Top Confirmed ~ The Risk Averse Alert

Friday, February 05, 2010

Top Confirmed

The setup for a steep selloff is in place. Gains registered since early-July 2009 (at the very least) appear at risk of evaporating sometime over days and weeks ahead.

Most imminently, however, a bottom to this week's turn lower, then a bounce, should be in store. The question is how much lost ground might be recovered. Truth is this afternoon's bounce might have recaptured the greater bulk of losses delivered thus far.

NYSE McClellan

To begin quite simply consider black markup — positive divergences — supporting the likelihood of an upcoming bounce ... and red, the probability of a swoon following.

Now, you might wonder why [lower] red lines extending from late October to present are seen negatively. You might think a positive divergence instead appears in place.

Look at it this way, though... How better disguise things about to fall apart? This has been the way. Look back at various technical measures prior to the market's thrashing and you notice this consistently.


Yesterday's price/RSI divergence remains intact. Today's turnaround was big, particularly for a Friday. Yet one subtle thing raises an eyebrow...

Increasing volume during this week's bath, although not as great as late-January's highest, still exceeded that coinciding with last week's supposed bottom to the first wave down. This suggests the first wave of the third wave down presently could be unfolding.

No doubt, this is how it looks, too. Wave 3 [down] appears to have begun. Per RSI divergence typically signaling an upside reversal, could this be but another instance wherein weak underlying conditions are disguised? RSI remaining on the sell-side (i.e. below 50) while $SPX has remained below its 50-day moving average raises the probability.

Still, given that the decline from January's top conforms to the channel you seen drawn, one also should be alert to the possibility the first wave down from top is ending now (rather than last week), and so a reaction back up this week's best levels might be in store straight ahead.

SPX 5-min

As you can see, no matter how this week's breakdown fits the Elliott wave count — black and red markup above delineate two alternate Elliott wave counts — there's reason to suspect one more wave down could unfold before a bounce preceding collapse develops.

Considering sharp rallies typical in larger declines ... the likes came this afternoon. Strong-handed shorts taking profits going into the weekend seems to me a most reasonable explanation.


Here we see confirmation of several things...

First, something of weakness disguised. This we saw particularly going into last Friday's bottom, by way of a lack of well-hedged long positions.

Second, possibility the third wave down from January top has begun. This by way of increased put buying the past couple days — the greatest yet since top, in fact. Some of these put positions, no doubt, likely are intended to be exercised.

Third, there's room to run. Again, a solid bottom likely will develop once long positions are more greatly hedged with put options.

And finally, a bounce straight ahead very well could be in store (the June-July 2008 period appears instructive).

So, for now I am sitting tight on purchasing a speculative, stock index options position...

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.

Analysis centers on the stock market's path of least resistance. Long-term, this drives a simple strategy for safely investing a 401(k) for maximum profit. Intermediate-term, investing with stock index tracking-ETFs (both their long and short varieties) is advanced. Short-term, stock index options occasionally offer extraordinary profit opportunities when the stock market is moving along its projected path.

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