Last Week's Market

On Friday we surpassed the previous Wave 5 high, signaling the need for another 5 wave sequence to complete. The market took out that high in the first hour, reaching the 1375 level, before drifting lower the rest of the day to close at 1370.87. 

The week started exactly as expected, with the markets moving sharply lower from the 1378 highs. After completing a 5 wave sequence at 1340, the market rebounded, also as expected. At this point we were looking for a rally, before a resumption of the downtrend. This rally has extended further than expected, however, and although the 1378 high remains intact, the current market action has caused us to re-evaluate our previous wave count to that high.

The wave from 1074-1378 unfolded has a nested wave sequence, and although we arrived at a completed wave count, it did not have the look of a completed nested wave. Normally in a nested wave, the middle of the wave is a nearly straight move in one direction, consisting of series of trend waves, and inverted corrective waves. When nearing a top, the fluctuations generally become larger, as the market completes the final waves. We did not see this happen, and there is a possibility that the market is still in a topping formation. Additionally, the top at 1378.04 fell just short of our target range. We have identified an amended wave count that allows the market to complete these larger fluctuations, and completing this wave within our target range. We still believe that we are in a topping formation, and still expect the market to undergo a significant correction in the very near future.

In the near term, the market has not yet completed the 5 wave sequence from the 1340 lows. At this point a move back up slightly above Friday’s highs to the 1375 level would complete a 5 wave sequence. That could be the start of another move down, with a move back above that level would require another 5 wave sequence to the upside.

Longer term, we now believe the 1378.04 high was the termination point of Wave 2, for the reasons discussed above. That would make the move to 1340 Wave 3, and the current move Wave 4.This count would indicate another move down to test the 1340 low for Wave 5. One, or possibly two more moves back to the 1378-1422. This would complete Waves 3, 4 and 5. This market action would be more characteristic of a nested 5 wave sequence, and complete that sequence within our original Wave 5 target range from the March 2009 lows.

5 Wave Model Basics

The 5 Wave Model is based on the idea that there is a single, identifiable relationship between waves, or price movements, that governs market behavior. This unique relationship can be found in each five wave price sequence, and occurs only at the termination point of that sequence.

As prices move in one direction or another, highs and lows are created, each one identifying a possible wave. Once five possible waves have formed, and for each addition wave thereafter, different potential wave scenarios are analyzed, until the model’s wave relationship criteria are met. This relationship consists of waves 1, 3, and 5 reaching our correlation threshold. We have found that in a given five wave sequence, the lengths of these waves are dependent on a specific characteristic generated by the wave sequence itself. This correlation can be shown for each five wave sequence we have identified here, and for each five wave sequence we have identified in over 80 years of market data. Each termination point in a five wave sequence then marks the end point of the next larger wave. Our threshold value is quite high, requiring an R^2 value of .99 or greater.

Because the model requires five waves of data to identify termination points, wave structure is sometimes difficult to identify before that point, unless marked by ending points of wave sequences of smaller degrees. Analyzing a wave during construction can at times be fluid, depending on how the waves unfold. Since our model is based on a correlation threshold, the ranges given for projected termination points can sometimes be large enough to allow for some movement within the range before a top is formed, or small enough to allow possible misinterpretation due to overlapping targets. At times these cannot be resolved until taken in context of a larger degree wave.

The basic wave structure is quite straight forward, with waves 1, 3, and 5 generally being in the direction of the trend, and waves 2 and 4 being counter trend moves.

Three separate correction waves have been identified with our model. The first is a basic five wave structure, following the same format as the basic wave structure.

The second is the Inverted Correction Wave. In this wave, wave 1 is a countertrend move to the previous wave. Wave 2 however moves beyond the termination point of the previous wave. Wave 3 another countertrend move, wave 4 again moves in the direction of the previous wave’s trend, with wave 5 the final countertrend move. These moves can be quite explosive. They can be identified because the correlation between waves 1, 3, and 5 occur before a next degree 5 wave sequence can be identified using the previous wave sequence.

The third type of correction is the Semi-Inverted 5 Wave Correction. With This wave, waves 1 and 2 develop as they do in the Inverted Correction Wave, but then wave 3 falls back below the termination point of the previous sequence, and after a wave 4 countertrend move wave 5 terminates below wave 5. This wave can be identified in the same manner as the Inverted Correction Wave.

Here we have covered the basic tenets of the model, and described the basic wave groups. We hope this helps in understanding our analysis of the model.

Thursday's Market

Although we were correct in saying a move above 1355 would mean a continuation of the uptrend from the 1340 low, we believe we misread the wave structure. It now appears the move from 1354 to 1354, was a 5 wave sequence in itself. That makes 1354.84 the top of Wave 3, and Wednesday’s close of 1352.63 the end of Wave 4.

With that in mind, today’s strong move to the upside then was no surprise. The market opened strong, and barely looked back the rest of the day. It also managed to complete a near perfect 5 wave sequence from the 1352.63 low to today’s high of 1368.72. The termination points for the sequence are 1363.04, 1358.12, 1365.79, 1363.62, and 1368.72. This also then completes a 5 wave sequence from 1340.03. This means the next move could be to the downside.

The level to watch now is the 1368.72 high. Since we have completed a 5 wave sequence from the low, a move above that would require the completion of another 5 wave sequence.