Thursday, June 30, 2011

Stocks and Commodities

Click on Chart to Enlarge

Given the extreme put/call ratios at the end of this recent correction, history suggests a multi week rally. We may still be early in that, but the flip side, is basically when the ratios spike to that high, there is another new low in stocks before a more sustained advance. So sentiment peaks or hits extremes before price does, which creates divergences before major moves.

If that is the case and stocks move below the recent lows, then I think most of the price movement is already done to the upside. I like looking at the fast stochastics for counter trend movements. The chart above shows it is overbought on the daily time frame. However, it typically needs a few days to lose momentum before a pullback happens. Basically wait for the red %D line to go back below 80. Now if you look at a weekly chart with this indicator, you see it is just rising out of oversold territory. So it may be a situation where we rally/consolidate a bit more then move to new lows creating weekly bullish divergence before another major rally attempt.

Prices have now moved to the upper bollinger band suggesting prices are statistically stretched to the upside on the daily time frame. On the hourly time frame, there is no significant bearish divergence on momentum oscillators suggesting a significant high is not imminent. That would be the first thing to look for if looking to bet against the rally.

Click on Chart to Enlarge

The CRB commodity index made a nice looking bullish MACD cross out of oversold territory with strong bullish divergence. Now there are other reasons that I have been expecting a more significant longer term correction based on cycles, CoT data, and US dollar price action/ sentiment, but a signal this text-book just must be respected. Price trumps all.

The price action has a nicely subdivided classic Elliott Wave structure which suggests and ABC zig-zag may be complete. To confirm this, price should be expected to retrace above the blue box (wave C) in less time than it took to form. If this doesn't happen, then we may be in a situation, where what looks like the C wave is actually the first part of a larger and more subdivided move (ex. we are in wave 2 and still have 3, 4, and 5 down to come). Or we could be in an "x" wave before another corrective pattern down forms. Basically I will use the price action relative to that blue box as a first clue to the possible pattern forming.

Another more subtle and subjective aspect of this pattern, is that the final advance before this correction looked (and had post pattern explosive behavior) like a "terminal" pattern or diagonal triangle in Elliott parlance. These patterns end patterns of a larger degree. If that is the case here, then by this metric we should see a larger correction of the entire recent bull market.

If you look at a chart of the S&P 500 during the last bear market, you will see the July 2008 low undercut the Jan 2008 low and had some bullish divergence. Prices rallied but when the rally failed and went to new lows, prices moved down fast. So the principle is that when a prior low is undercut like that, and price rallies moving above the old lows, it should be respected. But if the rally is weak and if it breaks to a new low, it can decline quickly. Any long positions should have a no wiggle room stop below the recent lows.

1 comment: