On Friday, I wondered if the bull market in the Dow was running on fumes. And this week, we have had a barrage of ‘bullish’ economic reports and forecasts for several major economies. For instance, the IMF (International Monetary Fund) has upgraded its projection of GDP growth for the UK from 1.9% to 2.4% in 2014.
But that’s not all – the big hitters are in Davos. And it seems most of them are very bullish on stocks. Two of these bulls are, in fact, the biggest US hedge fund managers! Here is a quote from one of them that I believe captures the spirit of this market: “The US economy hasn’t taken off. It’s doing OK. I’m hopeful that growth will pick up…”
That one word gives the game away: hopeful. This man runs a $20bn hedge fund and he is hopeful that growth will pick up? The US markets gained over 25% last year, with only a slight increase in the price/earnings ratios. So I would say that there is actually a whole bubble full of hope in these markets.
Is it the end of the road for ‘hope’?
Yesterday, the Dow fell over 100 pips at one point. This happened in spite of the ‘bullish’ global GDP forecasts. Is it possible that the market does not believe these forecasts and has run up too far on hope alone?
Let’s look at the charts since they reveal what the market is really thinking. Here is the hourly chart I showed on Monday:
I have a solid tramline pair working. And the gap produced on 2 January remains unfilled, despite several attempts to close it.
A gap in the chart is a very significant feature. And the fact is, most of them get filled in quickly by subsequent price action. If a gap goes unfilled for any length of time, it generally is an indication that it will not be closed. That’s when the path of least resistance is away from the gap.
Let’s examine the trading pattern since Monday:
The market made another dash for the gap following the upper tramline break. But it was stopped dead in its tracks by heavy selling that followed the ‘bullish’ growth forecasts. Note this was the third attempt to close the gap, and it failed spectacularly.
But I have another revealing short-term tramline pair to apply to the chart:
The rally off the 12 January low is within the trading channel between my up-sloping tramlines. The lower line contains multiple lows and the upper line has a superb PPP (prior pivot point), while cutting across the major 16,500 high. This is about as reliable a tramline pair as you will find.
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How to know if a break is genuine
The market did manage to break above the down-sloping upper tramline. It then came back to sit in the pattern I call a ‘hat’. This is where two tramlines of differing time scales cross. These tramlines are both lines of support.
The main tramline was resistance before the break. But that tramline has now been transformed into support. Normally, we see a kiss of this tramline before the market resumes its uptrend – if the break is genuine.
But the strength of the gap resistance line (red) overcame the potential support of the kiss. The market then fell straight through the hat in a kiss failure. I find that when hats fail to provide support and then break, the move away is usually very intense. That is what we found here – it’s a textbook example of this rule.
But was there another clue that the hat would give way?
The rally up from the 14 January low is a complete five waves up, with a long and strong wave 3 and a negative-momentum divergence at wave 5. This is a perfect setup for a trend reversal. Remember, five complete waves always leads to a reversal, according to Elliott wave theory.
Proof that markets are not manipulated
OK, we have a move down away from the gap, but how far is the first leg likely to carry?
For that target, I need to draw in a third tramline, which I always do after a tramline break:
And here it is. The market was in virtual freefall and yet the market ‘knew’ where to stop falling – on my third tramline target! Isn’t that incredible?
With such rules being observed time after time, can anyone say markets are manipulated?
So, with just a little knowledge of my simple charting methods, a short trade could have been put on just under my hat. It would have then covered near the third tramline for a very swift 150-pip gain. Longer-term traders would remain short.
That is the power of my tramline trading methods.
And the 1-2 Elliott waves I showed on Friday may well be operating.• If you’re a new reader, or need a reminder about some of the methods I refer to in my trades, then do have a look at my introductory videos:
• The essentials of tramline trading
• Advanced tramline trading
• An introduction to Elliott wave theory
• Advanced trading with Elliott waves
• Trading with Fibonacci levels
• Trading with 'momentum'
• Putting it all together
• Don't miss my next trading insight. To receive all my spread betting blog posts by email, as soon as I've written them, just sign up here . If you have any queries regarding MoneyWeek Trader, please contact us here.
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