Dr. Melt-Up Checks Market Pulse, Finds Budding Life ~ The Risk Averse Alert

Friday, January 16, 2009

Dr. Melt-Up Checks Market Pulse, Finds Budding Life

Before I speak one more word about melt-up prospects, let me humble this outlook with appropriate due given to other possibilities, because nothing is set in stone.

Nothing is set in stone... This is something I say now and again, and with good reason. Quite simply, new developments, impossible to foresee, incite a need to assess probabilities.

As you know, I use various underlying technical measures to substantiate my Elliott Wave analysis. These help identify Elliott Wave forms. Each Elliott Wave — whether impulse or corrective — has a defined character. Underlying technical measures help isolate one wave from another, and allow one to distinguish each wave by its character in relation to the others. Waves joining to form some larger construct — be it a 5-wave, "impulse wave" or a 3-wave, "corrective wave" — all are subject to this analysis.

My concern today is with the 5-wave decline from the May 19, 2008 peak. These five waves are thought to form wave (c) of an (a)-(b)-(c) corrective wave that began October 2007.


Underlying technical measures corresponding with a five-wave decline typically register their worst readings during the formation of respective third waves. That's because third waves generally are the most powerful ... the most dynamic ... of all Elliott waves.

These same technical measures typically begin showing improvement — underlying strength building — upon the formation of respective fourth and fifth waves of a five-wave decline.

One measure demonstrating this phenomena is RSI (the Relative Strength Index).

Now, about my present concern... The red line drawn in the RSI panel begins at the NYSE Composite's RSI peak in late-August. This marks RSI's best reading during the formation of what might be assumed wave 2 of five waves down from May 19, 2008.

This line extends to the present. It intends to show the level beyond which RSI might be expected to rise ... coincident with the formation of wave 4 of five waves down for May 19th. Again, this is assuming five waves down from May 19, 2008 have not completed.

You have seen this before. Over the course of the market's bounce off November bottom I have been anticipating the likelihood NYSE Composite RSI would exceed its late-August peak. Thus, until such time as relative strength improved as anticipated, I assumed the market's rally would continue.

Well, as you can see, the magic moment came during the advance leading into the New Year.

So, the question here is whether the rally off November's bottom merely forms wave 4 of five waves down from May 19, 2008?

This is an important question because if the answer is in the affirmative, all my talk about a pending melt-up will leave me looking like an idiot (proving once again how I am my own worst enemy). Wave 5 [of (c)] down would see to that.

Now, typically, I use red dots to depict price-RSI relationships coincident with a five-wave decline.You see these above, corresponding with [presumably] waves 1-4 since May 19, 2008.

(Bear in mind these red dots mark the most extreme RSI reading registered during the formation of any given wave. Each may or may not mark the actual end of the wave in question.)

So, considering the price-RSI configuration shown above by the red dots (revealing a rather typical relationship among each of the waves), you should gather why I am concerned about possibilities. Although underlying conditions are improving, nothing prevents this improvement from being furthered on a retest of November's low. As such, any near-term outlook calling for a melt-up might be challenged.

Now... what if five waves down from May 19, 2008 are more accurately defined by price-RSI relationships revealed by the blue dots? Thus wave (c), in fact, completed on November 21st.

There's something attractive about this possibility because it draws on Nature's "like from like" principle ... a notion the Elliott Wave Principle and its embrace of the Golden Section has at the core of its being (applying Nature's Law to human psychology in the matter of pursuits involving the making of money).

The first wave down ... from May 19th to September 17th ... itself consists of five waves (which also channeled quite nicely, as you can see above). RSI coinciding with these five waves is shown by the lime green dots I have drawn.

Note how RSI marking the fourth wave of these five waves (late-August '08) just about equals RSI marking the second wave (early-June '08). This is a bit atypical. More often than not RSI will improve during the formation of a fourth wave in relation to the second. In this case it did not. Not a surprise because we are evaluating five waves forming wave (c) ... a third wave ... typically the most dynamic ... where "pull" in the direction of the trend (in this case, down) is generally strongest.

Now, consider RSI coinciding with a larger five wave decline from May 19, 2008 ... marked by the blue dots I have drawn. Note how the fourth wave's best RSI reading (early-November '08) just about matched RSI marking the second wave (September 19, 2008).

RSI coinciding with five waves forming the first wave down from 5.19.08 - 9.17.08 (lime green dots) behaved very much like RSI coinciding with five waves down from 5.19.08 - 11.21.08 (blue dots).

That's the "like from like" principle in action. It's almost as if the RSI configuration during the first wave down (5.19.08 - 9.17.08) provided a "key" to how RSI might behave during the larger five waves down from May 19th through November 21st.

It seems entirely reasonable an Elliott Wave analyst should recognize how this "like from like" principle might take form even in underlying technical measures like RSI. It stands to reason that, whatever psychology defined the market's disposition at the start of the declining period in question, it would persist throughout.

To conclude this lead-off topic, then, you clearly see how RSI shows third waves to be the most dynamic, as well as how fifth waves [of a declining impulse wave] reveal improving underlying strength. Each of the three, 5-wave, Elliott impulse waves you see above — lime green dots: wave 1 of (c) ... white dots: wave 3 of (c) ... and blue dots: wave (c) — demonstrate this.

Now, about whether the market's bounce off November's bottom is but the fourth wave of five waves down since May 19, 2008 (returning to the red dots)... This still is an open possibility. Nothing is set in stone. I wish to acknowledge this in light of the outlook I have expressed lately.

