Fear is stalking the Dow Jones index

The bulls of the Dow paid a high price for their complacency, says John C Burford. And more punishment may yet be on the way.

A lot has happened in the stock markets since I wrote Friday's post. Later that day, the market entered free-fall territory. The Dow had closed off 333 pips by the time the session ended.

I would say this action has confirmed that the gap I identified on 2 January is a breakaway gap.

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

Over the weekend, the pundits were out in force explaining' the collapse. But while their entrails examination was very entertaining, it actually has zero forecasting value. Where were the experts' when the Dow was making its all-time high a few days ago? That was when we could have used their expert analysis.

So that's why serious traders concentrate on their charts and analytical methods it lets us position well in advance of any large move.

Advertisement
Advertisement - Article continues below

The power of tramline analysis

So why did the Dow suddenly turn tail mid-week? And why did this not happen at some previous point? These pundits have no explanation. It all seems so obvious to them - after the event, of course.

But I do have an explanation. And it has nothing to do with the news.

The market turned because my Elliott wave labels showed a completed rally and the Dow had made a precise hit on my long-term tramline I showed that chart on Friday. I am posting a copy of it just above my screen as a reminder of the power of tramline analysis. It is sure to become a classic.

One other factor is behind the big falls last week the sentiment picture. Bullish complacency had reached epic proportions. In fact, the Vix (the 'fear index') was near record lows. During such conditions, I always ask: where is the new wave of bulls coming from to drive the market ever higher?

One usual source of buying is from the bears who are being squeezed. But they appeared to be few in number, especially in the Nasdaq. That gave me the idea that the decline should be very sharp and deep. Last week's action certainly confirmed this thought.

Is the Dow's third wave complete?

On Friday, I believed the Dow was in an epic third wave down of various degrees of trend. This was my chart when the Dow was trading at the 16,200 level:

14-1-24-MWT-4

And this is the chart this morning:

14-1-27-MWT-2

Overnight, the market dropped to the 15,850 level a full 350 pips below Friday morning's level shown in the first chart. But in the process it has become deeply over-sold in the near-term. And that means it is due a bounce. This current bounce could be wave 4 - if wave 3 has completed.

Advertisement
Advertisement - Article continues below

But the move down is enormous and backs up my contention that it is a third wave of several degrees of trend. The A-B-C interpretation carries much less weight now given the steep decline.

This third wave is certainly long and strong, but it may not have finished its work. Still, it has fallen to the important Fibonacci 78% retrace of the last major wave up, and this level is usually good support. The odds of wave 3 having now completed is high, and wave 4 up is very likely in progress this morning.

Naturally, short-term traders could take their well-earned profits of at least 600 pips this morning.

Forecasting the extent and form of wave 4

14-1-27-MWT-3

Wave 4 will be a relief counter-trend rally and could be in the usual A-B-C form. And because wave 3 was so fierce, wave 4 could be short. It would then only reach the Fibonacci 23% level before turning down again in a fifth wave. That is my best guess scenario. If this occurs, then I expect wave 5 to be deep.

Whatever shape wave 4 turns out to be, the market has been hit hard and the bulls will need time to recover. But will the market give them that time, or will there be another sharp leg down very soon?

It appears I am well on my way to my first major target at the 15,000 level.

Advertisement

Recommended

Visit/trading/spread-betting/600782/boeings-share-price-plummets-heres-how-to-play-it
Spread betting

Boeing's share price plummets: here's how to play it

Boeing shares have fallen by a third this year. But there could be worse to come. Matthew Partridge explains how traders should play it
10 Feb 2020
Visit/519524/how-my-2019-spreadbetting-tips-fared
Share tips

How my 2019 spreadbetting tips fared

Matthew Partridge reviews performance of his 2019 spreadbetting tips. This year’s winners include Bellway, JD Sports and Taylor Wimpey.
17 Dec 2019
Visit/519285/bettingon-politics-some-safe-labour-bets
Spread betting

Betting on politics: some safe Labour bets

Matthew Partridge outlines a few flutters on what should be safe Labour seats in the general election.
10 Dec 2019
Visit/518916/ds-smith-will-deliver
Spread betting

DS Smith will deliver: here's how to play the share price

Packaging group DS Smith is profiting from the online retail boom. Matthew Partridge explains how traders can play the share price.
3 Dec 2019

Most Popular

Visit/investments/commodities/silver-other-precious-metals/600812/buy-silver
Silver and other precious metals

You should all own some silver. Just don’t expect it to make you rich

Silver is cool, beautiful and immensely useful. But for investors it's the most frustrating of metals. Dominic Frisby explains why you should own some…
12 Feb 2020
Visit/economy/600802/money-minute-wednesday-12-february-grim-times-for-european-industry
Economy

Money Minute Wednesday 12 February: grim times for European industry

Today's Money Minute previews industrial production in the eurozone, plus the latest from America's central bank.
12 Feb 2020
Visit/investments/investment-strategy/600804/the-secret-to-avoiding-being-panicked-out-of-your-portfolio
Investment strategy

The secret to avoiding being panicked out of your portfolio

With the coronavirus continuing to occupy headlines, investors still aren’t sure how to react. But the one thing you mustn’t do is panic. Tim Price ex…
11 Feb 2020
Visit/517625/tr-european-growth-trust-why-investors-shouldnt-overlook-europe
Sponsored

Why investors shouldn’t overlook Europe

SPONSORED CONTENT - Ollie Beckett, manager of the TR European Growth Trust, tackles investor questions around Europe’s economic outlook and the conseq…
6 Nov 2019