Stock Market Near a Peak

Today I’m revisiting my thesis from a few months ago that the stock market is in a bearish formation. Though it has rallied quite strongly over the past month, I think this strength is nearly exhausted. This is confirmed by technicals as well as sentiment.

 

First, check out the SP500 E-mini chart above. I see a very clear 5-wave leading diagonal, followed by a very clear 3-wave upward correction. At a minimum, we need to see a drop below 1,000 to complete this pattern.

Meanwhile, sentiment is very bullish. I have seen many bloggers commenting about the Head and Shoulders formation above, but everyone keeps talking about them and nothing ever follows through. Also, bloggers are very bullish in general, and bullish sentiment is at multi-month highs!

Conditions look ripe for a decline!

IWM Leading Diagonal

Back in May, I mentioned that the stock market finally ended its uptrend. I am still bearish the stock market, and my hypothesis is that it will not make a new trend high before making a new trend low. Currently, I really like the bearish pattern on IWM.

Let’s review the Elliot waves. From the 2007 high, there was a fairly clear 5-wave decline into the March 2009 low. This was followed by a fairly clear 7-wave rally (abc-x-abc) into the April 2010 high, which is corrective. I first mentioned this count near the April high.

When I counted 7-waves up for the corrective rally from the March 2009 lows, I expected to see an impulsive selloff to confirm that the long-term downtrend would resume. I believe we have seen this, as the first leg down since April 2010 was a leading diagonal with 5 overlapping waves. You can see that the leading diagonal was halted at a long-term support line, and since then we’ve had a 3-wave rally. Also, notice that volume has been substantially above average on the declines, and below average on the rallies. This looks like distribution to me.

Thus, at the point, I would expect the market to turn over soon and start heading down. The next decline should be a brutal 3rd wave.