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Complex Correction Scenario

Apr. 13, 2011 4:01 PM ET
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aarc's Blog
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The main indexes have been vexing me since March 31 (see 'At Wit's End' Instablog).  Today could be one those times when the lightbulb suddenly lights up:

-   img40.imagefra.me/i54d/aarc/155w_918_ubk...

More than 38.2% retrace will invalidate the Type II rally wherein the 1st wave is the longest and the 2nd wave correction usually consumes less time than the 1st wave rally.  Sometimes a tiny penetration below 38.2% (= 1303.92 for SnP500) can happen and is still acceptable.  The Right Shoulder measured target for the Potential Inverted Head and Shoulders is 1301 - which  SnP500 may or may not reach and or exceed (See yesterday's 'Poisoned Pudding' for the Inverted Head and Shoulders chart).

There are many ways to count the waves and none of them will be proven right unless and until the market has confirmed which particular one is the correct wavecount.  Confirmation usually comes near or at the completion of the expected rally (or sell-off in case of bearish wavecounts). 

Since I trade for what might happen in the future (rather than spend time kicking myself for failure to trade the potential scenario - or for making a late entry to the party);  I take stabs on a possible wavecount when it starts to become a high probability scenario instead of waiting for the confirmation later.  This type of pro-active trade needs precision entry and willingness to scuttle the trade at the earliest possible time if something unexpected happens - to minimize losses or at least make some tiny profits even if the TA proves wrong.

A better entry (but bigger loss potential) is to wait for the 5min chart to make a i-ii-iii-iv-v rally then buy the pullback a-b-c down with the bottom of the i-st wave the stop loss allowance - for this particular case.

The W-X-Y wavecount for the 2nd wave can be an Expanding Triangle + a Zigzag or + a Flat.   The Y-wave is tentatively a potential Zigzag with a c-wave failure since it is so much shorter than the a-wave (when viewed on the 30min chart).  As of now;  it is still highly unpredictable what will happen next until at least an initial confirmation by the market(s) says so.  

Required initial confirmation is still very hard to quantify at this stage.  However, a Zigzag down with a c-wave failure will usually result in a very strong rally that retraces the whole a-b-c down in less time than it requires to form the Zigzag - due to the patently weak Zigzag, if and when a c-wave failure do happen and/or got confirmed by the market(s).  To be forewarned is to be fore-armed.

I bought YM again today after lunch when the 5min chart produced a potential i-ii-iii-iv-v run down.  Half of the trade is for 'Guerilla Trade' and the other half a YM Swing Trade 'just in case' the W-X-Y 2nd wave scenario proved to be the correct scenario:

-   img40.imagefra.me/i54d/aarc/155w_381_ubk...

Sometimes it takes me 2 to 3 attempts before the trade would be proven successful or a failure.  That is part of the job since finding the termination point of a correction is so much harder than finding tops or bottoms of rallies and sell-offs respectively.  Corrective processes usually result in lots of whipsaws for a majority of short-term traders specially when using extremely tight stop losses.  Other traders prefer breakout buys;  but the potential losses can be 5x to 30x as compared to using momentum divergence buys or by buying the termination (nominal) target of a i-ii-iii-iv-v run down with stop loss below the maximum allowed.  Counter-trading the v-th wave volume spike is the most effective (most of the time) but requires very fast reflexes.

Better wait for tomorrow if trying to trade stocks or etfs since a massive gap down can result in a big loss (if something very bad happens again during the Asian, European, and/or Middle East sessions).

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