By Alessio Rastani – 27th February 2017
The stock markets made an incredible recovery last week.
Despite the drop on Thursday which had everybody freaking out, the S&P and most world stock markets recovered to near their highs.
So where is the market going next? Take a look:
The chart demonstrates “Elliott Wave Theory”, which is a very useful predictive tool.
Elliott Wave theory is is the idea that markets move in 5 waves (or 5 sections) in the direction of the major trend. After the 5th wave, we usually see a 3 wave correction (ABC).
By the way, these waves are a bit like Russian dolls – where each doll is within another doll and so on. So each wave 5 is composed of SMALLER mini-waves. Take a look:
Notice that waves 1, 3 and 5 (the IMPULSE waves) are each composed of 5 smaller waves. Waves 2 and 4 (the CORRECTIVE waves) are each composed of 3 smaller waves (known as ABC waves).
Again, this is similar to the idea of a Russian doll: dolls within dolls – or waves within waves.
So how does this help us?
Well, let’s take a look at this hourly chart of the S&P 500:
According to Elliott Wave Theory, we are most likely in a large wave 3 uptrend from the beginning of February (see blue number).
But this wave 3 is itself composed of 5 smaller waves (see red numbers).
If this wave count is correct, then last week’s market drop was likely wave 4 (a corrective ABC move) and now we are starting the final fifth wave in this larger wave 3.
If you are, it’s OK. I was also a little perplexed when I was trying to grasp Elliott wave theory.
But I have come to realise that Elliott waves are an incredibly useful LEADING indicator – and often can help us understand where we are in the greater picture – so we can make better “predictions” or future projections.
Now, if the above wave count is correct (and I think it is), then it is a question where this final smaller wave 5 is likely heading to.
There is likely to be resistance at the 2375 to 2380 levels. It is likely that we will see weakness at these levels, specially if we fail to close above these levels.
If we do close above 2380 (on a daily chart), then look for 2400 psychological level to be tested.
I think it is likely that 2400 will hold resistance, and we could see the larger wave 3 end at this level. This would result in a protracted wave 4 corrective move (ABC) down to support.
In the meantime, let’s buckle up for the ride!
By the way, using elliott waves is a bit like using a map (or GPS) in a strange town you have just flown into, and trying to find your way around. Sometimes the map will be labelled with the wrong street names (how annoying is that?) – but most of the time it is likely be right.
In any case, in my view, having a map is better than having no map at all…
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