[Update 8:40PM: The market has made 5 waves down in my opinion on at least the Wilshire5000 which is the entire market. I mean if it looks like a duck....quacks like a duck. It has the technical attributes to include the RSI low on a subwave three of wave three and the positive RSI and MACD divergence between waves three and five that warns of an impending wave two.
So basically thats what we have. Will we get new highs? I wouldn't be surprised about the Industrials (and maybe the NASDAQ) but the SPX and Wilshire is another story. I dunno, but all we can do is play what is before us and pick our plays carefully at this stage.
Another way of looking at it is this: Its now up to the market to prove its not a five wave move down, and it can only do this by making a new outright high. Anything less than a new high 'confirms' the wave structure. So the pressure is actually on the bulls to maintain upside bias and to make a new high.
In a nutshell, the market is forming perhaps a Head and Shoulders pattern. The wave (iii), if it is to come, will be the follow through of the pattern to the downside. At any rate, I expect a rapid move down if it is to occur thereby not letting in many to the short play as always seems the case.
So my point? My point is if one is wanting to take a bearish bias, then the setup is about as good "potential" as it gets. There are definite stop points if you take a bearish bias to include an outright new high as a possible stop. Wave two's can retrace deeply, typically 70% or more especially if there is divergence between some indexes. 80% retrace is a good stop point. It saves the pain of a complete new high, yet gives you breathing room to allow for a deep 75% retrace.
So the bottom line is this is an easy bear setup here if the wave (ii) plays out higher (or even not much higher). One just need to take a bearish stance and set a realistic stop. The risk is low, the reward is on the high side. We have recent down volume patterns on our side. We have monster volume on certain bearish ETF's like SRS, and FAZ and SPXU to warn us that perhaps something big is up. And we have an overall larger count supports more down moves.
There is one thing about EW theory is that in a bear market with 5 wave sub-patterns such as we propose that P3 will naturally be built from, you only get so many wave two retraces at several degrees of trend. You get a small (ii), then a [ii], a Minor 2, Intermediate (2) and then again maybe another 2. Thats about 5 instances where the setup is ideal to enter a huge swing short. The rest is going to be a bitch to play unless of course thats what you do for a living.
[Update 5:45PM: A closer look on the Wilshire squiggles reveals that the price high of today's early morning surge is a high price of wave iv making it a slightly upward flat move. The waves down from that morning high wave iv counts well enough as a 5 wave move in my book complete with a breakaway area that occurs in the third subwave.
At any rate, if this is a wave (ii), then my blue box target area has not yet been met. A nice day would be a gap up tomorrow on the SPX with a quick gap close being a wave b pullback. Then a wave c chugs higher in the afternoon. That would be an abc pattern, 5-3-5 zigzag we would be looking for wave (ii).
New lows today in most every index except the DJIA confirms what appears to be a 5 wave pattern off the highs. So a rebound wave back up could show divergence between indexes. The Industrials perhaps will make a new P2 high while the Wilshire and SPX will not. Not sure about the NASDAQ but it and the Russell 2000 took a good selloff hit today.
As I posted on Friday/Weekend updates, we were looking to see if the market made new lows under Friday's (to form a 5 wave pattern off the high) and whether all the indexes would follow. We supposed that the DJIA might not which was the case. This signaled some bullish divergence and the afternoon rally appears to be the result.
It turns out the squiggles turned in quite a complex wave iv as shown on the Wilshire. Some awesome nested waves. The rally today looks like 5 waves, but nailing down the squiggles might be tough. At any rate, if this is a wave two back up it should take the form of a sharp ABC pattern, likely zigzag as wave two's are wont to do.
Any new high is going to produce a crapload of technical divergences on the indicators which will be a bearish setup.