Thursday, July 17, 2008

Did You Say You Like Volatility?

Top Line: Between the closing bell and fifteen minutes later the market had a metamorphosis that changed the day from very positive to very negative. GOOG announced and the market did not like it. NDX may have topped this afternoon but there is a good possibility we will see a little higher price in the Dow next week.

The stock market responded to Thursday's drop in oil prices, the third day of losses in oil. Oil is down $15 in the last three days and Gas is down over 40 cents in those same three days. Remember that the price of gas in the market will be reflected at the pump over a period of days depending on where you might be.

Anyway...the stock market enjoyed another positive trading day as oil dropped another $4 or so. We were a little surprised by the large up move overnight which carried into the early trading Thursday morning. We should say we expected a mildly negative day. We know that options expire on Friday (tomorrow or today for you) so some volatility is expected but we certainly weren't expecting a complete reversal right after the bell.

We have been planning to trade or hold the QIDs as the market goes into its next down leg so we were paying attention to them on this day because of the early morning strength and then the late day rally allowed us to purchase some of them at a pretty good price around 43.82 just before the close. We decided to only buy a small portion of the position we want to own just in case better prices come along, we want to have some "powder dry" as the saying goes.

QID trades opposite the QQQQs with a 2x leverage effect--meaning that if the QQQQs go down the QIDs go up by twice the percentage. So with the QQQQs up 30 cents on the day, the QIDs were down about 65 cents near the close. As we looked at the QID in afterhours trading we saw that it was not down at all and was actually up. We thought there was some mistake or it was a quote from the day before...ok it's irrational but we certainly couldn't believe the number so...

Then we checked to see what was going on and found out that GOOG had announced their earnings and the market did not approve and then MSFT announced and also disappointed. Both of these events have caused a stir in the after hours market. The QID closed the after hours trading session at 45.40 up sharply from our purchase price just a few minutes before the regular trading hours closed. What to do, oh, what to do? We like these types of problems. We'll see what the morning never knows.

In case you're interested, here's the web site for ProShares. It indicates the ETFs that are available. If you have questions, indicate in the comments section...Ok, back to the real work...

We wanted to continue our discussion from the last post about Elliott wave. The discussion ended abruptly as we were getting to the good stuff. We think that the first wave (wave one) of the third wave is in progress. This wave started at the 13,000 level in the Dow back in May. Since third waves are normally stronger and longer than the other waves, they subdivide more deliberately and they are easier to "see". We don't think it's going to be very easy to explain it but our position is that the market is now in the fourth wave of the first wave of the third wave, very complicated indeed but here's what it means...

Fourth waves in a down impulse move are actually up moves which is why we've been looking for a rally over the past few weeks. Now the question is, "When does the fourth wave end and the fifth wave, a strong down move again, begin?" Of course, there is another question, too, which is "How deep will the fifth wave take the Dow?" Based on the patten that has emerged through the first four waves we can "guess" how far the fifth wave can go.

Since the first wave (of the third wave) dropped from about 13,000 to about 12,400 or 600 points, one possibility is that the fifth wave will be the same amount or about 600 points. That would be measured from the Top of the fourth wave (of the third wave) which could have occurred today near 11,450 (we had mentioned 11,500 in our previous post as a possible top here). If that is the case, we expect the minimum drop to take us down to 600 points below that at 10,850. Now, that doesn't really seem reasonable since we just traded at that price on Tuesday morning. No, 10,850 does not seem like the appropriate target. So, is there another?

We expect that the fifth wave will try to compete with the third wave for price movement. Wave three started right around our old friend 12,750 and ended on Tuesday at 10,850 for about 1900 points, ouch. So, if the fifth wave tries to compete with it, then we could see that 1900 points from where ever the fourth wave ends which should be either today at 11,450 or next week around 11,500. That kind of move would take us down to 9,600 which really feels like a good place to put in a low. In fact, since the Elliott wave Rule is that the third wave can't be the shortest of waves one, three and five, it is possible for the fifth wave to actually be more than the third wave because the third is already more than the first. (It makes sense, just read it again.) We're getting ahead of ourselves just a little but we wanted to give you an idea where we were heading.

We also want to be clear that this move since May (Dow 13,000) is just the First wave of wave three. There are waves two through five to go After we get done with the first wave which will likely take us below 10,000 before October. Once that low gets recorded, Elliott wave says that we should get a second wave bounce that will retrace, at a normal minimum, 38.2% of the first wave. Taking these points into account, the first wave will have gone from 13,000 to, say, 9600 or about 3400 points. Taking 38.2% of 3400 gives us about 1300 points which would take the second wave back up to nearly 11,000 in the Dow. These are very rough estimates and will be refined as we go along. The next big question is, "What about wave three?"

Well, since we think corrective moves take a while and are very complicated, it will take some time to complete. Since wave one will have lasted from May to September (there's that theme again, sell in May and buy in September), or about five months, we expect the second wave to last a little less than that but it could extent. The big guess would be a second wave top around January (state of the union, maybe???).

Then comes wave three, the big kahuna. The timing of wave three should be 2009, yes, most of the year, with devastating percentage moves in many stocks. Again, remember that the third wave is usually the strongest and longest and if wave one was 3400 points, imagine what wave three will be. Estimates are dangerous at this point but a simple estimate would be a factor of 1.618 as a minimum move compared to wave one. That math is 5500 points. If the Dow moves back up to 11,000 in wave two then it will get cut in half in wave three down. We are well ahead of ourselves but wanted to give you a little roadmap for the future.

Take care and read the post again. This is good stuff...

FSI at the close of regular hours: 86.25
FSI at the close of extended trading: 81.31 (still higher than April 17th)

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