Making sense out of the Dow’s apparent chaos

There is so much action going on in the stock markets that I could virtually write an important update every hour!

The volatility (size and frequency of the ups and downs) is huge, and most traders will be zigging when they should be zagging.

This is one of the most difficult and dangerous periods for trading in many a month.

On Friday, the daily range was 440 points, on Monday it was 700 points, and yesterday, it was 850 points! And with huge ups and downs in between.

If you were caught short yesterday near the low, you were in deep trouble!

But I have been able to stay on top of the major moves largely because of my powerful weapon – my tramline methods.

Trading Tip: Always be on the lookout for tramlines in pairs, in trios, and in even higher numbers. Remember, they operate in all timeframes.

It might look like chaos, but the tramlines are working perfectly

Recently, I have shown that even in the seemingly chaotic liquidation phase, the Dow has been following my tramlines perfectly.

Also, as I showed yesterday, the early morning Tuesday low fell right on to the Fibonacci 76.4% retrace of the entire rally wave up from the July 2010 low at 9,600, to the May 2011 high at 12,900.

Now, how did my call yesterday for a wave 3 low at 10,450 pan out? Let’s have a look at the hourly chart:

Dow Jones spread betting chart

(Click on the chart for a larger version)

My 10,450 low is holding (the market is currently 800 pips above where the market was trading when I wrote yesterday).

Recall, I used the confluence of my lowest tramline with the Fibonacci retrace level, together with a washed-out momentum reading to make my forecast.

Since I wrote yesterday morning, the market rallied right through my central tramline, hit my upper tramline, fell back down to the central tramline (with an overshoot), rallied back to the upper tramline, then fell back to the central line.

It then embarked on a huge rally, taking it past my upper tramline.

Last night, I could then draw a fourth tramline – and the market is currently sliding down it, as it eats into the overhead resistance from Friday’s trading.

I have drawn in the Fibonacci levels using the 12,900 high and the 10,450 low as pivots. The 38.2% retrace is only pips away!

Will it push on past my new tramline?

Short-term traders, who reversed their short trades yesterday, will now be looking for a place to take profits.

Also, traders who have missed the fun of the past week or so will be looking to get short, as they feel they have missed a great profit-making opportunity in this historic period.

And, of course, some ‘stale’ longs who held on through the gut-wrenching declines will be looking to unload on a rally.

Plus there are those who are short, seeing their profits dwindle on this rally, are looking for cover to protect their gains.

This is the typical scenario when a massive shock to the system hits. That is why there is so much volatility as leadership passes from one group to the other.

Why following the news will not help you

And please note that I have not said a word about the ‘news’. I do follow the news, but just to see what people are saying in terms of rationalising what the market has just done. (It borders on the bizarre at times.)

It’s no good acting on the news – the market has already made its move. As a trader, you must be able to forecast and act before the market moves, I’m afraid.

We can all see a chart and in hindsight find reasons for the moves. The market does not pay out for this, sadly.

But that is how the pundits ‘earn’ their salaries.

When I called the market low yesterday, the news that the Fed announced they were holding the discount rate for another two years had not emerged. This was the ‘reason’ stocks recovered, according to the media.

No. The reason stocks rallied was because the market was deeply oversold, and was hitting important Fibonacci and tramline levels.

But this way of thinking is off the radar of most market pundits. It is so much more dramatic to tell a story and they seem to be so knowledgeable, don’t they?

But try asking them for a definite forecast!

And when the market does top out, that will be my Elliott wave 4. I will then expect sharp moves down to new lows to make a wave 5 – hopefully creating a positive momentum divergence.

That is my ideal scenario.

When that happens, the traders/investors who have been buying shares on the dips will be deeply worried. That will be the time that the media will be full of doomsday scenarios.

Eurozone (and US) sovereign debt will be in turmoil again, and civil unrest will have intensified, probably moving away from the UK.

Meanwhile, I will try to stay on top of these exciting developments, so my writing may become more frequent.

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