The Count Comes Back

07/20/05 01:20:24 PM

by David Penn

The first rule of wave counting: when wrong, go long(er).

Security: $SPX
Position: N/A

"Hah-hah! Life goes on!" is all Nelson Muntz, local bully in the award-winning animated television series, The Simpsons, need say when it becomes clear to all of Springfield that the doomsday prognostications of Homer Simpson have been proven conclusively incorrect. Doomsday thus delayed, the characters of the fictional city then abandon Homer to his hopeless vigil atop a forbodding butte that seems like a cross between something out of Koyaanisqatsi and Close Encounters Of The Third Kind.

"Hah-hah! Life goes on!" was also my thought as the S&P 500 soared above its January highs, setting a new, four-year high. And while this new high forces a revision of my most recent wave count (see "Elliott Wave Corrections," July 14, 2005, Traders.com Advantage), it need not force much of a revision of the general outlook.

That outlook remains this: The markets in general and the S&P 500 in specific are in the late stages of a cyclical bull market that began in the October 2002 lows. This cyclical, countertrend bull market consists of a massive "A" wave from October 2002 until January 2004, a saw-toothed countertrend "B" wave from February 2004 to August 2004 and, currently, a "C" wave from the late summer lows of 2004 to the present day.

Elliotticians have been trying to call the end of the "C" wave for months. At first, it appeared as if the late December 2004 highs might mark the top. Then, when the S&P rebounded and surpassed those highs in March 2005, many wave theorists -- including me -- believed that a top was in. The March 2005 high in particular featured a clear negative stochastic divergence on a number of time frames (including the monthly!), which was a clear signal that a top of some significance had been made.

An updated wave count of the S&P 500 suggests more upside in the short term as a wave 5 is completed. Note the negative stochastic divergence at the end of wave 3.

Graphic provided by: eSignal.

Recent price action has reminded us of the difference between "a top" and "the top."

So where are we now? The chart in Figure 1 summarizes the wave count from which I am working. I believe we are in the fifth wave of the "C" wave advance, with the declines concurrent with the terrorist bombing in London on July 7 marking a fourth wave low. Importantly, this fourth wave did not enter the territory of the previous wave one -- at least not on a closing basis. In a market that has often been stingy with the sort of clues that wave theorists rely on for accurate counts, this kind of "tell" was particularly helpful.

Given this information, we should also be able to plot a likely upside range for the "C" wave using the Fischer projection method from his book, Fibonacci Applications And Strategies For Traders. First, let's take a look at our wave lengths:

Wave 1: 1132 - 1064 = 68
Wave 2: 1132 - 1096 = 36
Wave 3: 1222 - 1096 = 126
Wave 4: 1222 - 1143 = 79

So far, so good. Wave 3 is not the shortest wave -- in fact, it is so far the longest. And we've already noted that wave 4 does not intrude significantly into wave 1. Now for the projections:

Projection of wave 5 top from wave 1:

68 x 1.618 = 110
1132 + 110 = 1242

Projection of a wave 5 top from wave 3:

[Recall that the wave 3 measurement here is taken from the beginning of the entire move, not just the wave 2 low. Thus, 1222 - 1064 = 158. The other way of doing this would be to subtract wave 2 from wave 1 above, and add that amount to the wave 3 length in the wave length list above.]

158 x 0.618 = 97.6
1222 + 97.6 = 1320

We now have a minimum upside of 1242 and a maximum upside of 1320. As I've noted elsewhere when using these projections, I like to take an average of the two to get an "ideal" target. In this case, that "ideal" target is 1281.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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