End of Initial Plunge?

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The intraday low on Friday in the SPX undercut the next chart support level from the Nov 2010 lows and then reversed higher to close basically unchanged. The candlestick was a wide range long legged doji indicating indecision or balance in the market at this level.

The 3.0 standard deviation lower bollinger band was touched 3 days in a row now, which is very rare. I believe this favors an imminent rally attempt or pause in the decline.

If a rally is attempted here there are some relatively clear and consistent indications of what is likely to follow based on past similar occurrences. The most recent similar occurrences to our recent waterfall decline were the Jan 2008 and Oct 2008 plunges. The Jan 2008 plunged ended with 3 consecutive closes below the standard lower bollinger band. The Oct 2008 plunge ended with 5 consecutive closes below it and the 2 prior to those 5 were right at it. Our current market is 4 days in row closing below the lower band and the 2 prior to those 4 were right at the band. So this is about as stretched as we ever see it relative to the bands.

Now, for what has tended to happen afterwards.... The initial rally after the end of the plunge has tended to retrace to the level of the high of the prior 2 candles immediately preceding the low. In our case this is at about 1260. So given we are at 1200 right now, that means a 5% rally, which usually happens quickly (a few days).

Then it has been pretty consistent for a retest of the plunge low (possibly even slightly undercutting it) before a more prolonged rally attempt than the initial sharp rally attempt. This rally tends to end near the levels of the initial attempt forming a "flat" type of correction. It may be reasonable to look for a triangle or pennant formation in the current environment as well.

In looking at past retracements of plunge type moves over the last couple bear markets, it has been common for the next rally after the plunge to retrace 50-62% of the plunge move. In our case, assuming Friday was the plunge low, that would also put us at 1260 or a little above. Also the neckline of the head and shoulders top is around the 1260 level, so we have a lot of indications pointing to that 1260 level being a topping level if the market manages to push back up there.

As far as how traditional Elliott wavers would be labeling this move, they would not expect prices to rally above the June lows on this reaction. Thus far the move off the May top is following the "character" of a traditional 1-2-3 Elliott wave sequence relatively well, so it may pay to continue to look at the market based on that labeling sequence and be on the watch for a triangle or flat type wave 4 up soon.

As far as the larger picture I will direct readers to some other charts. The Russell 2000 index (IWM) has thus far double topped with the 2007 bull market high in very similar fashion to the SPX 2000-2007 double top. Now it has completed a daily chart head and shoulders top, so I wouldn't count on this index popping to new highs any time soon.

The QQQ Nadaq 100 basically formed a triple top on the daily chart over the last 5-6 months. Triple tops are powerful charts signals. The measuring target for them is similar to that for a double top. So, by that metric, there is more downside ahead for QQQ.

The Dow/Gold ratio has now dropped all the way back down to the March 2009 bear market low level (and slightly undercut it). I don't know how helpful this is, however, obviously paper assets have been continuing to under perform hard assets. When the ratio becomes extreme it may make for a good pairs/reversion trade, however, the long term trend in this ratio is down, so I don't know that I would take on a long stocks/short gold pairs trade for more than an intermediate term trade.

I expect precious metals to weaken in the very near future. Silver is likely to be weaker than gold. In fact a short silver/long gold pairs trade is probably a high probability, low risk trade from this level until the Jan 2011 low in silver is broken.

As I type this the stock futures are down 2.5% right back at the lows from Friday. I would actually expect a gap down here tomorrow to have a great chance to be a buying opportunity for a short-term gap-fill trade. However, if the market doesn't rally then we may see a breathtaking plunge tomorrow.