Sunday, August 25, 2013

MTU Weekend Ed. - This Gap is Different (8/23/13 Close)

SP500 fell 4.1% to Wednesday's low from its early August all-time high, leaving an unfilled downward gap that is 7 trading days old (Chart 1).

The most recent downward gap counts as the 13th downward gap in SP500 since its March 2009 bottom. It took an average of just 4.4 trading days to fill the previous 12 downward gaps, with the maximum duration of 8 trading days (Chart 2). Odds favor the present gap which is around 1680 being filled soon, unless a larger degree trend change is at hand.

An examination of downward gaps at the 2007 top is helpful(Chart 3). Specifically, the location and longevity of the initial downward gaps are informative.

The first downward gap in SP500 presented itself in a 3rd wave, not a 1st wave. The precise location of that gap is wave (i)-down of [iii]-down of 1-down. And it took only 5 days to fill that gap.

The second downward gap in SP500 surfaced at a larger degree 3rd wave, not a 1st wave either. The precise location of that gap is wave [i]-down of wave 3-down, in June of 2008. It wasn't filled until April of 2011.

If we could extrapolate to conclude that

(1) major down-market gaps tend to occur at the initial wave of a third wave decline (i.e., not the initial wave of a first wave decline), and
(2) the first downward gap in a major down-market nevertheless tends to be filled quickly,

odds appear to favor the present gap being filled soon. Naturally, we should be aware of the inherent risks in extrapolation.

From the perspective of wave counts, the sell-off in SP500 to date counts better as a three wave decline rather than a five wave structure (Chart 1). Thus, we are tracking the following scenarios:

[a completed ABC decline] implying that the gap will be filled next week, with potential new highs to follow barring the rebound being a wave X or another ABC in a flat or triangle.
[a wave [iv] rebound] implying that the gap is not filled immediately. Wave [v]-down of wave 1 or A will start early next week to wrap up a five-wave decline.  The wave 2 or B rebound has the potential to fill that gap.

[a wave (ii) of [iii] rebound] implying that the gap is not filled for some time.  Wave (iii)-down of [iii]-down is around the corner.

In light of historical gap statistics and insights from wave counts, it's reasonable to conclude that if the recent gap is not filled next week, it should serve as an early warning of significant downward pressure.

For larger degree counts since the 2009 bottom, please see Head and Shoulders (8/16/13).

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