Intel had planned on halting its mid quarter updates and provide only an annual outlook in January with adjustments to that outlook with earnings each quarter. Unfortunately conditions changed drastically for Intel and they had to abort those plans and issue a warning for Q1 on Friday.
SPX Chart - 240 min
Dow Chart - Daily
Nasdaq Chart - 180 min
Intel published a press release that was very harsh with numerous qualifications concerning business concessions. Intel said its previously published outlook for Q1 and for 2006 "no longer reflects the company's current expectations." They lowered revenue expectations for Q1 to $8.7B to $9.1B from expectations of $9.1B to $9.7B. This -5% cut in estimates is only the tip of the iceberg. Intel also said Q1 margins would be adversely impacted by their lower revenue and changing expense structure. Intel published a bullet list of six paragraphs containing factors that could impact operations going forward. Basically the 350 word description of adverse factors included competition, fixed costs, R&D costs, economic conditions, product mix, unit costs, obsolete inventory, order cancellations, customer order patterns, excess channel inventory and "market acceptance of Intel products." Essentially Intel threw every excuse they had against the wall hoping some of them would stick and obscure the real reason for the profit warning. The real answer in three letters is AMD. AMD is beating the heck out of Intel in the middle market. AMD is gaining share and new product offerings are exploding that use the faster/cheaper AMD chips. Intel lost its momentum and AMD is chipping away at its user base.
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Normally when Intel warns, especially an unexpected warning, the market crashes hard. Friday's initial dip was bought and the indexes rallied, some to new highs, before the Friday afternoon weakness settled in. The SOX actually rallied into positive territory with many chip stocks shaking off the Intel news as Intel specific. In reality it is Intel specific and the chip gains for the year illustrate this fact. While Intel is down -19% for 2006 and hitting a new 18 months low on Friday other chip stocks are in strong rally mode. For instance BRCM is up +58% for 2006, AMD +33%, NVDA +35%, even Cisco, a quasi chip stock of sorts is up +23%. Dell a staunch Intel supporter is also struggling with a close Friday only +50 cents above a 2.5-year low. However, Hewlett Packard has been selling out of its AMD powered computers and the stock price of HPQ at $34 is right at a five year high. It appears that hitching your wagon to the Intel star, a successful strategy in the past, has turned into a liability. Intel's star is falling fast and it is not likely to be a brief dip. Getting a momentum lead in the chip sector can be a lengthy process with lead times of 12-18 months. Once achieved the loser is faced with that same period before they can reverse the loss, sometimes even longer. Intel has the clout but it is a huge ship that turns very slow.
Intel Chart - Weekly
A milestone settlement was reached on Friday between RIMM and NTP in their long running patent infringement case. RIMM reportedly settled with NTP for $612.5 million and the court case was dismissed on Friday afternoon. This takes the cloud off of RIMM and the Blackberry product. RIMM paid the $612.5 million as payment of all past claims and for a fully paid up lifetime license covering all RIMM processes, services and technologies. Before you rush out and buy RIMM on Monday there is something else you need to know. RIMM also warned late after the close on Friday that revenue would be flat with Q3 at $550-$560 million and profits would be substantially below current analysts estimates. RIMM expects profits to be in the 64-66 cent range and analysts had been expecting 76-81 cents. They attributed the drop in revenue to a sharp drop in new subscribers over the last quarter due to the looming shutdown of the Blackberry system. This drop in revenue/earnings failed to offset the gain from the settlement of the suit. RIMM traded up +$13 in after hours despite the earnings warning.
RIMM Chart - Daily
RIMM Chart - 90 min
Friday's economic news was lost after the Intel headline with Consumer Sentiment slipping only slightly to 86.7 from 87.4. This tame report was ignored after the Intel news. The ISM non-mfg Index rose to 60.1 from 56.8 in January and was inline with the regular ISM gain we saw on Wednesday. Despite the tame economics interest rates continued their three-day rise. Yield on the ten-year note rose to close at 4.684% and a new 18-month high. This is very negative for the economy, the homebuilder sector and the markets. A 5% yield is typically acknowledged as a point where bonds become preferable to stocks. A yield over 5% provides a safe haven in times of market uncertainty. This is going to be a problem for the equity markets if it rises any higher.
