A Tipping Point: March 23, 2012

Bears are understandably shell-shocked after the past three months.   Top picking has been a frustrating and humbling experience, as markets -- like an addict in search of his next fix -- have ignored everything but the promise of additional QE.  But, the improbable low-volume, non-stop melt up might finally be at a tipping point.

As noted in yesterday's post, several key indices have finally reacted off their harmonic pattern targets.

RUT completed a Crab Pattern within the last leg of a Bat Pattern and has yet to clear a key trend line off the May and July highs.  COMP completed a tiny Crab within a little Butterfly pattern and tagged a key trend line off the 2007 highs.  DJIA completed a Crab pattern just a few points away from completing a Butterfly pattern and large Bat pattern.

Each of the indices is showing bearish divergence on the daily time frame within an overextended rising wedge that's in danger of being broken -- but haven't broken yet.  In spite of the completed patterns, there are some potential bullish patterns, such as the Dow's Bat and SPX's Butterfly, that might take prices just a little higher.

I've spent the past several days wandering the charting desert in search of some sign of things to come.  I posted a bit the other day about the SPX wedge within a wedge and how we're at Fibonacci levels of time and price in each.   I started by charting some basic channels and fib levels, along with the rising wedges.

As we discussed the other day [see: Big Picture, Part 2], the smaller yellow wedge apex is not only right at the .886 of the 2007-2009 price decline, but also the .886 fib levels of the larger rising wedge apex.  On top of all that, it's also at the .618 of the large rising wedge in terms of time.  This is significant, because rising wedges commonly give up the ghost around 61.8% of the way to their apex.

And, within the smaller rising wedge, we can also see we're at important fib levels -- .786 in terms of price and .886 in terms of time.

All this is well and good, and we clearly got the reaction we were looking for when we were looking for it.   The key level coming up is the small rising wedge bottom at 1374.   If we take that out, we could find our way down to 1300 in a jiffy.  And, the bottom of the large red rising wedge is currently all the way down at 1165.

I know I don't have to remind anyone here that rising wedges can hang on for a long time -- especially lately.   And, as mentioned earlier, there are still some potential bullish harmonic patterns that could fulfill to the upside -- notably SPX 1419 and 1433.  And, sometimes harmonic reactions are pathetically small bumps on the road to bigger and better things.

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Thus, the days spent wandering the desert.  And, let me be clear, this is pure spit-balling folks.  I've been looking at long-term patterns in the markets, trying to discern similarities that might offer a clue as to the big picture.  One era that fascinates me is the 1970s.

We had a decade-long war in Vietnam and an oil shock when OPEC imposed an embargo in response to our military support of Israel in the Yom Kippur War.  Oil prices went from $3/bbl in 1970 to nearly $40 in 1980.  The following chart, from the EIA and posted on Wikipedia, shows the blow by blow.  (For history buffs, there's an interesting chronology available here.)

Inflation went from 3.6% in 1973 to 11.8% in 1975 and 13.9% in 1980.   P/E ratios went from 17.7 in 1970 to 6.7 in 1975.  The 1-yr went from 4.62% in 1972 to 11.03% in 1974.  And, stocks were all over the map.  After gains of 25% from 1970-72, the S&P 500 had losses of 23% in 1973, 29% in 1974 and 14% in 1977; and, gains of 29% in 1975.

In short, it was an important inflection point. To Elliott Wave guys, it was an important turn in wave counts.  To all the rest of us, it was the payoff to The Great Crab.

What?  You don't remember The Great Crab?  Okay, so it's possible I just made that name up.  But, it's kinda catchy.  And, more importantly, it fits.

First, well... it's a Crab pattern.   It features a point B at about 50% of the XA price difference (for those who skipped the lesson, go back and read: Crab and Butterfly Patterns Explained.)   Second, it began in the Great Depression, so that gives the name a ring of authenticity.

And, finally, what else would you name a pattern that in 1937, after a 90% drop, 300% rally and subsequent 60% drop, pretty accurately predicted the following reversals at key Fibonacci points?

                                                       Fib.          Year       Decline

                                                      1.618         1956        19%
                                                      2.618         1961        28%
                                                      3.618         1969        36%


All that coolness aside, I believe the 1970s offer important clues to what lies ahead.  I'm doing some research that I'll publish in the next day or two that, quite frankly, is knocking my socks off.

Stay tuned.

Charts I'm Watching: March 22, 2012

ORIGINAL POST:

We're finally seeing reactions on the harmonic pattern completions we've been watching for what seems like forever [see: Everything's Coming Up Crabs.]

