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Saturday, August 1, 2009

P2: A Massive Grand Supercycle Backtest



I've been showing a lot of long term charts lately because I think we are nearing an important juncture: the resumption of the Great Bear market and on the precipice of a very scary move downward. So I'd like to revisit the Supercycle wave V theme yet again.

As most of my readers are everyday traders, you will know what I mean when I say a backtest may be occurring. Simply put, I am proposing that this Primary wave 2 rally is nothing but a massive "backtest" of a very long-winded Grand Supercycle upper channel line that resides very near where the market is today. Allow me to explain.

Elliott Wave theory, as laid out by Robert Prechter, proposes that the 2000 market top was a Grand Supercycle wave III top (in orange on chart) that stretched some 220+ year. It virtually aligns with the birth and rise of the United States. Within that Grand Supercycle wave III, there exists 5 subwaves of Supercycle degree (in purple on the charts). 1929 was the top of Supercycle Wave (III). After the Supercycle wave (IV) price low in 1932, a final Supercycle wave (V) impulsed upward in 5 subwaves of Cycle degree (blue). We cannot see all the activity prior to 1900 on this chart engine as I am unfortunately limited in what I can effectively show. So I make some assumptions based on sound EW theory. Allow me to explain some more.

A basic tenet of EW theory is the concept of channeling. Basically the price peaks of wave's 1,3, and 5 connect on a trendline and the peaks of 2 and 4 connect on a trendline. These trendlines typically form parallel trendlines, or whats known as a "channel". Again, channeling is a key concept of EW theory and gives us some of our basis for how we interpret very long term charts.

Every 5 wave structure from the submicro, to the Grand Supercycle, adheres to the concept of channeling. Just because a wave is very large (220 years long) does not mean it is more complicated. On the contrary, the larger the wave, the more closely Fibonacci expansion ratio targets are met and the more channeling adheres to basic concepts of connecting wave peaks 1,3,5 and 2 and 4. However there is something known as "Overthrow" on very powerful waves no matter what the size. That is where my charts come into play.

Again looking at the chart, Supercycle wave V (purple) lasted from the 1932 low to 2000 top. This 70+ year wave consists of 5 "Cycle" subwaves, labeled in blue. In theory, the blue Cycle subwave I, III, and V peak should have connected on a channel line (blue) just as subwaves II and IV connect. But something happened at where the Cycle wave V peak was "supposed" to end at about the red shaded dot area.....it extended above the channel line.

So looking at the charts, Supecycle wave (I) (not shown as it peaked in about 1837) , (III) and (V) should have also connected on a channel line (proposed purple). But purple Supercycle (V) also overthrows the purple channel line.

So based on this we can assume Cycle wave V should have ended at the touch of the upper blue channel line in about 1996 at DOW 5500. This is the red dot shaded area on my charts. You can see it struggled here yet it finally plowed on through and this is when the market got really extended and things got crazy. It kept on going until the 2000 orthodox price peak occurred. This 2000 top is the green shaded dot.

The advance above the purple upper Supercycle channel line was the result of a hyper-extended cycle wave V at the top of a Supercycle wave (V) in turn at the top of the most bullish Grand Supercycle wave III in history. It experienced "overthrow" of the channel and ran wild for a few years. This overthrow was largely the result of the expansion of credit which allowed people to borrow their way to a way of life that nature would normally keep in check. This is what Prechter could not possibly foresee nor predict.

Social mood was, in effect, "borrowing" from nature's laws. It did this through the Great Asset Mania, the greatest in the history of mankind. People were in a good mood and it reflected in both social and economic activity, asset valuations, and speculative fever. Laws were loosened at the very time when they should have tightened. Such is what happens at the top of a 220 year Grand Supercycle wave III. No one can see the top and no one can see the subsequent drop.

Then the Great Bear market began. A retrace Cycle wave "a" back to about 7250 occurred in 2002 and the DOW eventually met back up with the Supercycle purple upper channel trendline. This is the blue dot area in 2002 I show on the charts. It bounced off this trendline (blue dot area on the charts) and credit expanded yet again in another bubble of asset mania. Except this was a "b" Cycle wave and was actually a false rally built on a house of cards. The DOW was forming a corrective "expanded flat" in which the b wave price high (black dot area) goes higher than where the previous wave 5 price high occurred in 2000. We suspect this is a b wave because "real" valuations stopped long before the actual 2007 price peak. In other words when you were buying Valero (not a DOW member but just an example I thought of) at $75/share in 2007, when they are/were loaded with debt, you were buying a fantasy b wave cycle top. You can be sure that corporate debt fueled this expansive b wave valuations on the DOW 30 stocks. Prices were pumped way up on credit and the subsequent drop from 2007 - 2009 was harsh.

Regardless the market managed to stay above the Supercycle wave upper channel (purple) line after bouncing off in 2002. But in 2007 the party was waning and b wave was waning. The nasty Cycle c wave would begin. So the DOW actually topped in 2000, had an expansive Cycle (in blue) "b" wave rally that carried prices above the 2000 top in yet another credit -expanded bubble in an expanded flat. An "expanded flat" b wave occurs when the preceding wave was of such power that the main trend continues to "carry through" on the subsequent corrective wave. So the 2007 DOW top was a b "corrective" Cycle-sized wave and a false rally wave at that. The extreme sharp drop after the top confirmed it in my book.

So the Cycle c wave of that expanded flat is playing out now. Since an expanded flat is a 3-3-5 pattern, the current proposition is that Cycle wave c will consist of 5 Primary waves down that will eventually try and reach the lower purple channel line of Supercycle degree. Hence the less-than-1000-DOW target in a few years I show on these charts.

But Dan, the DOW seemingly traced 5 waves down from 2007 peak already! What gives? So aren't we done with the bear market for now??? Doesn't those 5 waves down form the Cycle C wave of your proposed 3-3-5 Expanded flat? The theory is no, we are not! Why? Because we had likely only 5 Intermediate-sized waves down which only formed Primary wave 1 at the March 2003 low. Toggle these charts to unlog scale and you can see it doesn't look at all so wrong.

And hence the "Primary Wave 2" (P2) rally we are in now. And after P2, comes a nasty P3 in which prices seek out the lower purple Supercycle channel line I show on the charts.

Which brings us to my main point: P2 is merely a massive "backtest" wave testing the upper purple Supercycle channel line (the purple shaded dot on my charts). And as traders, you all know that when a backtest fails, it heads to the lower channel line. And since there was significant "overthrow" of the upper channel line, the theory holds that there may well be underthrow on the way back down.

In addition, allow me also to state why Prechter theorizes that the DOW will head back to the DOW 400 (yes four hundred) area: Because if we are in a Grand Supercycle wave IV then according to wave patterns this correction should take us back to the previous subwave (IV) price range. That is a basic tenet of EW theory and you can see me often point that out on squiggle charts....so yes they should apply to Grand Supercycle wave charts too!

And the previous subwave "4" of Grand Supercycle wave IV is Supercycle wave IV which was...DOW 400 or less from 1929 to the Supercycle price low of 1932. So the theory holds prices should retrace to this area. Yes it seems unbelievable that the DOW could again be less than 500 but it was only 1975 when it was 570. So go figure.

P2: A Massive Supercycle channel backtest that should fail. Nothing more, nothing less.

And Cycle C wave should consist of 5 primary waves down forming the back end of an expanded flat on the DOW or something to that effect.


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