The S&P 500 is going to be watched extremely carefully by many market technicians throughout the next few weeks. In February it traced out a terminating pattern. That pattern in Elliott Wave terminology is called an ending diagonal triangle. An ending diagonal triangle takes the shape of a wedge and occurs at the end of a move. The waves within it are choppy and overlapping revealing weakness in the market. They are terminal patterns that indicate exhaustion of the larger movement and once completed, have a target of back to its point of origin.
We thought it would terminate by the second week of May in the 1320/1330 area. The market peaked near 1326 on May 8 and then dropped in the rapid fashion that typically follows a completed diagonal triangle. The S&P went from 1326 to a low of 1245 on May 24. It was surprising to see the diagonal target (the point of its origin) reached so quickly! The guideline is for a total retracement of the pattern in 1/3 to 1/2 of the time elapsed during the formation.
Support came in at that diagonal target. As seen on the chart, the 200-day moving average and the trendline from the 2003 low and the October 2005 low also came into play. According to my proprietary Fibonacci analysis, if the S&P breaks 1242 that support level will turn into resistance and the long-term picture of the market will have changed.
At this point, the technicians are watching to see if this diagonal ended just the rally from October 2005, or the entire bullish run from the 2002 lows. New highs are possible here if prices can find support soon, but odds for a further drop are increasing. While the bulls remain in control, for now, the bears may be gaining the upper hand. They see this as the end of a wave B rally from 2002 that has overstayed its course. Also, a four-year cycle low is due late this year; this is a cycle that has had an impressive track record (see “Market strategy,” page 26). That may have aided in guiding the diagonal to its target much faster than expected.
We will be watching to see how the market handles some Fibonacci targets, as well as the old diagonal trendline, if it is reached, and then the 1242 area. If the market fails and starts to sell off, we will be looking for a significant low to mark the four-year cycle between October and the end of this year.
Dominick Mazza is a technical analyst and full-time trader. He hosts a trading forum at www.tradingthecharts.com.