This is particularly critical since trading has proceeded much as was thought possible on January 2nd. A decline is a decline ... and just because I foresaw its possibility does not mean what I thought might follow (i.e. melt-up), indeed, will come to pass. There is in fact a constant need to reassess probabilities given ever-changing conditions.


Just yesterday we looked at the VIX. Let's examine this a little closer and consider things that appear to be saying, "Danger Will Robinson!"

First, there's today's sharp pullback in the VIX itself. Without going into detail let's simply note how this might demonstrate [unwarranted?] complacency.

(Then again, the news just might be that good ... at least as this affects the market's near-term prospects. That a new flavor of recent months' financial rescue attempts is being floated at a time when stocks affected by this find themselves at a point where a sharp bounce might reasonably be expected ... with this new development likewise coinciding with the upcoming, portentous change in Washington ... it seems we have circumstance making it worth pondering again How to Think Like a Thief.)

Consider next the sharp upturn of MACD on the VIX index. This, of course, has negative implications. It's a turn in the wrong direction for someone anticipating a market melt-up. However, let's not lose sight MACD remains on the right side of its balance (as this pertains to VIX, negative MACD implies a market whose underlying strength is improving).

Next in the parade of worries the VIX presents is the current RSI similarity to two periods last year — late-February and late-May. In both instances the market succumbed to additional selling pressure.

Yet consider VIX RSI at the present moment in relation to early-November. Much like then, VIX RSI stands at an inflection point located in the middle of its range. This is where the market's so-called "buy-side" and "sell-side" interests are balanced.

Back in early-November the sell-side won the day after VIX RSI fell to this point of balance among interests. So, what might be next ... now that VIX RSI has risen to this same point of balance? Might the market's buy-side prevail? Time will tell.

And what do we make of VIX RSI extremes (marked by red dots) since the market's May 19, 2008 peak? Do you see how even this derivative technical measure of the market's underlying condition is coinciding with five waves down in quite typical fashion, much as was discussed above? This view of VIX RSI seems to highlight earlier NYSE Composite RSI analysis, suggesting the fifth wave of five waves down since May 19, 2008 might yet unfold.

All told, though, I wouldn't make too much of this. Rather, by noting what appear to be red flags we are being risk averse.

Truth is there's plenty of reason to be optimistic about melt-up prospects. Indeed, you might duly note these "red flags" by and large are countered by other reasonable observations. Reasonable, that is, at least for the moment. Still, these serve to neutralize whatever warnings the VIX might be flashing.

Of course, here is a good deal more evidence supporting the case for a pending market melt-up...


If we are to assume renewed selling might imminently sweep over the market, then you would think the Pump and Dump, too, would be signaling trouble. However, this plainly is not the case.

The NASDAQ Composite's RSI and MACD configuration differs from that seen earlier in the NYSE Composite. If November's low marked the end of a third wave (of five waves down from early-June), then NASDAQ's present bounce (presumably forming wave 4) has a good bit further to go before the Composite once again turns lower.

Indeed, inasmuch as evidence over recent weeks — presented through the lens of NYSE Composite RSI and MACD — was suggesting the market's bounce off November's low had further to go, the NASDAQ Composite's underlying technical condition likewise is indicating the same.

Again, there is nothing set in stone about this. However, typical RSI and MACD behavior during the formation of a 5-wave, Elliott impulse wave down presently advises one to expect further improvement in both these measures before any sustained decline might roil NASDAQ.

Given this, there's an additional development worth noting here... You see it in the declining line cutting through NASDAQ's gap lower in early-October '08. This line was acting as resistance all the way down to November's bottom, but now it appears to be providing support. Arbitrary as this might seem, there it is, offering graphic evidence underlying conditions are shifting into the positive.

Thus, considering the case suggesting an imminent retest of November's low might be in order here (practically speaking this is, indeed, possible), the likelihood seems slim at best. Instead, the market's next leg higher appears more likely in store.

NASDAQ McClellan

Here you see the manner in which underlying conditions on NASDAQ appear similar to the early-April '08 period. NASDAQ's McClellan Oscillator appears positively poised to sustain a trade looking something like the market's April - May '08 advance.

This, of course, is not the only possibility NASDAQ's McClellan Oscillator supports. Looking at the Summation Index, you begin to suspect constructive, underlying buying interest might be about to hit the brick wall.

So, who knows? Maybe rather than melt-up NASDAQ might drag its way higher. Either way ... all things considered ... it does not appear the Composite is the least bit threatened here.

The fact both the Oscillator and the Summation Index both diverged at their respective November '08 bottoms (relative to October) remains significant. Likewise, the Summation Index has made an impressive comeback — demonstrating genuine underlying buying interest apparently intending to stick around (rather than trade in and out). This suggests strong hands are sinking capital into the market. Time will tell how long they stay.

NASDAQ 5-min

You gotta like how things are shaping up here. Today's comeback finishing near the day's high ... taming RSI ... bringing the buy- and sell-side into balance ... was about as nice a performance as you could ask for ... given the past couple days' RSI whipsaw.

NYSE 5-min

Enee, meenee, mynee, mo ... which way does RSI suggest we'll go?

NYSE McClellan

And here? (Consider this question from the perspective of support and resistance each of the NYSE McClellan indicators faces.)
Bottom line: Any Eunuch who reads this post slowly and carefully (what else does one have to do?) should realize why now probably is not the most fortuitous time, financially speaking, to be nutless...

Fast Money
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© The Risk Averse Alert — Advocating a patient, disciplined approach to stock market investing. Overriding objective is limiting financial risk. Minimizing investment capital loss is a priority.

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