RUT completed a Crab Pattern (in red) within the last leg of a Bat Pattern (purple) off the 2011 highs.  It never has cleared the TL off the May and July highs.  The May 2011 high was a double-top to 2007's.

COMP completed a tiny Crab within a little Butterfly pattern and tagged a key trend line off the 2007 highs.

I call it a trend line because it's exactly parallel to the line connecting the 2002 and 2009 lows.  A reversal here would make for four touches -- i.e. a channel.  But, COMP could continue bucking its bearish divergence and go up to complete the larger Butterfly pattern (purple) at 3250-3295.

DJIA still hasn't made a new high since completing a Crab Pattern a stone's throw away from a Butterfly Pattern (purple) completion at 13,338.64.  We're still watching for a clean break of the rising wedge in the price chart and the trend line in the RSI chart.

 

 

Though, it's important to note that, at these prices, we came within 28 points of completing a Bat pattern (yellow) at the .886 (13,317) in the weekly chart.  That would make for a logical back test if/when the rising wedge finally breaks.  It might also be the 5th and final wave target if today's move stays within the wedge itself -- which is just as likely.

Coming up....SPX.

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Charts I'm Watching: March 20, 2012

A quick summary of the major charts...

RUT has completed a Crab Pattern (in red) within the last leg of a Bat Pattern (purple) off the 2011 highs.  Significantly, it hasn't been able to clear the TL off the May and July highs.  The May 2011 high was a double-top to 2007's.

COMP is tagging a trend line off the 2007 highs which is exactly parallel to the line connecting the 2002 and 2009 lows.  A reversal here would make for four touches -- i.e. a channel. 

While the largest potential Butterfly Pattern 1.272 completion is still some distance away (3295 v current 3071), it completed a small Crab within a small Butterfly at 3062 and 3048 respectively.  I think that between the TL and the smaller Butterfly, we should get at least an interim low in the short run -- even though there's more medium-term upside to the 3250-3300 level.

 

DJIA peaked at 13,289, completing a Crab Pattern a stone's throw away from a Butterfly Pattern completion at 13,338.64.

Zooming out, we see that we're also bumping up against the .886 of the Oct '07 to Mar '09 drop at 13,317.09.  Either of these patterns could be considered close enough to be complete, but a small intra-day bump to tag the actual target is very feasible.

SPX is closing in on the .886 of the Oct 07-Mar 09 drop at 1472.43.  But, we're reaching important resistance levels in the rising wedge -- which is getting long in the tooth.

On a smaller scale, the Butterfly pattern from last July is approaching its 1.272 extension at 1421 -- assuming a Point X of 1347 on July 21.  This is the best fit for the Butterfly pattern, but it could be started at May 2's 1370 or July 7's 1356 -- resulting in slightly higher 1.272 extensions.


There is ample bearish divergence in every time frame.
 

More later.

Big Picture, Part 2: Mar 19, 2012

We'll start with the weekly version of the chart of channels I posted last night...

The parallel diagonals are by no means the only way to skin this cat, but they do demonstrate the market's tendency to relate future moves to past and present.  Just about all the turns are guided by the red downward-sloping trend lines; most of those that aren't are guided by the purple upward-sloping lines.  The handful of turns that don't relate to either all correlate with a Fibonacci level.

There are two rising wedges visible on the chart.  The dashed red lines both originate off important lows -- the late 80's/early 90's and the Mar 09 low and come together for an apex around January 2013 at about the 2007 high of 1576.  The solid yellow lines originate off the Mar 09 and Oct 11 lows and feature an apex around May of this year at about 1472.

What's particularly interesting to me about these two wedges, besides the bearish implications of rising wedges in general, is how they relate in time and price.   Note that the average rising wedge breaks down at about a Fibonacci .618 of the time from its origin to its apex.   And, in most cases rising wedges break down at Fibonacci price levels as well.  Let's look at our two wedges.

First, the smaller yellow wedge's apex at 1472 comes in right at the .886 Fib level of the Oct '07 - Mar '09 decline -- which is also at about a Fibonacci .886 of the red wedge's rise from Mar 09 to its apex.

Second, the time from inception to apex for the small yellow wedge is 3.1 years.  The time from inception to apex for the larger, red wedge is about 5 years.  Divide the former by the latter and you find the time relationship between the two is a Fibonacci .618 -- seen in the following graph.

