Fear is stalking the Dow Jones index

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.

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.

The power of tramline analysis

The ‘reasons’ for last week’s collapse have been well known in the market for some time – yet the market still rallied. We all knew emerging-market currencies were already getting weaker, and that China’s economy has been slowing for some time. These are two of the favourite rationales used.

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?

So what is the position this morning?

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:

Dow Jones spread betting chart

And this is the chart this morning:

Dow Jones spread betting chart

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.

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

I can now make some rough forecasts for the extent and form of wave 4.

Dow Jones spread betting chart

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.


  • adatherton

    So you’re saying back to 16k then down again?

  • Oscar Foxtrot

    Always enjoy reading your analysis John.
    Dominic Picarda at Investor Chronicle believes the bull run is still intact. I am a technical anaysis novice but he seems to place more emphasis on the 13, 21 and 55 4-hourly EMAs than you do. I guess its just a different way of looking at the charts. Where woud you place a sell order or is this something that you wouldn’t recommend? Always keen to learn more!

  • norman

    Man, I am REALLY annoyed.
    The darn yanks took my last position out, before FINALLY turning. I went short, at about 16470 around the 17-20th Jan, noting the downsloping tramline forming, running off the previous tops. The scum bags then made a break on Tues the 21st. This was quite a strong tramline by this point and so needed a strong break, which it had. So after coming back for what presumably would be the tramline kiss before setting of for new highs. The tramline was significantly broken imo so I had to turn my trade, I closed the short and went long.

    I knew the momentum was rediculously low, yet to brake such a strong tram line, they had then to be marching further up. So swapped my short trade, long, then they FINALLY tanked. And it turned out to be one of the most solid looking fake breaks I have ever seen- ba’tards. Was my final trading position too, after ages of loosing attempted bear positions. So then I had to sit out and watch them fall. Not happy, but absolutely nothing I can do about it of course. Just unbelievalby mad.

  • Oscar Foxtrot

    I’m with you Norman. I have had a short position on the Dow every time it went above 16500 since the new year. I had been waiting for a correction. When it happened I didn’t have the usual short position in place. As it fell I think I must have lost the plot and went long every time it paused for breath. So not only am I down 250 pips for going long but I have missed out on an additional 800 pips by not shorting. Have been beating myself up about it ever since but trying to learn from the experience and move on!

  • norman

    Yes I know tha feeling Oscar. And I think I can explain that one, and if you better understand it, you can better guard against it. I think the reason for that is that you want to NAIL the top, almost perfectly. Further, if it stops you out and then drops, thats even more annoying, so you you hope it will go back up, so you can reinstate your previously “erroneously” stopped out short position, and so think you may as well go long while doing so, and gather a few points on the way.

    But yes, once it drops past lines of support, you jsut gotta go with it. Sometimes takes forever to start to go, but once it does, look out below!

    I’m also pretty annoyed cause it just had to be coming at some stage, and when it did, it would be quite strong, so I would have all over it very aggressively, so think I probably woulda made about 100 times my money at least.

    Being greedy is one of things you have to guard against too however, but I wouldnt say I’m greedy, I jsut like playing the game. And when yuo are going with it when it finally moves, you can stack up postitions like nobodies business!

    • norman

      *sorry, about 50 times my money