Crossing the Rubicon

There is one question in the mind of all bears tonight, which can be summarized as follows:

Is this one for real?

In the past few weeks since the July 15 bottom we have rarely enjoyed more than two or three days of continuous downside momentum.  And judging by various comments and postings I came across today the consensus at this point seems to be that an upside correction tomorrow is almost guaranteed. After all, this is the kind of rhythm we’ve gotten used to: two steps up – one or two down – and then one or two up again. And all that blended with a healthy dose of sector rotation.

Which brings me to tonight’s title – it is apparent that we are about to ‘cross the rubicon’. What I’m getting at is that no matter which type of charting voodoo (EWT and others) you throw at the current scenario, we are at an inflection point that upon crossing would leave little doubt in anyone’s mind that the mind numbing bullish consolidation of late has come to an end, and that the long journey into the abyss (i.e. Dow @ 10,000) is in full swing. Having painted the picture a bit – let me now present my case:

Dollar weakens.

Let’s start with the Dollar tonight. As anticipated we saw the beginning of a medium term consolidation today, even though Prophet charts again paints a faulty candle (I have tried to approximate what I saw today before the close – so please forgive me if it’s not spot on). A rough target for the bottom of this down wave would be 75 – 75.5. Similarly, the Euro reversed course today and started to shoot higher after crude oil starting climbing its chart.

Gold in consolidation.

As expected Gold was able to drag itself into 2.5 Std. Dev. territory in after market trading after a positive day. I’m shooting for about 840 – 845 as our turning point. Again, expect considerably more weakness after we roll over.

Silver in selloff limbo.

Silver continues to be extremely oversold, which at this point is a bit of a mystery to me. Referring to the chart above: it’s obvious that we are still way outside the 2.5 Std. Dev., which is ‘unnatural’. I expected a lot more conviction here in terms of buyback action – my only guess would be that we are still experiencing heavy liquidation by some (still) unnamed hedge funds which are forced to sell massive amounts of contracts at unfavorable prices. Keep your eyes on the news ticker for some pertinent headlines.

S&P beginning its downtrend.

Now on to today’s market action in the main averages. The S&P made quite a bit of progress in the last two days, managing to breach the vertical lower support line (shown on chart) on Monday. This morning we saw a strong move down followed by mostly sideways action for the remainder of the day – frankly I would have preferred to see a stronger sell-off. Nevertheless, breadth in the S&P at close today was a negative 4.5:1 which continues to strongly support the bearish case. I do expect a brief consolidation, probably at the open tomorrow morning before we head further down. As mentioned in previous discussions – if this is indeed Minor wave 3 down expect it to be fast, long, and furious. Thus, on a preliminary basis I am numbering the first two waves as Minuettes (i) and (ii), as I strongly doubt that this constitutes the higher progression waves Minute i circle and Minute ii circle. A Minor 3 wave of Intermediate 3 is one of the strongest and most violent motive waves known in EWT, and in my mind what we are seeing here is nothing but a gentle preamble of what’s to come. So, it seems that we are currently in the process of tracing out Minute 1 circle of Minor 3. BTW, the same reasoning applies to the Nasdaq and DJIA charts below.

Dow continuing on bearish course.

The Dow is almost mirroring the action of the S&P right now and continues its bearish course downwards. Breadth on the $INDU at close today was a negative 8.3:1 and strongly supports the assumption that we are tracing out wave 3 at this point. I however need to see 11,200 breached, hopefully by the end of this week, before I can completely dismiss the possibility that we are in a continuation of wave 2.

Nasdaq supporting bearish case.

Extremely encouraging was today’s breadth in the Nasdaq 100 index ($NDX), which closed at negative 5.5:1. The Russel 2000 closed at a breadth of negative 3.9:1 – thus strongly indicating that the two leading indexes are now following in the footsteps of their currently weaker siblings.

In summary – what we are looking for now are continued sell offs interrupted only by brief (but often sharp) consolidation periods which should last one day or less. If we start going sideways from here again, in a similar fashion to what we have been experiencing in the last four weeks, we would need to re-evaluate the short term bearish case. However, at this point the probabilities are clearly in favor of a continued drop downwards, the pace of which should accelerate rapidly. Use the occasional rebound to load up on defensible short positions of your liking. Berk and I will surely keep posting our favorite picks here, so stay tuned and drop by regularly. In that context may I suggest to keep a very close eye on heavily overbought sectors (e.g. technology or financials) for potentially profitable counter trade plays in the days/weeks to come.

I am setting the short term indicator to mixed for tomorrow as I am expecting a brief push upwards in all four indexes before we head back down again. I don’t recall there being any crucial reports scheduled for tomorrow but any bad news (e.g Russians bombing Georgian pipelines) could of course lead to an immediate drop down. The long term indicator stands at a down trajectory.

Let’s have some fun tomorrow and don’t get scared out of all of your short positions if we see a pullback. Remember that the goal here is to find defensible positions at resistance zones. The name of the game is to plant your flag and prepare for several weeks of nasty downward action. The day trading approach we were forced into in the past few weeks will surely yield short term results, but would defeat a potentially very profitable long term strategy of riding strongly defensible short positions during the course of several weeks. In closing I would also like to propose that you consider FOTM (far out of the money) options, or at least grab a small amount of FOTMs in combination with OTMs and/or ATMs (depending on your trading style).

Cheers!