No – the Sky is Not Falling but a Correction May be Underway!

While I remain firmly in the bullish camp over the mid to long-term I have been expecting and anticipating a correction to begin for the past couple of weeks.  The extended nature of the moves underway has been impressive and to be honest really not that much of a surprise considering the position (an extended Elliott 3^rd within a larger extended 3^rd).   The persistence of the buyers over the past few weeks in allowing the market to open lower only to quickly buy it up within the first 30 minutes back to unchanged or slightly higher in advance of the normal starting time for most algorithmic computer trading has fallen into a pattern.  I am not sure what it will take to reverse that type of thinking or if it has changed yet.  The pattern to the intraday highs on Monday, though does show completed 5 wave patterns which in turn complete larger 5 wave patterns which again in turn complete yet a larger 5 wave pattern, which ultimately should produce a somewhat larger correction.  One that will unfold over several days not hours.   (I’ve included the discussion on Extensions below)

The Big Picture Revisited:

Staying in touch with what the “big picture” is remains very important.  I spent some time over the weekend updating all my long-term charts.  This was helpful as it gave me a very clear perspective on how large of a correction should be expected now and what would be expected to come.  While my expectation is for a decent “slap-down” to occur it is not the “mother” of all corrections as some have forecasted. 

All of the broader indexes (DJIA, S&P 500, Russell 2000, and NASDAQ) began their perspective rallies off of the March 2009 lows.  I fully expect additional new highs (several) for the DJIA, S&P 500 and Russell 2000.  The NASDAQ may have reached its peak(s) in 2000, however I don’t think it would be wise to exclude them just yet.  All the patterns are very similar in size and breadth with smaller differences likely within the internal counts.  Therefore based on this it appears that an across the board correction is due – but again not the collapse that many are forecasting.  That is at least a year or more away. 

So, what can be expected?  Smaller 4^th wave corrections within the context of larger (Cycle degree) 3^rd wave advances.  Here then are the updated levels for the:

DJIA – Support begins at 14840 to 14420 – additional support zones are below at 13,931 and 13587.  I would not be looking for a drop into the second or third zone, but rather for the top end to the middle of the first support zone to contain the move and set the stage for the rally to pick up again and take the DJIA to additional new highs.

S&P 500 – Support begins at 1600 to 1547 – additional support zones are below at 1508 and 1469.  Again, I am not looking for a more serious drop which would take prices into the second or third zone, but the top to middle of the first zone to contain the move.  Here as well expectations would be for the rally to pick up again and move the S&P to new all time highs.

Russell 2000 – Support begins at 957 to 900 – additional support zones are below at 882 and then 854.  While a stronger drop can not be ruled out as the Russell has tended to be the weak link previously – but the Russell along with the QQQ’s are more tech laden and that has added stronger upside momentum with the Russell 2000 breaking above the all important 1000 level on Monday.

Market Divergences have not disappeared.

Divergence is defined as “a deviation from a course or standard.” – source Merriam-Webster.com

Divergences occur when things that normally run together (in the same direction) begin to go in opposite directions.  Technically, as a trader it is important to recognize when they appear and to adhere to the “warning sign.”  This does not appear to be the case lately, as many seem to think there isn’t much need of divergences since the markets only move in one direction – up – right?  Wrong – divergences are clear signals that an impending change is on the way.  Denying their existence does not mean what is being signaled won’t happen.  The markets will correct on both a small and large scale.  It is not a matter of “if” but of “when”. 

Here are a few market divergences that can be added to the growing list of “why the markets will correct”:

• The S&P 500 is up over 7% in two months with the past few weeks producing a more parabolic vertical rise with the a few sparse down days here an there.  Copper on the other hand is down over 7% in the same two-month period.  The divergence is notable because historically, copper and stocks almost always move in the same direction. 
• The Volatility Index (VIX) is also signaling divergence.  The VIX has normally moved lower as stock prices move higher.  Over the past two months, as stocks have rallied  – the VIX has gained nearly 10%.  With stocks and indexes trading a new all time highs, the expectation would be for the VIX to be hitting new 52-week lows.  It’s not.
• Baltic Dry Index is produced by the Baltic Exchange in London and reflects the cost of shipping dry goods overseas.  Here is a divergence for those that seek economic reasons for the markets to move.  Over the same two-month period the BDI is down 5%.  If the markets are rallying because the economy is improving then the BDI should be moving up with the markets suggesting an increasing demand for shipping goods.  It’s not.

The markets are extremely overbought and the daily oscillators have turned lower on Monday.    Longer term I continue to expect additional new highs as the current larger advance that began off of the March 2009 lows continues. 

Remember, an efficient market will always trade to volume.  At the moment the search for volume remains to the upside, even though so many remain suspicious that the volume will be found at lower levels.  So it becomes a game of patience.  The shorts are not budging and the longs aren’t either – not yet anyway. 

The sector rotation out of biotech and into technology continues to carry the bulk of responsibility for the rally.  Should a pull back on a larger scale take place I would be looking to add MSFT, AAPL, and INTC to name a few of the titans.

The Diversified Trading System used together with Trade Manager should continue to produce numerous trading signals in the DJIA, YM (mini), S&P 500, ES (mini), RUT, TF (Russell 2000 mini), AAPL, AMZN, GOOG, NFLX, and LNKD, GS, and Tesla Motors (TSLA).    

Here is an updated list of the markets where I have found that DTS (all three birds) are producing numerous signals:

• DJIA future (e-mini available)
• S&P-500 future (e-mini available
• US$/Euro futures (e-mini available) – very highly recommended
• GS (Goldman Sachs)
• AAPL (Apple Computer) – very highly recommended
• GOOG (Google) – very highly recommended
• LNKD (LinkedIn) – solid intraday range
• NFLX (Netflix) – solid intraday range
• TSLA (Tesla Motors) – highly recommended
• 30-yr Treasury Bond future – may get quiet
• 10-yr Treasury Note future
• TLT (Treasury Bond Long ETF)
• TBT (Treasury Bond Short ETF)

Day Trading vs. Position Trading

The necessity to toss out most if not all of your old trading ideas and join the ranks of algorithmic trading remains important.  Day trading has increasingly become my first choice as the markets become more difficult to “read” and trade.

I advocate the use of overbought/oversold indicators and momentum oscillators to indicate where money is flowing, where an imbalance of buyers or sellers occurs and a  “bull trap” or ”bear trap” forms.   

I believe that it only gets more confusing going forward as the market ignores “the writing on the wall” and continues higher with a false sense of security built on negative input.  Price volatility has increased with the broader averages easily moving 2 to 3 percent and as high as 10 percent intraday.  Many stocks have seen daily trading ranges average between 10 and 15 points, with one day being 15 points higher and the next being 10 points lower. 

This type of action is the primary motivation behind my advocating switching strategies if necessary and focusing on day trading and less on position trading.  I do believe there are discernable longer-term positions investors should consider and implement, but the near to mid-term market gyrations have produced far more profitable day trading opportunities without overnight risk. 

I continue to recommend the best trading platform available to a broader range of traders from novice to expert.  The Diversified Trading System offers a cost effective product that allows a trader to enter into the “chaos” and trade more effectively.  

Trade Manager from Indicator Warehouse automatically calculates the correct amount of contracts or shares based on your account size or market volatility.  Automated stop-loss management and position sizing eliminates most of the problems most individual traders have.  Day trading and position trading both require (actually demand) good risk management.  Trade Manager does the job across the board and is an essential trading tool that ensures that you take the maximum profit from all your trades.