Overbought? Elliott Waves Say Not Even Close

10/15/2010 12:01 am EST

Focus: STOCKS

Back in late-February 2009, I decided enough was enough and I stuck my neck out and called for a massive bull market in stocks. I based this prediction purely on Elliott Wave patterns that I identified as bottoming and the sentiment gauges were off-the-charts bearish. We had not seen sentiment that negative since the 2002 lows.  The retracement of the S&P 500 over the eight odd years was a textbook Elliott Wave pattern, and frankly, I think I was the only person who noticed the significance of the 666 low as it related to the 1974 S&P 500 lows to the 1999/2000 highs. Why was that 666 number so significant and a key indicator of a major bear market cycle low? Well, the reason is that it marked a clear wave two Elliott Wave bottom, both in price, sentiment, and time, all at once.

At that level, the S&P 500, believe it or not, had retraced an exact 61.8% Fibonacci retracement of the 1974 lows to the 1999 highs. That was very significant in that the market bottomed right there and then began rallying upwards. At that point, it confirmed what I predicted in February of 2009: That we would begin a massive bull market in stocks. The correction from the 1999-2000 highs lasted roughly eight Fibonacci years and retraced 61% (Fibonacci golden ratio) of the 25-year advance. Everyone was bearish at the lows, again, a confirming piece of evidence to get long in the winter of 2009. That brings us forward in this new bull market to October 2010. Clearly, we bottomed in March 2009 at 666, but it was not random at all.

We are now in the early stages of a big wave three up in the markets. Wave one ended in April 2010 (a five-wave structure completes a large wave one pattern). Then, wave two corrected in A-B-C fashion, which had a 38% Fibonacci retracement of the prior 13-month rally. That completed wave two down into July 1, and sentiment again was horrible at the recent 1040 pivot.

Now, a wave three structure (five total waves) to the upside begins at 1010 on July 1 with a move to 1130, then a wave two to 1040, and now a wave three up (still in progress) to 1220 if I’m right. Bottom line is the long-term trends are bullish until the wave patterns materially change. Once 1220 is hit, we likely will get a pullback wave four down, then a fifth wave up to new highs past the April 2010 highs.

Below is the simplest of S&P 500 charts with some basic Elliott Wave labels. Getting complex with Elliott Wave forecasting is not a good idea. Best to you and your trading!

chart
Click to Enlarge

By David Banister of ActiveTradingPartners.com

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