Secular Bear Market Remains Intact

03/10/10 01:18:05 PM

by Alan R. Northam

The rally off the February 2010 low has now pushed so far that traders and even market analysts are now starting to consider that a new bull market is underway. According to the Elliott wave theory, however, the market has one more down leg to go that will carry the market to a new lower low before a bull market can emerge.

Security: !COMP
Position: N/A

Traders and market analysts are now starting to become very bullish and even one technical analysis newsletter writer that I know of is starting to believe that the market is in a new bull market trend. I do not believe that this is the case, and here's why.

Figure 1 shows the monthly bar chart of the NASDAQ Composite Index. This chart shows that a long bull market known as a secular bull market ended in early 2000. After every bull market there is a market correction. According to the Elliott wave theory, corrections come in three basic waves labeled A, B, and C known as a zigzag. While the zigzag is the most common, there are four different basic wave patterns that corrections can form into: zigzags, flats, triangles, and combinations. While market corrections can form into these well-defined wave patterns, a trending market only develops in five nonoverlapping waves.

FIGURE 1: NASDAQ, MONTHLY. This chart shows an Elliott wave count.

Graphic provided by: AmiBroker.com.

From early 2000 until late 2002, the NASDAQ moved down in five nonoverlapping waves labeled 1 through 5 on the chart. These five nonoverlapping waves form wave 'A' of an ABC zigzag. Waves 'A' and 'C' of ABC zigzag corrective wave patterns are always composed of five nonoverlapping waves, just as are trending waves.

Waves 'B,' however, are always composed of a smaller abc zigzag wave structure or a combination of other known corrective wave structures, making them more complex. From late 2002 until late 2007, the NASDAQ moved upward to complete a complex wave 'B' structure. We know this was a wave B because a wave B always follows wave A.

Now here comes the interesting part of the analysis. From late 2007, the market moved down in five nonoverlapping waves labeled i, ii, iii, iv, and v in Figure 1. Since wave Cs are formed by five nonoverlapping waves, there is a tendency to label the low made in early 2009 as the completion of wave 'C' and declare that the ABC zigzag correction is complete and a new bull market is underway.

However, according to the Elliott wave theory, wave 'C' must end below the low of wave 'A,' which has not yet occurred (See green dotted support line.) Therefore, we cannot label wave 'C' complete. However, there is an exception. According to the Elliott wave theory, an extended flat does allow for wave 'C' to be complete at a higher price level than wave 'A.' Again, an extended flat requires wave 'B' to have been completed above the origin of wave 'A,' which also did not occur.

Therefore, the wave structure from early 2000 to early 2009 is not an extended flat corrective wave pattern. Unfortunately, there are no other Elliott wave structures that allow for wave 'C' to be complete at a higher price level than wave 'A.' Therefore, the five waves down from late 2007 until early 2009 must be wave 1 of a larger nonoverlapping five-wave structure to form wave 'C' of the ABC zigzag market correction. This then means that the rally from early 2009 can only be corrective wave 2 and not the start of a new bull market, as some believe. This further means that once wave 2 is complete, wave 3 down, wave 4 corrective, and wave 5 down are yet to be completed. Once these waves are complete, wave 'C' will also be complete as well as the ABC zigzag secular bull market correction. Once this ABC zigzag market correction is complete, then a new bull market can emerge.

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.