As both the Dow Jones Industrial Average and the S&P 500 continue to hit all-time highs, market technicians are starting to worry about a few key developments they see unfolding that may signal the end of the bullish run. They’re watching a textbook Elliott wave pattern play out on the Dow, a long-term triple top formation developing on the S&P 500 and a potential spring slump on the horizon.
Elliott Waves in the Dow Jones
Click to Enlarge Ralph Nelson Elliott originally developed the Elliott wave principal as he was studying crowd behavior in the markets, and technicians have been using it ever since. Elliott waves are a remarkably predictive formation of price movements that help analysts determine how enthusiastic investors are about the current trend.
The basic pattern consists of five waves: three waves moving in the direction of the primary trend and two waves moving in the opposite direction. You can see a fantastic example of this on the daily chart of the Dow Jones Industrial Average at right.
Here’s how it has played out so far.
- Wave 1 – Started when the Dow bottomed out in mid-November
- Wave 2 – Began as we headed into the deadline for the “fiscal cliff”
- Wave 3 – Took off after a deal was reached to avert the cliff
- Wave 4 – Developed as traders took a breather after the huge surge higher
- Wave 5 – Came as the Fed reassured Wall Street that it wasn’t going to take its foot off the accelerator
So where to next? Typically, Wave 5 is as long as Wave 1, which means the Dow has almost reached its Elliott wave target. It could go a little farther, but the potential for a pullback is building.
Triple Top Price Patterns
Click to Enlarge Meanwhile, the S&P is flirting with a potential turnaround point of its own as it is on the verge of forming a triple top. As you can see in the chart, the potential pattern began in 2000, at the end of the tech bubble.
The pattern continued when the S&P 500 recovered during the middle of the last decade but then topped out as the financial crisis began to set in. Now, the pattern has a chance of forming its third top while investors wonder if the market is overbought as the European economy continues to endure its recessionary slide.
A price pattern is only a potential price pattern until it is completed, but so far, this one is looking quite interesting.
Sell in May, and Go Away
Click to Enlarge One of the favorite phrases you will hear pass the lips of an almanac investor is “Sell in May, and go away.” Historically, summer hasn’t been a fantastic time for the stock market. It used to be that most traders would take summer holidays and the light volume would lead to lower stock prices because there wasn’t anyone around to continue bidding stock prices higher and higher after the initial buyers had entered their new positions.
Recently, while volume has still tapered off during the summer – especially last summer – it seems that economic and political conflicts have been the key drivers of bearish markets during the summer months.
Selling in May, or at least taking a bearish stance in your portfolio, would have been quite profitable during the past three years. The beginning of May seems to have marked the high point for the year (up to that point) in 2010, 2011 and 2012. It will be quite interesting to see if the same holds true in 2013.
John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.