XRT Forms An Ending Diagonal

06/09/08 09:37:41 AM

by Alan R. Northam

The SPDR S&P Retail Index is forming an ending diagonal corrective wave pattern, signaling that the retail index will continue to move lower in price once this corrective pattern is complete.

Security: XRT
Position: N/A

The SPDR S&P Retail Index (XRT) is forming an ending diagonal corrective wave pattern, signaling that the retail index will continue to move lower in price once this corrective pattern is complete. Figure 1 shows the daily price chart of the SPDR S&P Retail Index. Note that XRT made a major bull market top at the end of May 2007. Since that time, XRT has been trading down and is in the process of forming a five-wave impulse wave, of which waves 1, 2, and 3 are complete and wave 4 is nearing completion. According to the Elliott wave principle, an impulse wave defines the direction of the major trend. So if my analysis is correct and the XRT is forming an impulse wave, then once wave 5 of the impulse is complete, the completed impulse wave will signal that the major trend for XRT is down.

FIGURE 1: XRT, DAILY. This daily price chart shows the Elliott wave count and the ending diagonal wave pattern.

Graphic provided by: StockCharts.com.

Looking at the relationship between the 50-day moving average and the 200-day moving average, we see that the 50-day moving average crossed below the 200-day moving average in late July 2007 and the 200-day moving average has been moving lower ever since. With the 200-day moving average pointing down, it is signaling that the major trend is already in the downward direction.

In mid-January 2008, XRT put in a temporary bottom and has been moving in the upward direction as corrective wave 4 unfolds. It appears that corrective wave 4 is forming as an A-B-C zigzag corrective pattern, according to the Elliott wave principle. However, in some cases corrective wave 4s can develop into very complex wave patterns. In the case of XRT, we can see that wave 4 is forming as an A-B-C zigzag pattern that has morphed into a somewhat more complex corrective pattern because wave C is forming as an ending diagonal pattern. If wave C would have been any other corrective wave pattern, it might have been possible for wave 4 to continue to morph into an even more complex wave pattern. Fortunately, wave C turned into an ending diagonal wave pattern, signaling that it is the last wave structure of the wave 4 correction.

Ending diagonal waves are overlapping waves and can appear in wave 5s of impulse waves and in waves C of A-B-C zigzag corrections. The ending diagonal wave is made up of five waves labeled a,b,c,d, and e. As you can see from the chart, waves a,b,c, and d are complete and wave e is now unfolding. Wave e will move up to the upper channel line of the ending diagonal wave pattern before turning back down. In some cases, wave e will not make it to the upper channel line before turning back down, so we need to watch for that. Once XRT breaks down below the lower trendline of the ending diagonal wave pattern, we will know that corrective wave 4 has ended and wave 5 down has begun. I prefer to add a little filter by looking for two consecutive trading sessions where the market closes below the trendline before calling wave 4 complete.

Once wave 4 is complete, then expect wave 5 to move below the low of wave 3. Wave 5 should unfold as a five-wave move in the downward direction, and once complete, it should be at a price level below that of wave 3, or approximately $27.25, unless wave 5 extends lower. Once wave 5 is complete, then expect the market to retrace as much as 62% of the complete move down from the end of May 2007 peak.

Alan R. Northam

Alan Northam lives in the Dallas, Texas area and as an electronic engineer gave him an analytical mind from which he has developed a thorough knowledge of stock market technical analysis. His abilities to analyze the future direction of the stock market has allowed him to successfully trade of his own portfolio over the last 30 years. Mr. Northam is now retired and trading the stock market full time. You can reach him at inquiry@tradersclassroom.com or by visiting his website at http://www.tradersclassroom.com. You can also follow him on Twitter @TradersClassrm.