Stock Market Elliott Wave Analysis : Intermediate Top Spotting

By: Dominick

With volatility, illiquidity, and uncertainty roiling equity markets this week, we tuned out the pundits, removed bias, and traded the charts as they evolved and presented the set ups we identified over the weekend. Last Friday, as “Cramerica” was capitulating, we were looking for a tradable bottom, barring some sort of meltdown. To this effect, last weekend's update said:

“From here, Dom acknowledges that the bears must see Thursday's high as an abc for wave 2, making Friday's selling a wave 3, but this is a low probability setup. Dom's working count has this leg ending soon, but also critical levels where this count has to be abandoned. Remember, price levels are the key to trading here, not unconfirmed counts.”

When Monday's low of 1432.25 came in at 10:50 , the chart below was reposted from the weekend folder, where it had been available for members, showing we were in the zone for our low target on this move. All we needed from there was a reversal, which we got amid all the talk of a rate cut, a 1987 crash, and most traders seemingly looking for the five waves down of the wave 3 mentioned last weekend which I didn't think would happen.

So, we got long the lows with an eye on a rough projection of the potential upside target around 1504. We work hard all week to be able to calculate targets 70 points away and seeing them be reached, this time was no different. 1504 was also the breakdown level we shorted a few weeks ago on the initial move from the 1556 highs which gave it more strength. An updated version of the chart above was posted going into Tuesday, when many figured we needed a cut or the market would sink. I always want to be aware of the Fed or other exogenous factors that could play with the tape, and occasionally will want to get out of the way, but on Fed day we continued to look for a move into the 1500 area, because hey, the site's called Trading The Charts , not trading the news. As it was, Tuesday's Fed meeting came and went without consequence as shorts were forced to cover on the perceived confidence from Bernanke in the markets and continued economic growth.

Then, on Wednesday, I made an announcement that was different than what I normally do intraday, something focused more on the big picture, and probably unexpected by the members. Some readers might think I'm just naturally bullish and that the last 400 points were just a lucky bullish bias, but at 12:50 PM, with the ES trading at 1498, I made the following post, which not only demonstrates my willingness to get bearish when appropriate, it also shows how TTC sets up a call on market structure without needing to give specific trades. But this was, in fact, the call of the week, if not the year.

I haven't had the need to get bearish too often in this market, but after rejecting the 3 of 5 down idea, I knew if there was a set up for the bears this was going to be it. The post is not just a call to blindly short, it has a specific message for members to take away. I wanted to see a specific number hold, then a new high around 1510 , and a dramatic reversal. If these criteria did not occur, members should trade the other way. Well, as it turned out, we got all those things, and a dramatic reversal it was!

Everyone should know that I'm not interested in the top-calling game. My experience, and that of everyone I've spoken to, is that trying to hit the top tick is a losing proposition. If you're lucky, you might get it, but even then the money you make will probably not get back everything you lost trying to get there. It's like Vegas, you might win sometimes, but you're rarely, if ever, a net winner. Still, this setup was the most dangerous pattern for the bulls that I've seen in a long time, so I put the top hat on, so to speak, for at least a tradable top, if not a major long term market top.

But, as Wednesday's market continued to lift, the usual cheerleaders were out talking up the resiliency of the rally, totally unaware of the ending diagonal C. As the 1493 make or break level held on the backs of shorts still needing to cover, trading curbs were instituted around 2:30 and prevented programs from paying up ticks. At this point, even a trader without the benefit of my charts should have seen the great risk/reward opportunity for sellers after 80 points of upside in just three days.

Ultimately, my target area was met and the market reversed hard from 1510.50, moving over 25 points in about 30 minutes before hitting the rising trend line near 1483.

The media couldn't explain the reversal and suggested the rumor of a bank or fund problem was the root of the selling. It seemed a likely story and most went with it. When the bank denied the rumor, ticks spiked and stocks rallied into the close, trapping shorts and relieving longs.

The rumor, denied, took away gains from anyone sleeping. After the bell rang it was funny to hear a comment from one of my moderators (Cos) that is amazed of the power of Elliott wave when used correctly. He went to say, “Since that late day rally went right to the .786 retracement, it did exactly what it was supposed to do to create a wave 2.” Most saw a bullish recovery, we saw the trap. Sure enough, Thursday morning opened with a 15 point gap down which left us completely unsurprised, even if the massive liquidity injection from the ECB was unexpected. I've already told you how I feel about the news, and considering the move was perfectly consistent with the structure we outlined the day before, we left behind the debate about what caused what and continued to trade the charts in front of us.

Thursday's decline reached our old target of 1457 in the afternoon and, as we sat on a single-day 50-point move in our favor, we decided it was time to talk TMAR, take the money and run, because a corrective ending was beginning to shape up. Some members decided to hold their short positions overnight and tried for that little bit extra, and really got it.

But with Friday morning's deep gap down, I absolutely had to pound the table early in the chatroom and warn not to go along with this drop, not to short the hole. At that point our biggest fear was Bernanke, who could pull a rate cut out of his hat, and we didn't want any part of that risk. Members and readers should take a look at a chart of January 03, 2001 and reevaluate their position if they're shorting against the Fed. The old saying is “Don't fight the fed!”, but the point is we don't really know what Bernanke's made of and, even if a rate cut isn't in the cards, he's obviously sensitive to the markets and overstaying any position in this tape is just not smart.

For anyone who took it, the long produced a 30+ point jump Friday morning alone. But overall, the trade Friday was sloppy and illiquid, ironic since the Fed was boldly injecting liquidity. The majority of members sat idle for most of the morning while the market scrambled to find direction. But cloudy tape like this is exactly where TTC's proprietary trend charts are adept at spotting changes in the underlying trend. The 5 min lifted as the 15min was already pegged, giving a good entry on a scalp long prior to a late afternoon rally into the cash market close.

We took profits and went flat, something I think more people should consider. This market is trading scared on both sides and liquidity is sparse – we're trading during a period that'll be remembered for years and probably decades to come, and it's just not like the old days anymore. Being flat is a position and that's us. I'm sure Monday we'll have a direction, but for now our biggest decision is whether to stick with Wednesday's chart, or let it go after using it for an intermediate top and 80 points. The biggest mistake I see most analyst's make is finding a chart that works, but then holding on to it indefinitely and turning a gain into a loss.

The reason to scrap such a perfect chart that produced 80 points already is that if the market doesn't gap down and sell off hard next week, there is a very bullish pattern waiting to setup and also a short term bullish pattern in a larger bearish count. With swings of close to 100 points, staying short a retrace these days doesn't work, period! Both setups can make a small low on Monday before firing back up. Basically, if you don't have more money than the Fed, don't let price get away from you here if you are already short. If we fall away from this area impulsively, Wednesday's chart will remain the working count.

The bottom line here is that we are not ever married to a position, and going into next week with this flexibility will allow us to repeat the money-making process all over again. With option expiration and active central banks we prefer to stay nimble and will let the market give us the next set-up, not the pundits and strategists.

My advice to day trading members has been to cut down on the size of the trades in this environment, think about the same.

Members can see those Weekly roadmaps by clicking on the chart below.

Market Oracle readers, make sure you check our “Featured Chart” each week located on this site's home page, on the left side half way down the page. This week we revisit an article we wrote in May which suggested a new film featuring fictional Wall Street hero Gordon Gekko could be interpreted as yet another sign of a top. 

Have a profitable and safe week trading, and remember:
“Unbiased Elliott Wave works!”

By Dominick

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