Weekly Review: Risk Growing

The past week was highlighted by the “perfection” of a TD Sell Setup on the weekly chart when we exceeded the 930.17 level. When a Setup is perfected there is a possibility that the current trend in force (in this case the rally from the March low) has become “exhausted”. Such exhaustion will usually manifest itself within a few price bars and may be just a pullback / consolidation (before the market continues its outstanding trend) or it may mark a trend reversal. One way I like to distinguish between the two possibilities is by using two indicators: Welles Wilder’s RSI and Connie Brown’s Composite.

This week we note that although the RSI (top pane) has confirmed the new price high by making a new high itself, the Composite Index (middle pane) is lagging. This is *potential* bearish divergence between the two indicators. The RSI would have to turn down (which would require price to turn down) from here to trigger the actual “sell” signal. Without a signal I favor the pullback / consolidation view. With a signal I would favor a much deeper retracement (move lower). In either event the current upside potential is quite limited (968-973) while downside risk is growing (max would be a retest of the March lows if a weekly “sell” signal is generated). Therefore I would not be a new buyer of equities here and I would protect any existing positions with tight stops. In fact, someone who was thinking “I wish I had sold my stocks” last autumn or early this year may now be looking at a good time to do so (if we get the weekly signal).

Of note in the coming week is the position of the upward sloping dashed green line. This line has served as a good proxy for the “demand” of equities over the past few weeks and is why Tom DeMark (TD) labeled it as the Demand Line. It sits at 948.42 next week while we closed this past week at 940.09. This sets up the likelihood that we will break below this line (quite possibly right at the open on Monday) -- which should be viewed as another sign of weakness.

Bottom Line: Upside potential is limited over the next few weeks while downside risk grows. Price action on the daily chart over the coming days should provide a good idea of whether we consolidate / pullback a bit from these levels or experience a much deeper retracement of the move up from March.

A Change In Trend (CIT)

The move higher in the cash S&P500 Wednesday pushed the Swing Index (created by Welles Wilder and represented in conjunction with price on this blog by the blue “swing lines” on the chart) above the last swing high of March 4. This price activity has created a Change-In-Trend (CIT) in price at the 666.79 low and is represented on the chart by the green ellipse.

Price CITs are important because they help solidify where Elliott Wave patterns have completed. The fact that this CIT has occurred in conjunction with a move above the most recent Price Reaction Point high means that I can have high confidence (hence the blue wave label color) that the March 6 low was wave v” of a complete trending impulse pattern from the February 9, 2009 high.

This complete Elliott pattern must be placed within the context of the larger market structure. Trending Impulse patterns can form within waves 1, 3, and 5 of a larger impulse or waves A (in a Zigzag) and C (Zigzag and Flat) of a larger Corrective Pattern. In this case I believe it was wave iii’ of a larger impulse from the January 6, 2009 high.

My next analytical step is to create targets for the next wave in the sequence, wave iv’. The first step in the process is to create Fibonacci price targets. They are shown on the chart as dashed horizontal lines. Note that we have hesitated at the cluster from 732-733. The next cluster is at 773. Wave iv’ should not go above 804.3 (the price area of wave i’). I will discuss my second step in setting wave iv’ targets tomorrow.

Patient ..... or patient?

Now that the cash S&P500 has made a new closing low for this move we have to ask if it (the patient) is in critical condition. Perhaps not, as the Relative Strength Indicator (Welles Wilder is a genius!) has not yet confirmed.

But is this bullish divergence? Not yet. The RSI must actually turn up without making a new low. The trader/investor must be patient.