We might be in the dog days of summer, but the last thing you should do is take this summer's activity for granted. We have been in rally mode for the better part of the past five years and have had a few mild pullbacks and a correction from May to July of 2006. That leg came in on no less than six-time windows of which the daily cycles were the smallest. I would not say that correction ended prematurely because the market is always right but many of the economic problems were brushed continuously under the rug.
For instance, we knew all along that a subprime mess was being created. We knew people were getting mortgages with interest only loans they could not afford. A smaller circle of people knew many of these so-called customers did not even have to verify their income. Everyone just assumed the risk could be passed on to the 'system' and if there was to be a day of reckoning, it was some distant point down the road. It is almost like looking at the stars on a clear night. You can see them, but they are so far away you think you could never get there. That might be true with astronomy, but reality has a way of sneaking up on us.
Last week we told you the Fed's injection of $38 billion had an outside shot of working but the cycles were not supportive. The highest probability occurrence would be a low in the 108-day low-to-low cycle with the March pivot, which fell on Tuesday through Thursday. This is exactly what happened. By late Thursday, price and time finally lined up and Fed actions were able to take root on Friday morning. The situation was mighty bearish here last week but one of the charts I cover on a regular basis is the All Ordinaries out of Australia. That chart hit an air pocket and dropped 500 points in three days. It is the kind of action the folks down under have not seen in a very long time but was anticipated in my evening updates. Our indices were hit hard as well but the Australian bears were able to accomplish in three sessions what took us a month to do.
There were all kinds of hysteria in the media by Friday. We were told that if the Federal Reserve Bank did not act, the market would have crashed by Monday. It is the sort of fear in the market that finally stopped the bleeding. This sentiment finally materialized at a point in time where the market did elect the turn window we told you about at the top of the week. Also, we reached a point in the Dow and NDX where price action was approximately at the 2.618 price extension of the last leg up in the rally from July 11 to the top. This is a naturally occurring event. What most traders on Wall Street do not realize is patterns will only go so far in relationship to prior legs without stopping to refuel. If they do realize it, they get caught up in the emotional aspect that causes people to do the exact wrong thing at the wrong time. There are many textbook examples of maximum extensions in my book and the setup by late Thursday was another textbook example to show why this was the place for a bounce instead of a crash.
Friday was strange in another way. In the first hour, the NASDAQ and Dow had already made a 38% price retracement of the whole move down from July. That means we already hit the minimum requirement necessary for a technical bounce right near Friday's open. You do not see that very often. You can look at this as the glass is either half-full or half empty. Many people who wanted to go long with a technical trading bounce were not given the opportunity of a decent entry and may have entered near the top of a corrective spike, which could be a bull trap. On the other hand the move off the low could be an A wave in the progression of a larger developing ABC that continues into our larger September time cycles. All I can say is those of you wanting to go long need to look at Thursday's candle which left a long tail and place your stops no lower than the equivalent of the middle of that tail.
We have big cycles coming due in late September but the beginning of the window (since we are dealing with the weekly time scale) is the day after Labor Day. We now enter the true dog days of summer, which is the second half of August. Even if I were on vacation this week or next (like many will be), I would not be far from these charts. However, we have probably hit a point similar to the eye of a hurricane. I would expect things to calm down. The highest probability is an ABC that will test upper resistance levels which implies a test of the 61% retracement all the way up to July resistance. Before we do that we can hit a smaller B wave down that at least fills Friday's gap up. While there is no crystal ball, I like the fact the charts have responded in a big way to last week's high probability price and time cluster. Breaking to new lows is a low probability outcome between now and September 4.
My book is at the right place at the right time. The methodology contained is an incredible navigational tool during these challenging times. Those who already have it know all they need to do is crack open Chapter 8 to see a similar setup to what is materializing in real time. The pattern recognition method goes a long way to giving you a big edge. It is available right here at the Futuresmag.com bookstore.
Also, this week I begin a regular spot on www.MN1.com Commodity Classics show, which is Thursday at 3:45 CST.
