How Low Will We Go?

The recent market drops have caused a number of my clients to inquire how severe a market drop I was expecting.
The chart below shows my thinking back on August 19, and not much has changed since then.

spy technical prognosis
click to enlarge

Stocks do move on fundamental intrinsic values in the long run, but they move on mass psychology in the short term. This mass psychology tends to move in wave patterns that correspond eerily closely to the mathematics developed by 12th century mathematician Leonardo Bonacci, known more commonly as Fibonacci numbers.

So back in August I was expecting the SPY to peak at 197.08. The actual peak was 4 points higher at 201.90, or off by 2 percent. From there, a retracement of 23.6% occurs over 90 percent of the time, and a retracement of at least 38.2% occurs around 80% of the time. Stocks can drop lower, than that but those are the most common levels. Accordingly, I would expect a minimum drop to the $165 (23.6% retracement) but more likely also down to $145. The first represents a correction of 18% off of the peak, the second a drop of 28%.

Of course, stock technicians know that after the 5th Elliot wave pattern peaks, in this case at $201 , it is common to see a downward retracement in a zigzag formation (ABC pattern) that retraces down 68.2%. This would take us all the way down to a level of around $112, or a 55% drop from the peak.

That dramatic drop is certainly possible, but I do not believe it is likely to happen. Note how our price and RSI slopes only diverge on the short term but on the longer term (30 period) RSI chart they are both sloping upwards, in a pattern of bullish convergence. This leads me to conclude that the market will find ultimate support at $145 level, then move higher from there.

Of course technical waves just measure probabilities, not certainties. But investors would be wise to batten down the hatches!

Please login to view the MEMBERS ONLY content. (Register here.)
You can leave a response, or trackback from your own site.

Leave a Reply

You must be logged in to post a comment.

Disclosure:This web site discusses exchange-traded options issued by The Options Clearing Corporation. Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options. Copies of this document may be obtained from your broker, from any exchange on which options are traded or by contacting The Options Clearing Corporation, One North Wacker Dr., Suite 500 Chicago, IL 60606 is not a registered investment advisor or broker-dealer. We do not make recommendations as to particular securities or derivative instruments, and do not advocate the purchase or sale of any security or investment by you or any other individual. By continuing to use this site, you agree to read and abide by the full disclaimer.