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Wednesday, August 4, 2010 - Ending Diagonal in Play

|Includes: SPDR S&P 500 Trust ETF (SPY), UUP

In previous posts I have been outlining some Elliot counts, both top interpretations say the market is very near the end of a counter trend rise. While counts on anything less than an hourly chart become murky (in my opinion at least), on daily charts, patterns tend to be very crisp. The best count now is the ongoing correction is an expanding flat, with a ending diagonal in the C wave position (the C wave is the rise since the July 1st low).

Chart 1- SPX Ending Diagonal

It looks to me like we are in the last leg of the diagonal. Today we most likely finished up the B wave of wave 5, and now we have a final C wave left to go. Ending diagonals tend to end with a thrust above the top of the trend line, followed by a violent break down. A break of the wave 4 lows would signal the next leg lower is starting. If confirmed by a momentum sell signal, I will be taking action on the short side.

Since I think the operative scenario is much more likely deflation (see previous articles on the bearish case), watching the dollar can also provide clues for the stock market. Most are already familiar with the negative correlation between stocks and the dollar during deflaton. Since the top in the dollar in early June, the UUP has retraced 61.8% of the rise since the December lows, sentiment surrounding the dollar is again very low, and today we might have had a bottom put in place.

Chart 2 - UUP

With a near perfect Fibonacci retracement, very bearish sentiment, and now a reversal on high volume that breaks a trend in declining volume, the dollar may have very well put in a low. I will be watching carefully for signs of confirmation, but this also has bearing on the stock market, signaling the "risk off" trade may be back. The timing is also what is interesting to me; just as the pattern in stocks says we are about to top, the pattern in the dollar says we are about to bottom.

Disclosure: Long SPY puts.