Rates are going higher according to most analysts. There are rate hikes in the works on a global scale including Japan close to a very rare hike. Lehman officially raised their target for the Fed Funds rate to 5.5% on Friday. According to Lehman the inflation indicators are rising and the Fed will be forced to continue raising rates. This is contrary to a statement by Minneapolis Fed President Gary Stern on Friday. The markets were trading nearly flat until after lunch when Stern commented in a Reuters interview that he viewed current Fed rates as at or near neutral and there was no reason to raise them any further. He said incoming data could change that view but for now there was no reason to raise rates. The markets reacted strongly with the Dow spiking from 11020 to 11106 over the next 90 minutes, a jump of +86 points. The Nasdaq added +15 point on the news and the S&P +10. Those gains evaporated shortly thereafter and all the indexes fell back into the red by the close.
Oil prices hit $63.80 intraday and closed only slightly below that level. The three-week high in oil prices combined with high interest rates and the Intel warning to kill any market gains by days end. OPEC president Edmond Daukoru said at a Press Club meeting on Friday that OPEC would discuss price cuts when it meets on March 8th. He did not expect any cuts but a -500,000 bpd drop was possible. He also said that while oil prices were over $60 production would continue at the current levels. The context of his comments were clear. $60 is now the floor that OPEC is comfortable with and the price is rising. Remember only a couple months ago it was $50 then $55 and now $60. Daukoru also said OPEC "may" meet between the scheduled March and June meetings to discuss production cuts. This tease only serves to keep prices higher on the possibility OPEC might meet. They are milking this production cut thing for all it is worth. The entire production quota ruse is a sham anyway since several countries can't meet current quotas due to production declines and equipment problems from lack of investment. Others are pumping at 100% of capability regardless of quotas. Still OPEC is managing the price almost perfectly with a rising price floor. Daukoru also played "pin the blame on speculators" for the current price level. This is also a recurring ploy to take the blame off OPEC for rising prices. Last year it was "blame it on the refiners." It boggles my mind they can play "support the price at $60" in one sentence and then blame speculators for the price hikes several sentences later.
Crude Oil Chart
Other factors impacting oil prices continue to be the Nigerian rebel problem and Iran. Iran will be probably be referred on Monday to the UN security council. With the Russian enrichment deal crumbling around the edges the outcome of the referral may not be very positive. Check the LEAPS Trader this weekend for more about Iran and the coming problem. China is also nearing completion of their strategic petroleum reserve and they will start diverting oil from the market to fill this stockpile this summer. The first facility will hold 33 million bbls with another 101.9 million bbls in three other sites on the eastern seaboard. China's oil demand is expected to grow +8% in 2006 to 7 mbpd making them the second largest oil consumer nation. This is half of last years growth rate but still very strong. China is planning on building their SPR to hold up to a 90-day supply by 2010. That would be close to a billion barrels by 2010 given their current growth rate. The U.S. is also adding to its SPR ahead of the coming hurricane season. The 26-member International Energy Agency is also quietly refilling its 1.4 billion bbl emergency stockpile after 60 days of draws to fill the void left by hurricane disruptions. India recently announced they were going to build a strategic reserve as well and it is initially expected to hold 40 million bbls. To put these numbers in perspective a fill rate of 100,000 bpd, the same rate the U.S. uses to limit the impact to prices, would take 400 days to fill the Indian reserve. Add in the 26-nation IEA reserve, China and the U.S. and that is a huge drain on supply on for the next several years.
Next week should see volatility in oil prices as the OPEC chatter comes to a head with their meeting. Interest rates are expected to continue to rise ahead of the March 28th Fed meeting. Both of those factors will influence the market. However, the economic calendar is very light. The only report of any real consequence is the employment report on Friday. Expectations are for a gain of +185,000 jobs. Pundits are very quiet on unofficial estimates given the recent volatility. Over the last four months job gains have fluctuated wildly from only +37,000 in October to +354,000 in November with Dec/Jan retreating into the middle of that range at +140K and +193K. The Friday number could miss estimates substantially and create havoc in the marketplace. Too strong a number would stimulate the Fed even higher and too weak a number could cause slowdown worries. This concern over jobs could keep the markets uneasy ahead of the report.