A close up reveals that movements within the small, yellow wedge are nearing some important Fib levels.  Prices are very close to the .886 (1418) of the price range.  And, Wednesday Mar 21 will mark the .786 of the time range.  Again, both of these measurements assume an apex of 1462 on May 7 -- a location which is as close as I can draw it, but a bit of an approximation.

Last, note that the intersection of these to Fibonacci levels occurs at the intersection of two of the channel lines we drew in that first chart above.  While channel lines are much more guidelines than absolute rules, a bounce at that four-way intersection would certainly make a lot of sense.

From what I read, the most logical Elliott Wave count is that we're setting up for a wave 4 correction -- unless this is the 5th and final wave up in this monster bear market rally.  This would be a very logical place.  Note also that there is very noticeable divergence on the daily chart, with the mother of all back tests on the dashed yellow TL that was broken two weeks ago.

One last note on this RSI chart... the drop in RSI from that brief downturn was massive compared to a measly 38-point price drop in SPX.  Compare this to the RSI drop in July, for instance, and it's pretty clear that the technical damage done to the market's internals has yet to be reflected in prices.  A strong downturn in the next few days could rectify that.

Last, thanks for your patience this week as I rush to finish the new website layout.  Lots of moving pieces that I think folks will enjoy, but it's taking time.  I'm watching during the day, of course, as things develop (or not.)  But, I'll be keep my posts to a minimum unless there's something important to say.

Good luck to all.

Big Picture: Mar 18, 2012

Every once in a while, I make myself sit down and reassess everything I believe about the markets.  As most readers know, I've been bearish ever since my first post on May 2, 2011.  The excessive bullishness I saw in the markets had finally gotten to me and, as fate would have it, I sat down to write about it.

Back then, I saw we were approaching a trend line coming up from the late 1980's and drawn through the 2002 lows.  We were also approaching the .786 Fib retracement of the Oct 2007 - Mar 2009 Gartley.  We were very deep into a rising wedge, and we were also about to complete a large Crab pattern that dated back to Apr 10.

Sure enough, that was a potent combination.  The market topped that day, and didn't finish dropping until almost 300 points later in what was widely considered (by bears at least) to be the first wave of P3.  Now, 330 points and many redrawn wave counts later, it's a great time to reassess the big picture.

First, it's worth noting that we're back to within 45 points of that long-term trend line -- currently at 1451 and rising about 8 points per month.  We're also bumping up against a new rising triangle.  And, the .886 Fib retracement of the Gartley is up ahead at 1472 -- around the end of May on the TL.

Interestingly, we recently completed a large Butterfly Pattern and Inverse Head & Shoulder Pattern for a 46-point reaction at the Gartley's .786, which led to a Crab Pattern within a Crab Pattern and Inverse H&S pattern that all point to current prices (1405-1409.)  It's not a perfect fractal of the last move, but it's pretty darned close.

Also entering the picture above is one of the purple channel line drawn from the 1576 Oct 07 high.  It's placement is somewhat inexact, but note that it is precisely parallel to the trend line connecting the 2002 and 2009 lows, and all the other parallels which have been influential over the past 10 years.  Today, it crosses in the vicinity of 1439.

While a move down from here would make perfect sense, it seems odd that we'd leave the .886 Fib line untouched at 1472, particularly given its proximity to the trend line from the 1980's and the rising wedge apex -- all towards the end of May.  There's also a 1.272 completion at 1451 of the large Butterfly pattern ranging from 1370 to 1074.

All this leads me to believe we're likely to see a reaction in the next few days, a decent-sized drop down to 1380 or so, followed by one last ramp up to the 1450-1470 area.  If I'm wrong, and we see a larger drop here, things could get ugly in a hurry.

More tomorrow.

Crab and Butterfly Patterns Explained: March 18, 2012

The Crab and Butterfly Patterns, like their cousins the Gartley [see: The Gartley Explained] and Bat, offers early warnings of potentially significant reversals in price trends.  Like the rest, they are thought to be successful about 70% of the time.  Combined with sound trade management technique, they can provide significant returns with limited risk.

CRAB PATTERNS

Crabs, like all harmonic patterns, feature a precise series of coiling retracements  -- failures to retake the previous highs and lows.  Unlike the Gartley and Bat, however, Crabs surge higher than the price level that starts the pattern before reversing, usually to 1.618X the price range previously established.

For an example of how Crab patterns work we'll look at this past January.  On January 23, 2012, SPX had gained 45 points in the previous five sessions, and seemed ready for a pause.  It opened strong that morning, a continuation of the overnight ramp job in the futures, but on negative divergence.

