that occur matter of minutes to waves that taken hundreds of years to unfold. All waves are theorized to have a direct relation to the Fibonacci sequence in time and price.

The following labels were proposed by Ralph Nelson Elliott on his works on Elliott Wave Theory.

Grand supercycle - Hundreds of years
Supercycle - Several Decades (about 40-70 years)
Cycle - One year to multi-year waves
Primary - Few months to couple of years
Intermediate - Weeks to months
Minor - Week
Minute - Days
Minuette - Hours
Subminuette - Minutes

Orthodox Elliott Wave practitioners do not factor in inflation in their wave counts. Victor C. Ling of Elliott Wave Trends proposes wave counts adjusted for inflation.

Hindenburg Omen and Elliott Wave Theory

When I first read about the Hindenburg Omen I thought it was one of those esoteric signs that so many people like to speculate on. But after researching it and reading more about it, I found this is a valid technical analysis signal for stocks as it is based on a number of technical criteria that needs to be met in order for this signal to be given. Which generally are:

1. Daily number of NYSE new 52 Week highs and the daily number of new 52 Week lows must both be greater than 2.2 percent of total NYSE issues traded that day (currently, greater than or equal to 69, which is above 2.2% of 3126).
2. The NYSE 10 Week moving average is rising.
3. The McClellan Oscillator is negative on that same day. 
4. New 52 Week Highs cannot be more than twice the new 52 Week Lows (however it is fine for new 52 Week Lows to be more than double new 52 Week Highs). This condition is absolutely mandatory.       

 And according the criteria listed above, we had a signal on August 12th, 2010. Usually, in historical analysis whenever there are several signals clustered together in a 36 days period it has a substantially high probability of predicting market crashes of 10% or more. Coincidentally, the current mainstream Elliott Wave count calls for a massive downturn withing the next few weeks so we will tell by September or October the relation between Elliott Wave Theory and this signal. It's worth noting that in the last 25 years this signal when it comes in clusters has only failed 1 out of 7.5 times, therefore the probabilities are very high. Below is a table of the past performance of the Hindenburg Omen:

Date of first Hindenburg Omen Signal	# of Signals	DJIA  Subsequent % Decline	Time Until Decline Bottomed
8/12/2010	1	In Process	In Process
6/6/2008	6	51%	244 days
10/16/2007	9	16.3%	99 days
10/16/2007	9	16.3%	99 days
6/13/2007	8	7.1%	64 days
4/7/2006	9	7.0%	34 days
9/21/2005 (1)	5	2.2%	22 days
4/13/2004 (2)	5	5.4%	30 days
6/20/2002	5	15.8%	30 days
6/20/2002	5	23.9%	112 days
6/20/2001	2	25.5%	93 days
3/12/2001	4	11.4%	11 days
9/15/2000	9	12.4%	33 days
7/26/2000	3	9.0%	83 days
1/24/2000	6	16.4%	44 days
6/15/1999	2	6.7%	122 days
2/22/1998 (3)	2	0.2%	1 day
7/21/1998	1	19.7%	41 days
12/11/1997	11	5.8%	32 days
6/12/1996	3	8.8%	34 days
10/09/1995	6	1.7%	1 day
9/19/1994	7	8.2%	65 days
1/25/1994	14	9.6%	69 days
11/03/1993	3	2.1%	2 days
12/02/1991	9	3.5%	7 days
6/27/1990	17	16.3%	91 days
11/01/1989	36	5.0%	91 days
10/11/1989	2	10.0%	5 days
9/14/1987	5	38.2%	36 days
7/14/1986	9	3.6%	21 days

Elliott Wave Structure

The Elliott Wave structure is based on the premise of crowd psychology in markets. The theory states that investor's psychology will swing from optimism to pessimism and vice versa in predictable wave forms.

In one of Ralph Elliott's works, "The Basis of the Wave Principle," Elliott's model states that stock market prices fluctuate between five waves and three waves at all degrees of trend, as the illustration shows above shows. Within the main price trend, waves 1, 3, and 5 are called "motive" waves, and each motive wave itself subdivides in five waves. Waves 2 and 4 are counter trend waves or "corrective" waves, and subdivide in three waves. In a bear market the main trend is downward, therefore the structure is reversed, so it would be five waves down and three up. Motive waves always move with the main trend, while corrective waves move against it.

What is Elliott Wave Theory

 

Elliott Wave Theory is a form of financial market's technical analysis that forecasters use to identify trends and extremes in investor psychology. Elliott Wave Theory was developed in the 1930's by Ralph Nelson Elliott, an accountant by trade. His analysis of stock market price movements indicated that prices fluctuate in specific wave like patterns, thus the name "Elliott Wave". He published his works on his book The Wave Principlein (1938) and, in several articles in Financial World magazine. Elliott published his second and most comprehensive work in 1946 in a book called Nature’s Laws – The Secret of the Universe (1946). Elliott theorized that "because man is subject to rhythmical procedure, calculations having to do with his activities can be projected far into the future with a justification and certainty heretofore unattainable." Elliott's work fell into obscurity after the 1950's and his works were revisited in the 1970's by Robert Prechter, whose interpretation gained him notoriety in 1987 for predicting the crash that year.