Other than economics there is little news to move the market. Q1 earnings are over and we are still a couple weeks ahead of the Q2 warnings cycle. This is the perfect time for the market to pick a direction unhampered by facts. Unfortunately we are still stuck at the recent highs with material gains very hard to make and hold. The Dow is starting to look like the Nasdaq of several weeks ago. The recent high was set back on Feb-22nd with a series of volatility spikes to progressively lower highs and a pattern of nearly instant retracements. Five times since the 22nd we have seen serious selling spurts and Dow 11000 is looking more like the Alamo every day. Bulls are shoring up their defenses at 11000 while the bears amass by the thousands just overhead. If that support level breaks it could be a long drop.
The Nasdaq has suddenly found buyers and it came within 8 points of a new high on Friday. That +25 point spike off the Intel induced lows was quickly erased and support at 2300 was the only thing that kept us from a dramatic sell off. The support for the Nasdaq rally came from the SOX, which rallied +27 points from Tuesday's close to hit 550 on Thursday. The SOX gave a bunch of that back on Friday. With Intel poisoning the chip sector we could see some more weakness despite some of the majors trying to break free from Intel's shadow.
Nasdaq Chart - 30 min
The SPX rallied to hit 1297 on Monday and promptly retreated to 1280 on end of month selling on Tuesday. After fighting for three days to recover that 1297 high it was successful on Friday despite Intel. Unfortunately it could not hold the high ground and collapsed to 1287 at the close.
While I would like to believe that there is a stealth rally still lurking behind all of this volatility we still need a breakout to confirm it. The repeated attempts to make that break continue to fail but we are chipping away at the overhead resistance. The other side of the coin is the March history I provided for you on Tuesday night. With the history of March declines so bearish there are clearly quite a few bears sitting on the highs hoping for a repeat. This sets up the potential for a bear-b-que if something does produce a sudden breakout.
I would continue to honor our new long/short indicator at 1280. As long as we
hold over that level I would remain long in hopes of the stealth rally making a
charge. However, as each day passes without
a breakout the chances for a
breakdown increase. Do not hesitate to short a break of 1280. Keep your eyes on
the chatter about the jobs report due out Friday and try not to let it sneak up
on you. That could be the pivot point for the week and what the bulls are
waiting for to power a breakout. Should the markets turn negative before the
report the numbers will probably be ignored until the correction runs its
course. Remember the table of March declines I posted in the Tuesday newsletter.
This is March and the clock is ticking.
Cameco - CCJ - close: 38.01 change: +0.67 stop: 35.29
Why We Like It:
BUY CALL APR 35.00 CCJ-DG open interest=642 current ask $4.20
Picked on March xx at $ xx.xx <-- see TRIGGER
Ultra Petrol. - UPL - close: 54.60 change: +2.13 stop: 51.95
Why We Like It:
BUY CALL APR 50 UPL-DJ open interest=1176 current ask $6.70
Picked on March xx at $ xx.xx <-- see TRIGGER
Valero Energy - VLO - close: 56.52 change: -0.21 stop: 53.49
Why We Like It:
BUY CALL APR 55.00 VLO-DK open interest=4213 current ask $4.20
Picked on March xx at $ xx.xx <-- see TRIGGER
Apple Computer - AAPL - cls: 67.72 change: -1.89 stop: 70.11
Why We Like It:
BUY PUT APR 70.00 QAA-PN open interest=22163 current ask $5.60
Picked on March 05 at $ 67.72
Intl. Bus. Mach. - IBM - cls: 79.96 chg: +0.02 stop: 81.05
Why We Like It:
Shares of Big Blue have been under performing the market and its peers for several weeks in a row now. The slow trend of lower highs is pressing the stock closer toward the bottom of its $79.00-82.00 trading range. The P&F chart is bearish with a triple-bottom breakdown sell signal and points to a $73.00 target. We suspect that the next move will be lower. We're suggesting that traders use a trigger to buy puts at $78.89, under the February low. If triggered then we'll target the $74.00-73.00 range.
