S&P 500: Party over?

The broad markets, as tracked by the S&P 500 index, peaked the last day of 2013 and on the first trading day of 2014 began a correction to the downside. However, there remains considerable upside potential after the correction is complete.

The party isn't over, but the punch bowl is more than half empty.

In the discussion below I use the exchange-traded fund SPY as an avatar for the index.

The Dec. 31, 2013 peak at $184.98 was, in Elliott wave terms, the completion of wave 3 {-1} and its waves of lesser degree. Wave 3 {-1} began Aug. 28, 2013 from $163.05.

Click on chart to enlarge.

SPY 180 days 5-hour bars (left), 20 days 15-minute bars (right)

There's no telling in Elliott how deep the wave 4 {-1} correction will go nor how long it will take to do its work. Wave 2 {-1} corrected by about 50% and fourth waves tend to be more shallow, so it may not be a devastating decline.

But again, there is no rule. The only standard under Elliott is that the decline can't fall below $163.05, which is 11.9% below Tuesday's peak.

The tip-off that the rise from August was over came as the price fell below the start of wave 5 {-4}.

What could be wrong with this analysis? Wave 3 {-3} is quite an outsized movement for its degree, and the ensuing waves at the {-4} degree are quite sloppy. I can't be certain at the very near term that I have the relative degrees correct. If I've counted wrong, then the present decline will reverse in short order and move to higher highs.

But if I'm right, then SPY, and the S&P 500, can be expected to begin a correction that most likely will last for months.

Bigger picture, the end of the downside correction will move SPY into the final act of an uptrend that began Oct 4, 2011 from $107.43 and indeed, at one degree higher, from July 1, 2010 at $101.13.

The entire rise is taking place from the Great Recession low set March 6, 2009 at $67.10.

Click on chart to enlarge.

SPY 10 years weekly bars (left), 3 years 2-day bars (right)

In reading market analysis, I have noticed a tendency among some to lose sight of the fractal nature of the markets. Each decline is followed by a corresponding corrective rise of the same degree.

So there is money to be made by playing the shorter-term movements even if they run counter to the larger trend. I never go to cash in an instant because of a turn that ultimately involves waves of fairly high degree. They're worth noting, but they don't govern my trading.

To put things in perspective: Look at the upper right of the 3-year chart above you'll see a tiny hook below the $184.69 price bubble. That tiny hook is the beginning of the wave 4 {-1} correction.

References

My shorter-term trading rules can be read here. And the classic Turtle Trading rules on which my rules are based can be read here.

Elliott wave analysis tracks patterns in price movements. The principal practitioner of Elliott wave analysis is Robert Prechter at Elliott Wave International. His book, Elliott Wave Principle, is a must-read for people interested in this form of analysis, as is his most recent publication, Visual Guide to Elliott Wave Trading. 

Several web sites summarize Elliott wave theory, among them, Investopedia, StockCharts and Wikipedia.

See my post "Chart Analysis: Nomenclature" for an explanation of my method for labeling waves on the chart.

Disclaimer

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.

No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.