Where to next for the Dow Jones index?

I last covered the Dow back on 3 November. I had taken a nice short-term profit on a short trade, when a five-wave pattern had been completed in almost text-book fashion.

I stated:  “I expect very congested markets in the near term, and I will be observing the action to see if another low-risk pattern develops. But I hope I will see an A-B-C upward correction to the five wave move – that would be ideal”.

I’m pleased to say that my ideal scenario was followed almost to the letter.

Below is a chart of the trading since then.

The market rallied off the truncated fifth wave in wave A, pulled back in wave B, and then rallied in wave C. It doesn’t get much clearer than that with Elliott waves!

Dow Jones spread betting chart

(Click on the chart for a larger version)

Anyone using these elementary Elliott wave concepts would be waiting for wave C to play out – and then establish new short positions.

One point – because of the extreme overlapping of the minor waves in this pattern, there was not a clear-cut momentum divergence at wave C on the hourly chart, which ideally I like to see.

But that did not detract from the sell signal, as this extreme overlapping pointed to the reluctant nature of the rallies. They were on borrowed time.

Trader tip: Examine the nature of counter-trend rallies and dips – and also on the trending movements. A strong move with little in the way of overlapping corrective waves usually indicates a powerful thrust, where trading with that trend normally is the correct strategy.

Now, with my A-B-C waves firmly in place, I can now draw in my tentative wave count from the top. The 1 November low is my new wave 1, and the C wave is my new wave 2. We are currently in wave 3 down.

As we know, third waves are normally long and strong. Thus, from Elliott wave theory, I expect rapid progress down from here.

Trader tip:  I advise all traders to be familiar with the basic concepts of Elliott wave theory. I know that it can get complicated because of the fractal nature of markets, but keeping to the simple principles, as I do here, is sufficient for most traders to get aligned to the profitable side of the markets. If you need to brush up on Elliott waves, you can see my video tutorials here: An introduction to Elliott wave theory.

Where are my major targets?

OK, so where are my first major near-term targets?  Here are the Fibonacci levels drawn off the 4 October low and the top:

Dow Jones spread betting chart

(Click on the chart for a larger version)

We are currently challenging the 38% level, where there also lurks significant chart support. This chart support is provided by the various lows put in since the 26 October low.

If the market can break this support, then it’s off to the races towards the 50% level at 11,350 area (300 pips below current market – marked by the blue bar). Much lower prices beckon thereafter.

Why am I very bearish on the Dow? For an answer, let’s look at the larger-scale Elliott waves:

Here is the daily chart going back to the recent 2 May top:

Dow Jones spread betting chart

(Click on the chart for a larger version)

From that top in May, I can count red waves 1 and 2 (the 22 July high), and if correct, we are in a wave 3 (red).

Also, from the 22 July top (the red wave 2), I can count yellow waves 1 and 2 (the 27 October high). If correct, we are in this wave 3 down.

So we are likely to be in third waves down in multiple degrees of trend (ie we’re in third waves down when measured from different tops). The red wave count starts at the 2 May top, while the yellow wave count is one degree smaller than the red (it starts at the July 22 top).

Could the Dow fall below the March 2009 low?

But that is not all – let’s look at the even larger picture:

Dow Jones spread betting chart

(Click on the chart for a larger version)

From the all-time top in October 2007, I have the big wave 1 to the plunge 6,500 low in March 2009. Then the massive rally to the May 2011 high in wave 2. We are now in the early stages of a potential huge wave 3, which should eventually take the market below the wave 2 low at 6,500.

That would be an earth-shattering move, and to most people is utterly beyond their comprehension.

But back to the here and now, and my Fibonacci targets remain my focus. In terms of tramlines, I am unable to draw anything sensible just yet, so no help from that quarter.

Meanwhile, the market remains weak, but of course, subject to sharp rallies induced by policy announcements, especially from the eurozone.

The authorities will do almost anything to prevent a deflationary collapse – and that could be temporary bad news for short-term traders!

• 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:

Advanced trading with Elliott waves

An introduction to Elliott wave theory

Trading with ‘momentum’

The essentials of tramline trading

Advanced tramline trading

Trading with Fibonacci levels

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