When I last covered the Dow on 21 August, the market was in the process of stair-stepping its way lower, on what I hoped was a third wave.
Remember – third waves are usually long and strong. Their signature characteristic is a rapid move in one direction. When I see the market move decisively lower making a ‘cliff-edge’ trace on the chart, then I suspect I am in a third wave.
Here was the hourly chart back then:
This is the type of action I was looking for – and it indicated to me that I have a genuine third wave working.
Now if I could identify the end of this third wave, I had a likely target for short-term profits.
Finding my short-term target
As trading progressed lower, I monitored the down wave and compared it with the previous wave up from the 24 June low.
Why did I do this? Simply because the Fibonacci retrace levels often represent strong support – and from there the down move could be turned around. This would give me one clue to help me find my short-term target where I would take profits.
Here are my Fibonacci levels which I had placed on my chart since the 4 August top:
The 15,400 shelf of support neatly coincided with the 23% level (this is common), which gave me confidence that the other Fibonacci levels would be respected.
As the market dropped down towards the 76% level, I noted the potentially large positive-momentum divergence (red bars). This meant the selling pressure was drying up and to get ready for a snap-back rally in wave 4.
And as the market hit the Fibonacci level, I decided to take my short-term profit of over 600 pips on my short trade.
And as the market rallied off this support, I knew I was in wave 4 up. Of course, I had little idea how high this wave would carry, although a rally to the Fibonacci 23% retrace of the wave down would be the bare minimum.
And so it played out, the wave 4 (w4) slightly overshot the 23% retrace. The market then turned around and went on to make a new low in wave 5.
Now I can say that the trend is down, as I have a completed five wave impulse pattern. But what now?
After a five wave move, I believe it should have a counter-trend rally, preferably in three waves.
So what is the picture this morning?
Well, I have my A-B-C rally, but it has stalled at the Fibonacci 50% retrace of wave 4. This is a very weak rally so far.
And that is a crucial point. If after such a solid move down as we have seen (over 800 pips), the rally is weak; then if this holds the move down should resume in earnest.
That is why the Wednesday low at 14,760 is a key level. If this is broken soon, the move down should gather pace.
That thinking was behind my decision to reinstate my short position at the C wave rally. And I was able to enter a very close protective stop because if the rally extended, my shallow rebound theory was likely wrong and I wanted to be out.
As for tramlines, I am unable to find any decent ones on the hourly chart, but my long-term tramlines are still working:
I have my complete five waves up and a solid tramline break.
The move down is a new wave 1 which appears to be incomplete. The big test though is the Wednesday low at 14,760. That is my line in the sand. If the market breaks that level, wave 1 down is still in progress.
But if this low holds, then the wave 1 low is in place and the market will move up in wave 2. Momentum is oversold here, but it often stays oversold for a long time when the market is in a sharp move. I don’t see there is a reason to go long!
In any case, my new short-term short trade is protected by a very close stop to limit any loss. I await the next move.