The Dow rallies to a new high – what now?

Yesterday I laid out a reasonably strong case for last Thursday’s high at 12,920 to be the top of the incredible Dow rally off the October low at 10,400.

I showed a convincing minor five-wave Elliott wave pattern off Thursday’s high, an extreme in investor bullishness (which normally coincides with tops), and a large-scale rising wedge, which normally resolves downwards.

In previous articles, I also showed that the recovery off the October low looks much more a classic A-B-C pattern than anything else. As we know, these three-wave patterns are corrective to the main trend, which is down.

Why yesterday’s rally cancels my Elliott wave signal

In yesterday’s article, I stated that a resolution out of the wedge would be either a move well above the 12,920 top to break the upper trendline, or a break of the lower trendline.

Overnight, the market rallied to take out the 12,920 level (high so far this morning on my spread betting platform is 12,940, so only a small move above that level).

That means my pretty Elliott wave signal is cancelled most emphatically.

This just proves that there is no such thing in the markets as a ‘sure thing’. They are probabilistic – and my job (as yours as a trader should be) is to identify high-probability low-risk entries. And using my 3% rule and break-even rule can help minimise my losses on losing trades.

But does this new high mean I am totally wrong to look for a top around current levels? Let’s take a look.

Here is the updated chart showing the market in relation to the wedge boundaries I showed you yesterday:

 Dow Jones spread betting chart

Focus on the blue box. As you can see, although the market has made a slight new high, it is still well within the bounds. That means the eventual move out of it could still be to the downside.

The negative factors I mentioned earlier still hold, so despite my loss on that trade, I shall be still looking for a top soon. And I think it may come sooner rather than later – and here is why.

This could be the final wave up before a reversal

Take a look at this next chart as I zoom in a little closer:
Dow Jones spread betting chart 

This shows the action since the minor low of 30 January (highlighted in the blue box in the first chart). I can count a very nicely proportioned five-wave pattern complete with a ‘long and strong’ third wave – with the fifth wave forming this morning.

The implication, of course, is that if correct, the fifth wave would be the final up wave and lead to a reversal down.

Now, the final top of this fifth wave may still lie ahead – and it could reach as far as the upper wedge line at the 13,000 area without violating this pattern.

But if the market falls to the area of the purple bars, which lie at or below the lower wedge trendline, that would confirm the market had finally turned.

If these levels can be broken, I would expect a very rapid decline immediately.

Why I’m waiting on the sidelines, ready to pounce

As we are seeing, stock market tops are usually drawn-out affairs – unlike markets such as gold, silver, crude oil and currencies, which can be ‘spiky’. With stocks, it is usually necessary to make several attempts to jump on board.

But I’m convinced the glittering prize is awaiting me. I need just a little more patience. I know that when the market is holding up longer than I would like, it is very tempting to throw in the towel, as several prominent US bears have recently done.

There has been a surge in bullish consensus recently – and I’m sure many bears who have changed their stance have helped pump up the numbers!

I have been around the markets long enough to know that this is the very time to hold my nerve and to trust my reading of the market. Even though I know some traders’ emotions would be telling them to abandon ship!

I know that as a trader, I have the luxury of being able to stand aside, waiting for the very best time to enter. And that’s why I am on the sidelines without a position, but waiting to pounce.

• 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:

The essentials of tramline trading

Advanced tramline trading

An introduction to Elliott wave theory

Advanced trading with Elliott waves

Trading with Fibonacci levels

Trading with ‘momentum’

Putting it all together

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