No Comments Written by Anthony Truong on August 3, 2008 – 2:24 am

Summary: The primary count is that a second wave correction is still developing, but due to recent market movements alternate counts need to be considered.

Just when we thought this correction in wave 2 would be easy to read, things had to get a bit more complicated.

On Thursday (31 July 2008), the overnight trade took the Dow and S&P500 within ticks of the peak of what we are labelling as wave A (primary count), but prices did not surpass this top and instead began to fall. Friday’s (1 August 2008) action continued this trend to the downside.

PRIMARY COUNT: This would almost be like ‘cheating’, but we have two counts at the moment that are equal in probability. Both counts continue to call the peak of 23 July 2008 as wave A, but the interpretation of subsequent waves differ for these counts.

(1) (Labels apply to the S&P500 Chart above) Wave A topped on 23 July 2008, and wave B bottomed on 29 July 2008. The recent high of 31 July 2008 was wave 1 of a larger wave C, and the drop that began Thursday (31 July) and continued through Friday (1 August) constitute wave 2 of this larger wave C. Wave C will continue to develop, with a wave 3 (which should take prices above the high of 31 July) and a wave 5 (which should take prices above the wave 3 high) yet to form. This wave C will typically take the form of a 5-wave impulse, but there is the possibility that it will form a ending diagonal triangle. In either case, we should get a 5-wave move upwards that should take prices to a new high that is above the wave A high, before the trend reverses dramatically.

(2) (Labels apply to the DJIA Chart above) As in (1), wave A topped on 23 July, but wave B did not bottom on 29 July but instead is actually tracing out a prolonged pattern called a contracting triangle. Contracting triangles are comprised of 5 internal waves that reduce in size as the pattern progresses, forming a wedge shape. The pattern thus far has formed (smaller) waves A, B and C of a larger wave B. We should get one more up-down sequence (waves D and E) to complete this wave B triangle before a large rally ensues (wave C of a larger wave 2).

Both of these counts, although calling for different pattern structures to form, anticipate new highs over the next week or two. These highs should occur somewhere between the 50% and 61.8% retracement of the preceding wave 1 (Wall Street chart)/wave 1 (SPX chart) – specifically, that’s 11,980 – 12,250 in the Dow, and 1,310 – 1,350 in the S&P500. We are leaning more towards the ‘wave B contracting triangle’ scenario [(2) above].

ALTERNATE COUNT: Although we do not believe that the following scenario is occurring, we think it is important to mention, as it is possible given Elliott’s guidelines and rules.

(Labels apply to the S&P500 Chart above) Depending on how one interprets July’s price movements, wave A (of a larger wave 2) could have been complete at the high of 21 July; wave B bottomed at the low of 22 July; and wave C topped at the high of 23 July. This A-B-C 3-wave move formed a completed wave 2; the fall from the high of 23 July to the low of 29 July can be viewed as the first wave of wave 3 (unlabelled), and the rally from 29 July to the high of 31 July is the second wave of this wave 3 [it is implied that wave 3 will continue to subdivide to comprise smaller waves 3 through 5, before bottoming].

This is not a wave count that we are considering as a high probability one, as the smaller wave 2 almost completely retraced the smaller wave 1 of a larger wave 3. Although the Wave Principle allows for wave 2’s to retrace 100%, but no more, of wave 1, this does not commonly occur – what is more common is for wave 2 to retrace 61.8% of wave 1. If the yellow line in the chart above is broken, and especially if the wave 1 low is exceeded, we may have to elevate this count to a higher status.

Trading Strategy: [Please note this is NOT a recommendation of a trade] Aggressive traders may try to short the US indices (futures, perhaps) once they reach the 50% – 61.8% retracement levels mentioned above (and if the wave patterns are fully formed), or alternatively they can purchase put options on the indices.