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S&P 500 To Head Lower

06/25/10 10:08:57 AM
by Alan R. Northam

The Elliott wave theory shows that the S&P 500 has much farther to go on the downside before we can consider the market ready to start moving higher.

Security:   SPX
Position:   N/A

The Standard & Poor's 500 formed its latest higher high in April of this year. Since then, the market has moved down in five nonoverlapping waves. Nonoverlapping waves are defined as when the low of wave 1 and the high of wave 4 do not cross. As can be seen in the chart, wave 1 and wave 4 did not cross. Therefore, the five waves down from late April to late May meet the requirement of nonoverlapping waves. These five nonoverlapping waves then define the next larger trend. Since these five nonoverlapping waves were going down, they define a larger downtrend in progress. The question now becomes, "How large is this larger downtrend?" We will address this question in a minute. First, however, let's look at how the wave structure has performed since late May.

FIGURE 1: SPX, DAILY. Here's the S&P 500 with the labeling of the Elliott waves.
Graphic provided by: MetaStock.
Following the completion of five nonoverlapping waves the market enters into a market correction. This market correction is made up of three waves which, according to Elliott convention, are labeled with letters instead of numbers. Typically, market corrections are made up of three waves that form a zigzag pattern and are known as ABC zigzags. This typical pattern is shown on Figure 1. However, at times market corrections can morph into more complex corrective structures. We never know for sure when a market correction is over until the market moves below the low of wave B. Once the market moves below the low of wave B, then we can assume that the market correction is over. However, confirmation comes when the market makes a new lower low. To be sure, market corrections are tricky to determine when they are complete, whereas in trending markets, it is much easier to determine when the trend is complete.

To be clear, once a market moves in five nonoverlapping waves, a market will enter into a correction that retraces part of but not all of the five nonoverlapping waves. And since the five nonoverlapping waves determine the direction of the larger trend, following the correction, the market will continue to move lower as it works to complete the larger trend.

There are two possible answers to how large this larger trend is. As a minimum, it is made up of the first five nonoverlapping waves, a market correction, and a second set of five nonoverlapping waves. As a maximum, this larger trend could be composed of three sets of five waves and two sets of corrective waves where each of the five waves and corrective waves alternate. Thus, the larger trend could be made up of the first set of five waves, followed by a set of corrective waves, followed by a second set of five waves, followed by a second set of corrective waves, and followed by a final set of five waves.

From this basic understanding of the Elliott wave theory, we can look at the chart of the S&P 500 in Figure 1 and see that there are five nonoverlapping waves that have formed and one set of three corrective waves. We can also see that wave C looks to be complete and the market is now headed lower to move below the low of wave B and therefore signal that the market correction is most likely over. From the basic theory of the Elliott waves, we also know that this market must make at least one more set of five nonoverlapping waves, of which the first of these five waves is most likely now under way. This therefore indicates that the S&P 500 has much farther to fall before we can consider that the market is ready to start moving higher again.

As long as the next five waves in the down direction continue to develop as nonoverlapping waves, our analysis remains valid and we can expect the market to continue to move lower until these five waves are complete. Following these next five waves down, we will need to study the next set of upward waves. If they form a three-wave ABC zigzag, then we can expect the market to continue even lower. However, if they form five nonoverlapping waves upward, we will know that the larger trend has reversed back to the upside.

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 or by visiting his website at You can also follow him on Twitter @TradersClassrm.

Garland, Tx
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