The Elliott Wave analysis is a form of trading that relies on the recurring wave patterns of the market to both analyze and trade stocks. Uptrends typically unfold in five waves: three of those waves are up, and two are down. Corrections on the other hand (which include the two down waves in an uptrend) usually unfold in three waves: two down waves with an up wave between them. These patterns occur on all time frames, which means that there are waves within waves, within waves ... from waves lasting centuries right down to tick charts. For those new to this form of analysis, it is best to stick to basics and find trade candidates based off a simple A-B-C correction on a single time frame. Currently, the bulk of stocks - represented by the Russell 3000 Index - appear to be in Wave B. If the price declines from current levels (the December 4 close) it is highly likely Wave C will be under way. Wave C creates significant shorting opportunities, but also acts a warning signal for those that are long or bullish.
SEE: Elliot Wave: Introduction
iShares Russell 3000 Index Fund (ARCA:IWV) ETF represents one of the largest indexes for United States stocks, and therefore is a very good gauge of how most stocks are performing on average. In mid-September, the ETF peaked at $87.48 and fell to a low of $79.53 in November - Wave A. The rally which began off that November low is Wave B. If the price drops below the trendline of Wave B, it is highly likely that Wave C is commencing. A short entry could be taken and a stop-loss order placed above the Wave B high. A profit target is placed below the low of Wave A ($79. 53), expecting the downtrend to continue. At this time it is unknown how high Wave B will travel, but it is very unlikely that it will get near the 52-week high of $87.48.
Apple Inc. (Nasdaq:AAPL) peaked at $705.07 on September 21 and then fell to a low of $505.75 on November 16. That decline is Wave A. The rally since November 16 is Wave B. If the price declines much below $550 again, it is likely to trigger additional selling and Wave C will be underway. Ultimately the target for Wave C - should it occur - is the long-term trendline currently intersecting just above $406 (but rising over time). At this time it is unknown how high Wave B will travel, but it is very unlikely that it will get near the 52-week high of $705.07.
SEE: Elliott Wave Theory
A corrective phase appears to be in effect for Walmart (NYSE:WMT) stocks as well. Wave A began with the $77.60 high in October and completed with the $68.45 November low. The rally off that low point is Wave B, which is still showing strength. If the Wave B trendline is broken (currently $70.50) Wave C will likely be underway. A likely profit target area is between $66 and $63.
Exxon Mobil Corporation (NYSE:XOM) peaked at $93.67 on October 19 and declined to a low of $85.06 on November 16 creating Wave A. Wave B is currently underway and at this point it is unknown when it will end. A drop below $86.50 (Wave B trendline) signals Wave C has started and lower prices are likely to follow. Potential targets for this move can vary significantly. If it is a Wave C, then the target will be below $85 and there is a high probability zone between $81 and $78.
SEE: Technical Analysis: Support And Resistance
The Bottom Line
Wave C presents an opportunity to take a short position in a stock or ETF that has already shown that the downtrend has begun and is about to move lower again. The move lower in A, and the lower high created by C (relative to the start of Wave A) shows the stock/ETF has lost momentum and any significant selling is likely to trigger Wave C. Keep in mind though that multiple waves on different time frames are playing out at the same time. While a set up may look perfect, adjusting the time frame you are viewing may change the outlook. Further reading on the Elliott Wave is recommended if you intend to use it for trading or analytical purposes.
Charts courtesy of stockcharts.com
At the time of writing, Cory Mitchell did not own any shares in any company mentioned in this article.