Tuesday, January 08, 2013

Leading Stocks Analysis Confirms Rally but Elliot Waves Indicate Final Wave

Unfortunately sometimes the stock market does something that doesn't immediately make sense, even though it was expected.  The current rally off the November 16th bottom appeared to be headed for a final run to end the second leg of the 2009 bull market and the rall started in October 2011.  Washington created uncertainty and leading stocks analysis forced us onto the sidelines as day to day volatility made it almost impossible to hold long positions without taking on enormous overnight risk.  This was the best and most prudent course of action that saved many a lot of money and heart ache as the stock market and leading stocks gyrated through out December with no progress.

Last week the government finally settled the fiscal cliff uncertainty it created and the stock market took off.  Unfortunately, unless you were already positioned to the long side, taking the risk that Washington would not settle the matter in a timely manner and face a major gap down with no profit cushion and most stocks below pivot points, it was difficult to chase it higher and start initiating positions as the stock market and most leading stock were immediately too extended to chase.  But as always, the stock market presents a secondary opportunity.

The leading stock analysis turned positive for the first time in several months, indicating that positions can be initiated on pullbacks.  The only caveat now is the narrow leadership, lower quality stocks breaking out, most leading that have broken out are now violating upper longer term upper trend lines, many breakouts on low volume and from erratic consolidations.  This type of behavior is indicative of a bull trap.  It is the final hoorah, where anxious buyers chase in fear of missing more of what they've missed for the last year or years and early short sellers run for cover in fear of being wiped out.

Elliot wave analysis points to this being the final wave of the rally that started in 2011 and the final wave of the second leg of the 2009 bull market.  Which means that there is another major leg higher, but not before we experience a major bear like correction, expected to start within the next few weeks.

Historical precedent is a main component in the analysis, but it has its limitations.  Nothing says that the stock market cannot create a new precedent.  Which is why it is important to sit out if the stock market is not doing what studies indicate it should be doing.  Use the time to watch and learn how to identify this situation in the future.

The current precedent that is being used is the final run, February to May 2006, that ended the rallies started in August 2004 and October 2005 (second leg of the 2002 - 2007 bull market).  The NYSE took the lead while the Nasdaq lagged and the major leaders GOOG and AAPL topped.  During that run, GOOG and AAPL did bounce helping the Nasdaq make new highs, while stocks like TIE and NTRI climaxed and lesser quality names led, before the entire stock market topped in May and rolled over into the summer correction that setup the third and final leg of the 2002 - 2007 bull market.  At this point there is no reason to believe this precedent will not hold.

If the precedent does hold expect the Nasdaq and Dow to follow the NYSE and S&P to new highs over the next two to five weeks, while the remainder of leading stocks climax and finish their moves.  Be prepared to take profits on the way up.  Waiting for them to break below the 20 or 50 day moving average could be too long.   This is the type of rally where stocks start to pullback from over extended positions and keep pulling back giving back the entire run very quickly, in some cases days, not weeks or months.

The way to play this going forward is to buy pullback in leading stocks already on the move and sell as they become over extended.  Buy the back if they pullback in an orderly fashion and repeat the process until they stop.  There is probably only one or two trading opportunities left before this rally runs its course.

Can't say this enough, don't fall in love with the trend.  Washington has another round of uncertainty pointed at us and it is just a matter of time before the cat fighting goes full steam ahead regarding he sequestration and debt ceiling.  Both sides have already started to dig into trenches very far apart from each other.
If you're new to the markets, and that could mean even a few years in, stay out, watch, and learn.  It is okay to miss a move.  Even experienced professional traders miss moves in the stock market when they do not conform to their strategies.  The idea is to protect your capital, so you can fight another day.

As always, comments and questions are always welcome.