BUY PUT APR 85 IBM-PQ open interest=12553 current ask $5.30
Picked on March xx at $ xx.xx <-- see TRIGGER
KB Home - KBH - close: 65.47 chg: -1.46 stop: 68.05
Why We Like It:
BUY PUT APR 70 KBH-PN open interest=1798 current ask $6.10
Picked on March xx at $ xx.xx <-- see TRIGGER
Ashland - ASH - close: 66.10 change: +0.71 stop: 64.75
Be careful here. We are urging caution with ASH. We cannot find any news or catalyst to explain it but shares of ASH gapped higher to open at $67.11 this morning and then promptly crashed right back toward support near $65.00. We have been suggesting a trigger to buy calls at $67.05 so this morning's spike higher would have opened the play. The good news here is that traders did buy the dip toward support at $65.00. The bad news is that ASH remains under resistance in the $66.50-67.00 region. We would not suggest new positions at this time. Wait for a new relative high over $67.11 before initiating new bullish call positions. Our target is the $72.00-72.50 range. The P&F chart points to a $97 target and today's spike higher has produced a new ascending triple-top breakout buy signal.
Picked on March 03 at $ 67.05
Cigna - CI - close: 123.52 change: +0.21 stop: 119.90
The choppy sideways action in the major averages is not helping shares of CI. The stock is churning sideways itself between $122 and $124.50. We really hesitate to suggest new bullish long positions here with the failed rally in the DJIA and NASDAQ on Friday. A move to a new high (around $124.60) might be okay as an entry point to buy calls. Currently our target is the $129.75-130.00 range. CI's P&F chart is bullish and points to a $154 target.
Picked on February 26 at $124.57
Garmin Ltd. - GRMN - cls: 74.00 change: +1.30 stop: 67.75
GRMN is a new bullish play from our Thursday night newsletter. The stock displayed relative strength on Friday with another new high on rising volume. We don't see any change from our original play description so we are reposting it here:
Lately there have been some negative comments about GRMN facing tougher competition for its global positions and navigation systems. Yet that has not stopped the stock from breaking out to new all-time highs. What we could be seeing right now is a potential short squeeze. The latest data puts short interest at 17.4% of its 59.8 million-share float. On a technical basis we certainly like Thursday's breakout and we're going to suggest that traders consider new call positions in the $70.00-73.00 range. However, we would prefer a pull back toward the $70.50-70.00 region as our entry point but GRMN's relative strength may not produce any dips in the near term. The P&F chart is bullish and points to an $85 target. We are going to target a rally into the $77.00-78.00 range.
BUY CALL APR 70 GQR-DN open interest=4768 current ask $5.90
Picked on March 02 at $ 72.70
Hartford Fin. Srv. - HIG - cls: 82.03 chg: -0.87 stop: 79.95
Friday's trading in HIG looks pretty bearish. The stock produced a bearish engulfing candlestick pattern and closed right at short-term support at the $82.00 level. We have very little doubt that HIG will retest the $80.00 level soon, which is another level of support bolstered by its rising 200-dma. If you do not want to risk HIG dipping to $80 and then continuing lower it might be wise to consider an early exit right here near $82.00 to limit any losses. We are not suggesting new bullish plays at this time. We'll be looking for a bounce from the $80.00 level as a potential entry point.
Picked on February 14 at $ 82.12
Monster Wrldwde - MNST - close: 48.98 chg: -1.16 stop: 47.75
MNST is a new bullish candidate from our Thursday night newsletter. We do not see any change from our original play description so we're reposting it here:
MNST has spent the first half of February consolidating its earnings-inspired rally toward $50. The second half of February witnessed a slow climb higher and now shares are testing resistance in the $50.00-50.50 range. This is a momentum play. The stock looks very overbought from its lows in October but there's no telling where the momentum will stop. We believe that if MNST breaks out to a new high then odds are it will rally toward the $55.00 level. We're suggesting a trigger to buy calls at $50.65. If triggered we will target a rally into the $54.85-55.00 range.
BUY CALL APR 45 BSQ-DI open interest=769 current ask $5.30
Picked on March xx at $ xx.xx <-- see TRIGGER
Altria Group - MO - close: 72.11 chg: +0.50 stop: 71.85
MO's performance on Friday looks like a bounce from rising, technical support at the 200-dma. Aggressive traders might want to consider potential entry points here. We would rather wait. Many of the technical indicators are still bearish (except the daily RSI, which is starting to look positive) and MO still has short-term resistance at $74.00 and its 50-dma, now at 73.96, and its 100-dma, now at $73.70. We are suggesting that traders wait for a breakout over $74.00 and use a trigger at $74.10 to buy calls. If triggered we'll target a rally into the $77.50-78.00 range.
