Wednesday, May 6, 2009

"Triangles, Triangles Everywhere - And Not a Drop to Drink"

Click on Chart to Enlarge

This post may not be very interesting for anyone not obsessively interested in pattern identification, but I think it may at a minimum give chartists a few helpful ideas for understanding what it means when successive phases of market action (in the same direction) get progressively larger and what kind of action typically marks a true trend reversal.

The chart above is the 2000-2003 bear market in the S&P 500. First off I won't go into detail on the labeling other than to say what I will say again later. From a market logic/psychology perspective when a "wave" or "pattern" ends, it will completely retrace the most recent leg up or down in equal, or typically less, time than the recent leg took to form. Notice the successive overlapping moves from the bull market highs, with each move down larger on a % basis than the last down move. This forms a downward sloping expanding pattern.

The important part of an expanding triangle are the A, C, and E waves. They should be successively larger on a % basis. The intervening B and D waves may or may not be larger than the previous wave. In the case above, the B and D waves are smaller than A and C respectively. Another aspect of these patterns is that they commonly occur as the first phase of a large complex correction, or sometimes in what is called an "x" wave position in Elliot Wave theory. An "x" wave is a middle wave between other corrections in a complex correction. These patterns will almost always slope up or down in the direction of the larger complex pattern. This is all the more true in large scale patterns like the one above. If they formed on a horizontal axis, that would be odd as the market is gyrating wildly with no net loss or gain. There is almost always a force pulling the market one way or the other.

Another aspect of these patterns is that the E wave is so strong, that it almost never is retraced in less time than it took to form. That encompasses the basics of these patterns. Now to a couple more examples.

Click on Chart to Enlarge

This is a chart of the current market. I have recently said that an upward expanding triangle may be what is forming here. Each rally has been successively larger since the October bottom. But here is THE MOST IMPORTANT THING from my perspective........As I mentioned above, new psychological trends start with price moves that completely retrace the previous wave in less time than it took to form. This has not happened in the current market. Whether considering the last wave down as being from the February highs or the January highs, neither was retraced in less or equal time than it took to form. For this reason, I believe the current move is NOT the beginning of a new bull market, but a glorified bear market rally instead. At a minimum then we should expect a significant retracement of the current rally, but the pattern is suggestive of significant new bear market lows in months to come from my perspective. While the E wave doesn't have to be larger than wave D, it usually is, so I would guess a rather quick push up above 944ish would likely occur before this rally tops.

Click on Chart to Enlarge

This chart is the banking index, $BKX. The portion of the chart I have shown I believe is best viewed as an expanding triangle. One of the give aways is the slight undercut of the A-C trendline by wave E. Also, because wave E is typically so large and vertical, it is usually a very powerful corrective pattern on its own - often a double zig-zag or a smaller scale expanding triangle. The chart above is interesting because it appears that the E' wave of the large expanding triangle is a smaller degree expanding triangle and the E wave of that smaller expanding triangle looks like a complex correction, showing the two most common ways expanding triangles end in one chart.

While fibonacci relationships are not thought to be common in expanding triangles, wave E may relate to either wave A or C by 1.618 or 2.618. Wave E would equal 1.618 times wave C at 957ish on the S&P 500, so that may be an area to pay close attention to and consider going short/bearish if the market rises that far and is short-term overbought near those levels.

Tomorrow I plan to give a brief update on the Investor's Intelligence and the AAII surveys and see how the bullish % is coming along. If this week ends strong, then next week will be very interesting to see the II survey because each week's data is for the past week through Friday.

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