Where's The Bottom? Cycles Paint A Clear Picture

Has the selloff ended? What will the bottom look like and am I at risk of taking further losses?

What should I do?

This post is going to help you understand the structure of the markets and what is really happening. Price always attempts to seek out new price highs or new price lows. In this case, we are seeking out new price lows with a downside price rotation. Price structure, which is normally discussed in Elliot Wave structures is the process of setting up new higher high or lower low waves as price rotates in a defined wave structure. Keep in mind the broader wave structure that is currently unfolding.

Over the past 16+ months, we've suggested that the price rotation in 2018 was a Wave 4 downside price rotation of a Wave C upside price structure. If our analysis is correct, the last rally we just experienced (ending near February 1, 2020) was the end of a Wave 5 upside price move that completed the Wave C upside price structure. This would indicate a very real possibility that the current downside price trend is a Wave 4 downside price move.

For readers that are not familiar with the Elliot Wave process/structure, each major wave (1 through 5 or A through C) can consist of various types of minor wave structures (as you can see from the middle chart in the example above. The major wave 1 could consist of a 5 wave minor wave structure (as shown). The major wave 2 could consist of a 3 wave minor wave structure (as shown) or even a downside 5 wave structure.

Going even further, each of these minor wave structures could consist of even smaller price wave structures. These types of price rotations often populate in 1, 3, 5, 7, 9, 13 and 21 wave structures. Unlocking the major wave count and minor wave count can help us unlock swing-trading and day-trading opportunities.

So, to put into context what we are attempting to convey to you is that we believe the peak in early February 2020 was the end of a major wave 3 and the start of a major wave 4 (to the downside). Because the upside price wave 3 originated after the 2009-10 price bottom, we believe true support in the markets is likely the midpoint of the 2018 price rotation range or near the low price levels of 2018. These price levels represent a very clear support level and low price target level that continues to follow the price structure rules of Fibonacci and Elliot Wave. If the 2018 lows are breached and the markets continue to push lower, then we fall back to the 2016 price lows and midpoint level.

Weekly YM Dow Jones/h3

This Weekly YM chart highlights the two lower MAGENTA lines that we believe represent clear price support for the Dow Jones (24,000 & 21,450). At this point, the YM has already moved below the 24,000 level and closed trading on Monday, March 9, near 23,900. Although this price level has breached the 24,000 level, we do not consider “support” a hard level (like concrete). It is like water in many cases and it matters what price does when it reaches this level. If price finds support near this level, it will begin to bottom out and potentially trade sideways before attempting to move higher. If not, the price may stall near this 24,000 level before breaking down to the 21,450 level (or lower).

We do believe the INDU/YM will put in a bottom before the ES and NQ do. Thus, we believe support will be found in the INDU/YM well before support is found in the other major US stock market indexes.

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Weekly SPY S&P 500/h3

This weekly SPY chart highlights the same setup with the two MAGENTA lines we've drawn. The first level of support for SPY is $261~$262. We believe this midpoint of 2018 high to the low trading range will offer a fairly strong support level for the SPY to attempt to set up a price bottom. Below that, the $234 level (the lower range of the 2018 trading year) would provide very clear support for the SPY.

The same type of price theory and expectations are at play on this chart as with the YM chart above. The YM has already reached our first level of support, yet the SPY is still $12 away from this first support level. This would suggest the YM may begin to set up some type of price support while the SPY may continue to trail a bit lower over time.

If this first level of support does not hold, then we would be looking for the 2018 price low levels (near $234) to become the next target for support. Ultimately, the price must either continue to attempt to break previous low price points as it attempts to establish “new price lows” or, at some point, it will fail to break past lows and that is where it will find support. The midpoint, often called the “belt line” (a Japanese Candlestick term) is used by technicians for two reasons: first, it represents 50% of a defined price range and, second, Japanese Candlestick theory teaches us the BeltLine is “the center of control” or price. Once price breaks this level, then further trending may continue.

Weekly NQ Nasdaq/h3

Lastly, this weekly NQ chart with the three MAGENTA lines drawn on it. The top line is the 2018 price peak level. The middle line is the midpoint of the 2018 trading range. The lower line is the bottom of the 2018 trading range.

The NQ has been the high-flying sector in the US stock market for many months. You can see the massive rally that took place near the end of 2019 pushing the NQ up to nearly 10,000 before the recent correction. Compared to the YM and SPY charts, it is easy to see the NQ rallied much stronger than the others. This is why we believe the downside price move in the NQ could also be far greater in scope than the YM or SPY.

If the NQ falls to our midpoint level (near 6795), the NQ must call another -1100 points to reach this level. Whereas the YM has already reached this critical price level and the SPY is only about $12 away from that same level. Therefore, the NQ, in our opinion, could continue to trend broadly lower throughout Q1 and possibly into Q2 before finding any real support.

The low price range of 2018 puts final support for the NQ near 5,832. From current levels, if price falls to this support level, it would total an additional -2066 point decline (-26.11%). It would also represent a massive -40% selloff from the peak set in February 2020 (near 9763).

Concluding Thoughts/h3

Where's the bottom? What's next? Our advice would be NOT to chase this selloff and NOT to attempt to bottom pick this move. We believe the Covid-19 virus event will last well past April/May 2020 and we believe both Q1 and Q2 results will be far below expectations. Therefore, we don't believe any real bottom will setup before May, June or July of 2020 – after Q2 earnings are announced and contingent on the virus event subsiding and earnings starting to recover. Otherwise, we could be “searching for a bottom” for quite a while yet.

Still, massive price rotations are taking place in the major markets and various sectors. If you are a skilled trader and are able to manage risk properly, you should be able to identify multiple opportunities over the next 90+ days for incredible trades.

Written By: Chris Vermeulen