Sure enough, it fell 16 points by the following morning, completing an a-b-c move and tagging a low of 1306.06.  It bounced hard off 1306, and attempted to regain its recent high.  But, it failed just past the .618 fib level at 1316.63 and fell back towards its recent low.  Here, it failed again, putting in a higher low and heading back up again.

At this point, we had a Point X (the origin of the pattern at 1322.28), a Point A (the 1306.60 low), and a retrace to Point Bat 1316.63.  It reversed here, putting in a Point B that was in the required range of a .382 to .886 retrace of the XA decline.  Some prefer a Point B below the .618 retrace, but many (including myself) believe a reversal at up to the .886 is perfectly all right.

After the reversal, we saw a Point C in the required range of .382 - 886 retrace of AB, and started heading higher.  Point B was only slightly higher than the .618 retrace, so there was a possibility that we were working on a Gartley or Bat.

Remember, a Gartley Pattern requires a reversal at the .618 and plays out to the .786.  A Bat features a reversal below the .618 and completes at the .886.   Given a reversal this close to the .618, many traders would attempt to play each prospective pattern as it came along.  We'll save a discussion of various strategies for another post.

Suffice it to say that after SPX cleared the original Point X, a reversal at the 1.618 extension was definitely in the cards.  We saw a slight pause at the 1.272 -- where a Butterfly sometimes reverses -- and reached the 1.618 when we gapped open the following morning.  Because the final surge was so strong, we overshot by 1.17 -- reaching 1333.47 versus our Point D target of 1332.30.

Like all Crab Patterns, the degree of the reversal is a function of many other factors.  The strongest reversals are those that take prices in the same direction in which the market was already trending.   But, in general, we look for a move of .618 of the AD price distance.  Beyond that, we look for other Fib levels such as .786, 1.272, 1.618, etc.   They're charted below in yellow.

In this instance, we reached the .618 level at 1316.53 a few hours later, bounced at the .786 at 1311 and continued to 1300, very close to the 1.272 Fib level.  All in all, we had a 33-point move off the 1333 high -- about 2.5%.  For an active trader, a 33-point move opens up some very profitable opportunities.  However, it's often difficult to forecast the degree of the move, so many traders play the reversal and get out once a modest profit is in hand.

We had a little help in anticipating the degree of this reversal because once we reached and reversed at the .786 on the way down, there was a possibility that we'd go on and complete a Butterfly pattern that normally extends to the 1.272 or 1.618.  In fact, that's exactly what happened.

BUTTERFLY PATTERNS

Butterfly Patterns are the fraternal twins of Crab Patterns.  They require a Point B at the .786 XA retracement, rather than the Crab's more generous range.   And, they complete at either the 1.272 or the 1.618 extension.

In the example above, we saw a completion only 14 cents away from the 1.272 extension target.   Note that the previous Crab pattern melded into a Butterfly: the Crab's Point C became the Butterfly's Point X.  And, the Crab's Point D became the Butterfly's Point A.

Because Butterfly Patterns can extend to the the 1.272 or the 1.618 Fib levels, they can be a little tricky.   Playing the 1.272 means placing appropriate stops, just in case it's the 1.618 that shows up instead.  The results are similar to other harmonic patterns -- with objectives starting at the .618 of the AD, and going up from there.

Here, we saw a nice move to the .618, which reversed to the .236 before moving on to the .886.  There, it reversed to the .618 before zooming on to the 1.272 and eventually, the 1.618.   Total move: 53 points for about 4%.  Again, playing patterns that pay off in the direction of the trend usually means greater payoffs.  Anyone who doubts the power of Fibonacci would do well to study that chart!

Those readers not yet asleep or cross-eyed from the above might notice that the payoff from the Butterfly Pattern created yet another Crab Pattern.    Note how the original small purple Crab Pattern  melds into the medium-sized, yellow Butterfly Pattern that morphs into the larger, purple Crab Pattern.

Relabeling the points, it's easy to see.  Yet, I'll be the first to admit that in the heat of the battle, it's sometimes tricky to keep all the various possibilities straight -- especially when dealing with smaller patterns that might or might not be part of larger patterns.  Again, I look at technical analysis, chart patterns and fractals to try to sort it all out.

When the new website is up and running, I'll track as many major and minor patterns as I can on the major indices.  Traders can take advantage of knowing where to look for turns, while longer-term investors can gain confidence in positioning their portfolios.

Speaking of the new website, I should get back to it.  But, I've had lots of questions about Crabs with all the larger patterns currently completing [see: Coming up Crabs], and wanted to get the info out asap.  Good luck to all.