A Fourth Wave Reversal

On Wednesday, the S&P 500 experienced a downside reversal day. The index meandered all morning, but then rallied to a new recovery high by mid afternoon. It then reversed course in the final 90 minutes to break below Tuesday’s intra-day low and finish with a 1.0% loss. Breadth was negative by a 15:4 margin.

The rally from Monday’s low to this morning’s high seems best counted as the fifth and final wave from the September 2 low. This, coupled with Wednesday’s “outside day, closing down,” suggests that there will be further downside follow through in the days ahead.

However, since the five-wave rally from September 2 is best counted as only the third wave from the mid August low, the anticipated downside follow though should be a fairly well-contained fourth wave decline that, in turn, should be followed a post-August fifth wave rally to another recovery high.

S&P 500

We used the phrase “well-contained” for four reasons. First, fourth waves typically do not retrace more than 38.2%-50% of the preceding third wave of the same degree. That range almost exactly encompasses the September 11-14 pullback from 1048 to 1035. Second, that same September 11-14 correction is currently best counted as the second wave within the five-wave September 2-23 rally. When, as in this case, the wave 1 rally is longer than both waves 3 and 5, the wave 2 correction is important support, even without Fibonacci considerations. Third, since the August 17-25 rally topped out in the 1037-1038 range, a coming pullback probably should not overlap that peak. Finally, the dominant post July uptrend line is current near 1038 and rising by about three points per day. So, in a perfect world, the anticipated follow through probably should be contained to the 1048-1038 area.

What if it doesn’t hold 1048-1038 range? The rally from August 17 to September 17 can be counted as a five wave pattern on the hourly (closing basis) chart. That would make the pattern since the September 17 high a counter trend correction that should have a Fibonacci relationship to that month-long rally. For reference, a 38.2%-61.8% retracement encompasses the 1038-1015 range. (Notice how 1038 shows up again). This would be our alternative scenario.

A break of second support at 992-991 would be the first lower low on the weekly chart since the July low. The July low (869) continues to be is tactical support.

On an arithmetic scale a 50% retracement of the decline from the 2007 high to the 2009 low implies a challenge of 1121. Meanwhile, 1159 is the point at which the post-July rally will equal the March-June uptrend. Chart resistance (from the September 2009 reaction low is apparent in the 1155-1156 area. Thus, the 1121-1156 range is a potentially significant range.