on February xx at $ xx.xx <-- see TRIGGER
Occidental Petrol. - OXY - cls: 95.00 chg: +0.72 stop: 89.49
The oil sector indices closed on Friday near unchanged levels but that didn't stop OXY from hitting new four-week highs. The company had some positive news on Friday. The country of Ecuador lost an appeal in a British court in a legal fight with OXY over a $75 million tax dispute (source:Reuters). Looking at shares of OXY we are not suggesting new bullish positions right now. We'd only consider new plays if we saw a bounce from the 10-dma, near $92.00. Our target is the $97.50-98.00 range. The Point & Figure chart suggests a $108 target.
Picked on February 21 at $ 92.00 *gap higher*
Potash - POT - close: 97.65 chg: -1.13 stop: 92.49
The upward momentum in POT stalled a bit on Friday as traders did some profit taking ahead of the weekend. Shares are relatively close to our target, which is the $99.50-100.00 range, so we're not suggesting new bullish positions at this time. More conservative traders may want to seriously consider just exiting early right here to protect any profits.
Picked on February 23 at $ 93.05
Total - TOT - close: 126.39 change: -0.91 stop: 124.95
French oil company TOT is still struggling to gain any upward traction. Shares have drifted back toward support at its rising 200-dma but the stock can't seem to build on any bounce. We are not suggesting new bullish positions at this time. More aggressive traders can use a bounce from $125.00 or a move over the 10-dma (127.47) as a new entry point. More conservative traders can wait for a move over the 100-dma near 128.60 or the 50-dma near 130.66. If TOT does rebound then we would target the $137.00-140.00 range. The P&F chart still points to a $176 target.
Picked on February 16 at $127.61
(What is a strangle? It's when a trader buys an out-of-the-money (OTM) call and an OTM put on the same stock. The strategy is neutral. You do not care what direction the stock moves as long as the move is big enough to make your investment profitable.)
Building Materials - BMHC - cls: 68.61 chg: -0.48 stop: n/a
Our time with BMHC is growing short. March options expire in just two weeks and if you want to exit ahead of the stock split then we have about a week and a half. Currently for this play to be a success we need to see BMHC continue lower and sink toward the $60.00 level. A week ago we adjusted our target to breakeven at $8.20. More conservative traders may want to adjust their target even lower to increase their chances at recouping some of their capital. We are not suggesting new strangle positions. The options in our strangle play are the March $90 calls (BGU-CR) and the March $70 puts (BGU-ON). Our estimated cost is $8.20.
Picked on December 18 at $ 80.95
Encana Corp. - ECA - close: 43.91 chg: +0.68 stop: n/a
ECA has been chopping up and down in a $5.00 range for the last three weeks. We need to see ECA pick a direction and go. This sideways action is bad news for a strangle play. Fortunately, we still have some time left. We are not suggesting new strangle positions. Our strangle strategy involves the April $50 calls (ECA-DJ) and the April $40 puts (ECA-PH). Our estimated cost is $3.45. We are aiming for a rise to $5.95.
Picked on January 10 at $ 45.56
Loews Corp. - LTR - close: 94.59 change: -0.03 stop: n/a
Our aggressive strangle on LTR only has two weeks left before options expire. We are not suggesting new strangle positions. Buying this strangle was a bet that LTR will be trading at more than $102 (above resistance) or less than $88 (under support) by March expiration. The options in our strangle are the March $100 calls (LTR-CT) and the March $90 puts (LTR-OR). Our estimated cost is $1.75.
Picked on February 13 at $ 95.72
Ryland Group - RYL - close: 68.43 change: -1.63 stop: n/a
Homebuilders continued to see profit taking on Friday and shares of RYL lost 2.3% to close under the $70.00 level again (and its exponential 200-dma). We are not suggesting new strangle positions at this time. Our play involves the April $80 calls (RYL-DP) and the April $70 puts (RYL-PN). Our estimated cost is $7.00. Our target is $12.00.
Picked on January 22 at $ 75.19
Beazer Homes - BZH - close: 63.13 change: -0.77 stop: 62.65
Homebuilders continued to be under pressure on Friday. The DJUSHB home construction index lost 1.85% and technical indicators for the sector index are definitely turning more bearish. Shares of BZH could not handle the pressure and broke down intraday under technical support at its simple (and exponential) 200-dma. We have been stopped out at $62.65.
