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Wednesday, August 15, 2012

Elliott Wave Update ~ 15 August 2012

Yet another narrow-range, low-volume trading day.  The S&P continues to flirt with 1400+ in a seemingly consolidation mode in order to take an eventual hard crack at breaking above the current malaise and make new highs above 1422 SPX.

THE "WALL OF WORRY" EFFECT.
We have all heard of the "Wall of Worry" effect. This is where stock prices make significant gains yet sentiment is considered "sour" and too "worrying" despite the positive price action. The theory is that the more worry, the more stocks gain because sentiment is too bearish to support selling (if a majority is sour on stocks there is no one left to sell - only to buy instead).  Thus the market climbs the wall of worry. It is only when excess bullishness finally takes hold and price action weakens does a significant decline occur. In other words "the trade becomes too one-sided."

But how much is too much excess bullishness and in what context of the wave pattern does one judge this? Well thats always a judgement call.

EFFECT OF A NARROW TRADING RANGE 
These kinds of narrow trading ranges can have generally two effects on market sentiment in how it relates to the "wall of worry". This is of course a generalization but allow me to explain the two conditions below.

In the first case, sometimes after making a nice breakout gain the market is technically overbought (high RSI, etc) and a narrow trading price range is needed to work off the overbought conditions and weaken overly bullish sentiment and overbought indicator conditions.  Thereby the market "resets" (also known as a pullback) while maintaining the breakout solid price gains. Th is kind of price action is considered bullish and supports further decent (at least) price gains once the "reset" period is over..

In the second case, the market breaks to a higher range on more neutral sentiment and technical standings, and a subsequent narrow trading range results in strengthening bullish sentiment. In other words, as prices continue to "levitate" everyone piles into the trade - yet prices languish or at the least - under-perform expectations. This second condition is tougher to decipher.  After all, a "low volume pullback" is considered bullish overall.

WHAT IS OCCURRING NOW?
It is of my opinion that the market broke toward 1390 and above on a more neutral sentiment standing (thus many have argued it was/is "climbing the wall of worry") and the subsequent narrow trading range has strengthened bullish sentiment despite the weak price action. Therefore the "wall of worry" is breaking down as price continues to trade sideways in this narrow range.  This indicates that people are piling into the long side of the trade and that overly bullish conditions are starting to ripen for a reversal.

EVIDENCE OF A STRENGTHENING SENTIMENT
Since bursting higher on August 3rd above the 1390 mark, the market has languished 8 days creeping ever higher in a series of lower highs - albeit narrow - prices.  The end of August 3rd (the day the GDP report came out), Sentiment Trader's "% of Indicators at an Extreme" chart stood at 9% Bearish extremes (market bullish - wall of worry effect) and just 3% market Bullish extremes (market bearish - "crowded one-sided long trade effect").  In other words even after the breakout Friday of August 3rd the "wall of worry" was seemingly intact and causing prices to move higher.

"WALL OF WORRY" IN PLACE:

WHAT HAS HAPPENED SINCE AUGUST 3rd IN THE NARROW PRICE RANGE?
Sentiment has greatly strengthened. This is probably due to the series of small "higher lows" in price. Yet overall the SPX managed to gain only 16 points in 8 days since that August 3rd intraday high of 1394 SPX.  This strengthening bullish sentiment has occurred despite the weak price action. I view this as overall bearish. Simply put, the "wall of worry" is dissipating quickly with no significant price gains


Sentiment Trader's "% of Indicators at an Extreme" chart stood at 21% Bearish extremes and only 4% bullish extremes as of last night. ( I don't have tonight's update yet.)   This proves that sentiment has strengthened toward overly bullish despite the horrible low volume and the myriad of divergences that exists between many subindexes. I view this as overall bearish.

"WALL OF WORRY" HAS EVAPORATED (DESPITE WEAK PRICE GAINS AND ACTION SINCE)
CONCLUSION:
One could make a solid argument that sentiment was bearish and thus the break toward 1390+ SPX was on the back of climbing the wall of worry.  But since then in 8 days, the SPX has managed only 16 points in gains. Yet the wall of worry is no longer in place - in fact it has been obliterated!  This is not only bearish for sentiment readings for the long term, but it is something that really has not happened since the 2009 low rally.

We have something different going on with sentiment and price action this time. And it favors the bears long term.

BOTTOM LINE:
Sentiment, price action and wave form are tricky things but they form the heart of any long term wave structure.  Once cannot precisely pinpoint things of course.  The market could go on and make higher highs above 1422 SPX. But if this happens, there may be non-confirmations between other indexes such as the Wilshire 5000.  And overly bullish sentiment might make an even more extreme case despite the fracturing price action.

We can only watch and wait. But the last 8 days has covertly strengthened the bear's hands overall in my opinion longer term. In fact - dare I say - price and sentiment action, and particularly VAPOR VOLUME supports the notion of an outright market crash very soon.  Remember the Hindenburg Omen was triggered a few weeks ago. This alone is a good sign of a fractured market. And  a fractured market can be a dangerous market for bulls.

NYAD chart making a break for wave [v] of 5 of (5) of [5]

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