S&P 500 Drop - What To Expect Next

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Includes: BXUB, BXUC, DMRL, EPS, IVV, PPLC, RSP, RVRS, RYARX, SDS, SFLA, SH, SPDN, SPLX, SPUU, SPXE, SPXL, SPXN, SPXS, SPXT, SPXU-OLD, SPXV, SPY, SSO, UPRO, USMC, VFINX, VOO
by: Brian Fletcher

Summary

S&P 500 invalidated the impulsive move higher.

The two most likely alternative upside structures.

Stay calm and assess market action to tell you when to exit equity positions.

Yesterday’s drop was dramatic, and from an Elliott Wave standpoint by breaking below 2,850, the S&P has now removed any possibility of an impulsive move higher. So, what does this mean? It means there are two other possibilities that become much higher probability counts. The two counts are diagonal 1 and diagonal 2. I'll discuss there difference in this article, how to interpret the difference, and what to expect next.

The diagonal 1 count, as shown here by a view of the S&P futures contract (ES), has now reached lower support overnight into the 2,748 region, and so long as this level, or no lower than 2,722 level holds, a move up to 3,047 – 3,137 are still in the cards.

What is causing me to view this count with a reasonable degree of skepticism is that yesterday’s move down has all the characteristics of an Elliott Wave 3rd wave down. If we view the recent decline as an impulse, it is now at the 2.0 extension within the downside structure, which is a common Fibonacci extension for a 3rd wave. So, if ES (SPX futures contract) can hold over 2,722, the upside on the chart shown overhead till quite easily be obtained.

Alternatively, if we see a bounce up to the 2,800 region followed by further downside into the 2,695 region, then I will be consider this entire structure of the move off the low in May of this year as a much larger diagonal - diagonal 2. In this scenario, we would see a lot of whipsaw occur in the coming weeks, but would expect to ultimately retrace back to .764 level at approximately 2,885 region, only to be followed crash like c-wave of a larger wave ii down to the 2,640 region. In the larger diagonal, levels would eventually top in the 3,200 – 3,300 levels.

Regardless of which pattern plays out, this is not a time to panic sell. Rather, watch for whether support holds in the 2,748 – 2,722 areas for the immediate diagonal to provide another high into the end of this year. If these levels fail to hold, we will be looking to exit most individual stock positions on the next larger bounce into the 2,885 region and sit out the choppy action of the larger diagonal.

Long term investors should seriously consider using the larger bounces and/or new high, depending on which scenario plays out, to exit equities in favor of holding cash through the next major down cycle. If SPX does break support and throw us into the larger diagonal scenario, this is incredibly difficult market action for traders, and the significant risk is that the overall high has already been established and the larger diagonal 2 fails to provide new highs. It is for this reason that IF support of 2,692 does break, we suggest using the larger bounce back to the 2,885 region as an opportunity to exit equities. Said differently, at that point, the remaining upside potential in equities before a much larger decline does not outweigh the downside risks.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.