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The 'Drama Queen' Market

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t took me a couple of days to figure it out. But first, let's get one thing out of the way; my Friday morning view, articulated here, was clearly wrong. It was mainly motivated by my bias towards wave 3 achieving a 'textbook' length of 2.618 x wave 1, as well as towards $SPY reaching $218, based on my interpretation of the Open Interest distribution shown in chart 1 below. 


Chart 1. Options Calls and Pus Open Interest distribution.

But when it comes to trading, flexibility is the name of the game. Chart 2 below ruled the day and dictated our subsequent actions. A snippet of the TradeWinds' Twitter Alerts History and real-time guidance is depicted here.


Chart 2. ES U6 (S&P September) - How we acted relative to the confirmed Head and Shoulders targeting 2149.

This Coming Week

The wave structure in play is depicted in chart 3 below, alongside the auction that developed throughout last week. By reconciling these two sources of information, I was able to forecast the most likely moves for the coming few days. In short, be on the lookout for a partial bounce retracing a good portion of the most recent down leg shown in chart 2, followed by the final down leg to the 2130 area. Again, this analysis is conducted on the S&P September futures contract (ES U6), not the cash index ($SPX).

You might ask why I favor the 2130 area. The answer is multifaceted: 

  1. By exceeding the 50% retracement mark relative to the size of wave 1, wave 2 is deemed deep. Hence, wave 4 is expected to be shallow (less than 50%) relative to wave 3 in order to adhere to the "size alternation" guideline. Alternation in "complexity" is also to be expected, and we seem to be getting it. While wave 2 is almost a swift straight line, wave 4 is a protracted affair with a myriad twists and turns. 
  2. Wave 1 through wave 5 unfolded within the two diverging blue lines outlined on the chart. In classic pattern identification terms, this is a Broadening Wedge whose downward breakout has been confirmed, and whose guidelines call for a near-full retracement. That's why wave 3's landing zone spans the highlighted yellow area. 
  3. The weekly auction sports three distributions, D1, D2, and D3. This profit-taking pullback will serve to fill the two Low-Volume Areas (LVA) separating D3 and D2 on one hand, and D2 and D1 on the other. Consequently, support will have to come at D1's PoC (Point of Control), namely, 2130ish.
  4. The S&P Basis (i.e., Futures price - Spot index Value) is roughly 4-5 points. This means a pullback to ~2130 by the futures contract (ES U6) would equate to a pullback to ~2135 by the cash index ($SPX). The significance of 2135 is illustrated in chart 4.


Chart 3. ES U6 (S&P September) wave analysis and forecast.


Chart 4. $SPX - The 2135 all-time high was finally exceeded. A back-test is underway.

Trade smart,

Peter 


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