MARKET APPEARS TO HAVE COMPLETED FIVE WAVES OVER THE LAST YEAR WHICH INCREASES THE ODDS FOR A DOWNSIDE CORRECTION -- MOVING AVERAGE TRENDS WEAKEN -- MARKET MAY NOW REVISIT MARCH LOW AS PART OF DOWNSIDE CORRECTION
THE MARKET'S HAD A FIVE WAVE ADVANCE... Determining Elliott Wave counts can be very subjective. One way to make it little easier is to employ a "ZigZag"overlay on the price chart. [The ZigZag is located in the same Overlays menu that includes moving averages]. The idea of the ZigZag overlay is to apply a percentage filter on market trends. The default setting is 5% which means that only price moves of at least 5% are shown. Anything smaller than 5% is ignored. You can change the percentage filter to make the lines more or less sensitive. I increased the ZigZag filter to 7% in Chart 1 to show the two 7% corrections from last August and this March without upsetting the 5% line count. The lines help eliminate some of the subjectivity when counting market waves. Chart 1 shows five clear lines since last summer's bottom. Three up lines and two down lines. [The numbers were added by me]. Elliott Wavers know that five-wave advance is usually a signal that an upmove has been completed and that correction within the uptrend is likely. I've also recently shown a number of negative divergences on daily and weekly indicators like RSI. Why that's important is that fifth wave negative divergences are usually more serious warnings of a market correction.
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Chart 1
% NYSE STOCKS ABOVE 50 MA BELOW 50%... One of the signs of a weakening in the market is the increasing number of NYSE stocks that are slipping below their 50-day moving averages. The blue line in Chart 2 is the percent of NYSE stocks that are trading above their 50-day MAs. It's a very volatile line which often swings from overbought readings over 90% to oversold readings below 20%. It last reached 90% last October. The green line is the NYSE Composite Index. The first thing you'll notice is that the percent of NYSE stocks over their 50-day MAs during April was only 75% which is much lower than the October number. In addition, the blue line has just dropped below 50% for the first time since March and has undercut its April low. That means that more than half the NYSE stocks have now fallen below their 50-day averages. That's normally a sign that the broader market is weakening and increases the odds for a market correction.
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Chart 2
% STOCKS ABOVE 200-DAY MA IS ALSO SLIPPING... A measure of the market's major trend is given by the percent of NYSE stocks trading above their 200-day moving average. That's the red line in Chart 3 which is compared to the NYSE Composite Index (green line) over the last three years. It's normally a good sign for the market when the red line starts rising as it did in the spring of 2009 and last summer. It's a sign of weakness when the red line starts dropping (as it is now). The chart also shows that readings below 20% reflect an oversold market reading (as in late 2008 and early 2009), while readings over 80% reflect an over-extended market. A downturn in the red line from above 80% (as happened last spring) usually warns of a market correction. A market correction often brings the red line down into the 40%-50% region as it did last spring. It then rose back over 80% during 2011 into overbought territory. Unfortunately, it's now starting to weaken again. Chart 4 shows $NYA 200R dropping to 74% as of yesterday and in danger of undercutting its March low. You can see the red line falling faster than the green line. That's also normal at the start of market corrections.
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Chart 3
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Chart 4
MARKET MAY REVISIT MARCH LOW... It's not unusual for a fifth wave correction to return to the bottom of wave 4. In the case of the S&P 500, that would mean a potential drop to its March low near 1250. Using closing prices, that would entail a drop of -7.8% from the recent high which would roughly match the previous two corrections of the last year (waves 2 and 4). A drop to the March low would also be roughly a 38% correction of the rally from last summer which is also normal. Another way to measure a potential downside target is with Bollinger bands. While 20-"day" bands are normally used for short-term trends, 20 "week" bands are more helpful in intermediate trend analysis. Chart 5 shows "100-day" bands which simply convert 20 weeks to 100 trading days. That allows us to use an intermediate trend indicator on a daily chart. Chart 5 shows the S&P 500 bearing down on its 100-day average (dotted line) which stopped the two previous pullbacks during March and April. If that support line is broken (which appears likely), the next downside target would be the lower band (currently at 1255) which closely approximates the March low (green line). Technical indicators have also turned negative. Daily MACD line (below chart) have turned down. [Weekly MACD lines are also negative]. The 14-day RSI line (top of chart) has fallen below 50 which suggests a further drop to 30. [Last Friday, I showed the weekly RSI line failing to confirm the recent S&P move to new highs and forming a negative divergence]. Recent intermarket trends which include a stronger dollar/weaker Euro, falling bond yields, and rotation into defensive market sectors are also consistent with a market correction. So is the seasonal trend which normally starts to weaken during May.