Picked on February 15 at $ 65.05
MDC Holdings - MDC - close: 60.10 chg: -0.55 stop: 61.15
MDC is another homebuilder caught up in a two-week long sell-off that doesn't seem to be showing any signs of stopping. We had been suggesting that readers buy calls on a breakout over $65.00 with a trigger at $65.05. The play has never been triggered so we're dropping MDC as a candidate. If the stock moves under the February low and it might be time to evaluate MDC as a bearish candidate.
Picked on February xx at $ xx.xx <-- see TRIGGER
Prudential - PRU - close: 74.73 change: -0.86 stop: 74.95
The breakout in PRU has failed. The stock continued to sink on Friday and traded below round-number support at $75.00 and technical support at its 50-dma. We were stopped out at $74.95. If PRU continues to sink and trades under the 100-dma, then traders might want to consider bearish positions and target the 200-dma near $70.00.
on February 24 at $ 77.10
Last week I introduced the concept of Elliott Wave Theory and why it's so effective in measuring stock price movements. If you missed the article here's the link: http://www.OptionInvestor.com/page/oin/commentary/newsletter/2006/02-25.html>
This week I want to continue the introduction to EW analysis and show some practical ways to use it.
Practice is the key. There are charting programs out there that make an effort to label the waves for you. I have found all of them deficient and it's mostly due to these corrective waves. Labeling waves by hand on your own chart is the single best way to learn the nuances of them and helps you get a feel for how the market is moving. An example of getting a feel for a wave count is what I call the sniff test. If it doesn't look right it probably isn't. Computer programs have a hard time with the sniff test whereas the human brain is very good (with a little practice). Since the corrective wave count is often not clear until after it finishes, or just before it's about to finish, the human brain is better than a computer at projecting (visualizing) possibilities.
As mentioned above, Fibonacci retracements of a move give us targets for a correction. The most reliable Fib retracements to use are 21.4%, 38.2%, 50%, 61.8% and 78.6%. The combination of these retracements and the Fibonacci projections based on Fib relationships between the waves can be very helpful in identifying price targets. Another useful technique, and quite simple to employ, is the use of trend lines and parallel channels. Trend lines are used by many traders and parallel channels do a good job at showing you the measured moves that the market tends to make.
The wave patterns very often stick to trend lines and parallel channels. In an uptrend take a parallel to the uptrend line and attach it to the first high between the two lows. Referring to the figure below, you first draw a line from the start of a rally through the first pullback which is wave-2. The parallel is then attached to the top of wave-1 and the extension of it is often times a good guide for where wave-3 will stop.
Drawing Parallel Channels
After drawing in the trend lines as described above, once it appears wave-3 may have ended, draw a line from wave-1 to wave-3 and attach a parallel to wave-2. This lower line will often mark where wave-4 will find support. If wave-4 stops at a different place than the parallel line, draw a line from wave-2 to wave-4 and then attach a parallel to wave-3. This parallel line will then often mark where wave-5 will end.
One other thing that I like to do, which is not shown above, is draw in a mid-line centered between the two parallel lines. This often marks minor support and resistance during a move and it very often marks where wave-5 will end (in other words it often does not make it up to the top line). Most programs will draw regression channels that are similar to these parallel channels but I like to draw them manually since they're off the EW count.
Drawing these kinds of parallel channels also works for corrections. Once you have two highs in a pullback and draw your downtrend line on them, take a parallel of that line and snap it to the low that is between those two highs and that often marks where the next leg down (wave-C) will stop. This will be especially true if the market gives two equal legs up or down in its correction (wave-A = wave-C).
Let's look at a couple of real life examples. Actual wave patterns are never as cut and dried, or as easy to identify, as the above patterns and this is where the subjective interpretation comes into play. A combination of EW analysis, Fibonacci retracements/projections and trend lines/channels makes for a powerful combination to determine price moves. Add in your other favorite technical tools for confirmation and you've got a trading system that is hard to beat. Let's take a look at a rally in the RUT to dissect the move and see how the count progressed:
Waves (1) to (3)
After the rally got underway, you can take a guess at waves (1) and (2) and then once we got a deeper pullback underway from the high in mid June we could label that as wave-(3). As an alternative it would have been labeled A-B-C in case it was going to be just a 3-wave upward correction against the decline from earlier in the year. So a red trend line was drawn from wave-(1) to wave-(3) and a purple parallel line was attached to wave-(2). This provided a guide as to where wave-(4) might pull back to. Some times it drops down to it and other times it chops sideways over to it.
