Monday, December 10, 2012

Ending Diagonals & Market Decline!!

Note: IPM Model update has been e-mailed to Subscribers. 

Since Nov 27, 2012 market has gone net sideways, which has created divergences among the top US indices. For example, DJIA has continued to crawl higher, while Russell 2000 & Nasdaq have remained lower. This kind of behavior suggests that we are in a correction phase. However, the correction phase could turn violent in the near future, especially as we are approaching the IPM Turn Window.

A very interesting observation which has accompanied the recent sideways market action is the increase in market's optimistic sentiment. Since everybody is looking forward to a Fiscal Cliff deal and the subsequent market rise, we might see a surprise market decline. Especially because Congress is no where close to a deal. Furthermore, recent market action in DJIA has carved out an Ending Diagonal.

Ending Diagonal
The ending diagonal is a narrowing price move composed of two converging trendlines. The ending diagonal is a special type of motive wave that occurs primarily in the wave 5 position when price has moved too far and too fast. For Example, recent Euro price action (chart shown below). However, Ending Diagonal can also occasionally take place at the beginning of the trend. For example, Summer 2011 rally's first wave took the shape of a diagonal!

Dow Jones Industrial Average is showing the best possible Ending Diagonal pattern, as shown at the end of the recent market action (Figure 1). A basic characteristic of this pattern is that it is made up of overlapping waves, and the Ending diagonal occurs after market has rallied sharply from a bottom. Both conditions have been satisfied by the chart below:

  1. Overlapping waves are shown in Figure 1 (a, b, c, d, e)
  2. Market rallied almost 700 points in 2 weeks. 

During the diagonal formation market structure remains confused with distribution taking place. Once these patterns are completed, they result in sharp market moves in the opposite direction. Ending Diagonals have highest validity, if no one really knows their occurance, and that is true right now because I have not read this analysis anywhere on the internet.

Figure 1 - DJIA

The horizontal lines in Figure 1 show the max top area i.e. if the market rises above that band, it will suggest that the market is not forming an ending diagonal pattern.

Please note that overlapping wave structure can also mean a series of 1s and 2s, which is typically followed by a sharp rally. But due to the IPM Window Turn date (potential market bottom), coming up and due to the sentiment, technical, and fundamental reasons mentioned above, sharp market rise is a lower possibility.

Figure 2 (below) shows the Elliott Wave analysis of the DJIA index over a longer term time frame. This chart clearly shows the 5-wave rise from Nov 16 bottom. Interestingly, this rise also has an overlapping structure and has formed a diagonal pattern. As mentioned before, a similar pattern was carved out in July 2011 before the long stock market rally started in August 2011. In summary, the completed 5-wave pattern (shown below) suggests:

  1. Markets should soon decline and bottom within the turn window
  2. Market might have just put in the ground work (impulsive first wave) for a sustainable up-trend.
  3. Market's upcoming decline should bottom above Nov 16 low.

Figure 2 - DJIA

A similar Ending Diagonal pattern was recently witnessed in the Euro currency. Figure 3 (below) shows the pattern and the consequential market decline.

Figure 3 - Euro

Above chart clearly shows the power of the Ending Diagonal. The night when market was topping, I was analyzing the Euro chart, and asking if we are seeing an Ending Diagonal because Euro had rallied very sharply since Nov 12, 2012  low, and because we were approaching the IPM Turn Window. And it is highly unlikely for the market to start its sharp decline without the Euro first topping. That is exactly what happened.

Since topping a few days ago, Euro has declined in a clear 5-waves format. This clearly suggests that Euro will either decline further or will consolidate at these levels, which will put pressure on European and U.S. stocks to start declining.

Another Ending Diagonal was recently seen in the Housing Market chart. This might have severe consequences for the future of the housing market in the United States. This chart will be further explored as part of the series on the housing market.

In short, market is giving signals of an upcoming decline. However, one should be vigilant of the market trend acceleration to the upside, which is a very low possibility at this point in time. Therefore, one should manage risk. 13250 is a critical level in the DJIA index.

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  1. Naqvi, Thanks for the update and the email! I was wondering if the IPM date was going to move and I'm kind of glad it did (I hate to buy on Friday and wait the weekend for the IPM window date of the 17th). It seems with the news this morning out of Italy, this may start a decline (futures down). Be careful out there... Brad

  2. Market on Dec 11th is above 11,250 on DOW. If it closes here do we switch to long side?? Thoughts Naqvi or anyone?? Thanks

  3. Sorry to correct you, but thats 13250 on the DOW, and I have the same question. Should we go long and is the SP500 at a good entry point too? I almost wonder if this isn't the usual run-up to the FED meeting then the usual decline. But it seems the market wants to take off even with the "fiscal cliff" hanging upon us. Again, any thoughts anyone? Be careful out there...Brad

  4. Thanks for correction, bad typo 13,200 DOW. I am very surprised by the market going up with fiscal cliff hanging. Carey

  5. Me too, I don't know if this is a "blow off" or what. I'm nervous to go in because what Ben says tomorrow could tank this market quickly. Brad

  6. Guys. If S&P breaks above 1480 then it is a for sure an up trend. Right now we are getting bullish 50 to 70% (medium term). The S&P is retracing the Fibonacci retrace of 60 to 85% back from the last Nov decline. There is still a chance of a decline.

    If you can't take the risk i would wait until the s&p breaks above 1480. If you are willing to take a risk then buy now. I took the risk and bought the s&p at 1350. I am taking advantage of this rally. But again, i took the risk back then. Now, the risk is more elevated as we are close to an IP (inflection point) of market trend change.

    Good luck

  7. If people here don't know what Fibonacci is, i would suggest to learn this stuff first (buy a book or something about EW and Fibonacci) and then start trading. After you learn all this stuff, you'll understand Naqvi forecasts much better.

    Naqvi, do you recommend books about this stuff?

  8. Elliot Wave and Fibonacci are great tools, unfortunately they are not as reliable with the continual FED intervention. I understand that the retractment is in the 60-80% of November highs but it is more of a trend trading market now (IMO) and that is not a good thing to get into the middle of - not when the trend is feeling toppy and too much optimism. The only thing that seems to be working is the bouncing off of the 50 and 200 day and other resistance points (like Fibbonacci). Also, as Fibonacci hits "1" it needs to break into a new range or it bounces or pulls back depending on trend - same with Elliot Wave. Good points though Joseph. I wish I got in when you did! Brad

  9. As predicted in the special report the market was about to breakout and it seems like emerging markets are breaking out. As for the ipm, we might see s pull back but it will not be as significant. The issue is that global. Markets were in a bear market for so long that us sentiment. Might not have an impact on breaking out emerging markets.


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