And sure enough wave-(4) stopped near that lower trend line (middle of the chart below). Now it became a question where wave-(5) would end.
RUT, Finish Wave-(4) and Start Wave-(5)
As the rally progressed and came up near the upper trend line in mid July, it looks like it ended and first impression is that wave-(5) ended at that high. But looking a little closer at the inside of wave-(5) shows why it wasn't to be trusted as the end of the run up--as the rally progressed we got a quick succession of two highs and pullbacks, labeled waves 1 and 2 and then (i) and (ii) in the above chart. It can't be waves 1-2-3-4 where you'd label wave-(i) on the chart above as wave-3 intead and wave-(ii) as wave-4 because 4 would overlap wave-1 and wave-3 would be the shortest wave. Both would be rule violations.
So the small rally and pullback in the first week of July has to be another smaller degree 1st and 2nd wave as labeled above. This is the reason the high in mid-July would be labeled wave-(iii) and it meant we needed to look for waves (iii), (iv) and (v) to finish wave-3. Moving to the next chart, pick up from where we had wave-(iii) near the upper trend line, again about in the middle of the chart.
RUT, Finishing Wave-(5)
Remember, each impulsive wave, as wave-3 of (5) needs to be, consists of its own 5 waves so after wave-(iii) and then the pullback to wave-(iv), the next leg up was wave-(v). That finished one larger degree wave which was wave-3. Notice the negative MACD divergence against wave-(iii) and wave-(v) in mid July. The 5th wave is almost always negatively divergent against the 3rd wave and it's something you want to check for to add to your confidence that you have the correct count. Use either MACD or RSI for this as they're very powerful tools in EW analysis.
After the completion of wave-(v) and therefore wave-3, we got a sideways triangle wave-4 into the end of July and note how this predicted the last move up to wave-5 in early August. Sideways triangles in this position of a rally are highly accurate in predicting the last move is coming. Once wave-5 completed it finished the next larger degree wave-(5), thereby completing the 5-wave count up from the April low. Note how wave-(5) finished essentially at the mid-line of the up-channel, a common occurrence. Note also the continued bearish MACD divergence at the wave-(5) high.
One last technique to help identify where the final 5th wave will end is to look for the relationship between the 1st and 5th waves. The common relationship between these two waves is that wave-5 will equal 62%, 100% or 162% of wave-1.
RUT, Using Fibs to Project wave-(5)
This chart shows a Fib projection for wave-5 of (5) based on the size of wave-1. QCharts has a tool to do this but you can obviously calculate it by hand. Wave-1, of wave-(5), at the end of June, ran from 625.84 to 646.04 so 20.20 points. From where wave-4 ended at the end of July, at 668.82, adding 20.20 points gives us an upside target of 689.02 which is what the Fib projection on the above chart shows. Had the rally not stopped there, I would have been looking for the upside Fib target of 701.50 up near the upper trend line.
Once price broke down from the parallel channel we had confirmation that the 5-wave move up from April had completed. Many times price will then rally back up to test the bottom of the channel which is usually a good spot to get short. And then once that bounce completes and price continues lower you have your first two points (the high of the rally and then the high of the bounce) to draw your first downtrend line. Wait for the next leg down to complete and snap a parallel line to it and start the whole process all over, this time looking for a corrective pattern that corrects the 5-wave impulsive move up from April to August.
As I said at the start, this is not an easy tool to master. If you're serious about adding this technique to your toolbox, here is a recommended reading list. I would read them in the order listed so as to get a better understanding of the subject without getting overwhelmed with detail that's hard to understand. The last two books are less about the details of wave structure and more about the market and the economy and how you can see the application of EW Theory. You may email me any questions you have on the subject. Good luck and have fun with it.
1) The Elliott Wave Principle Robert Prechter and A.J. Frost
Today's Newsletter Notes: Market Wrap by Jim Brown, Trader's Corner by Keene
H. Little, and all other plays and content by the Option Investor staff.
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