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What Kind of Stock Market Correction Is This?

Stock-Markets / Stock Markets 2011 Feb 01, 2011 - 02:56 AM GMT

By: Steven_Vincent


It's widely accepted that stocks are in a correction at this time. The question remains: "what kind of a correction and how long and how deep will it go?". My analysis has been and continues to be that we are in the initial stages of a bull market (in Elliott Wave terms SPX is currently in Wave 3 of a five wave bull run). While this conclusion needs to be checked and reevaluated on an ongoing basis against market action, particularly during any corrective mode, at this juncture I see no evidence that indicates a major trend change in progress. I'm approaching this decline as a pullback within an uptrend and will be working to identify a good entry point for a long position. At the same time I will be working to identify a set of criteria that would cause me to cash out of profitable long positions and consider reversing to the short side.

Thus far, aside from the usual deflationist permabears like Robert Prechter, there has not been a big slew of calls for a major market top. This is one indication that the correction still has some distance in time and price to travel before we see a bottom. I would expect to see a good number of top calls in the blogs and a couple of days of "bears on parade" on CNBC and Bloomberg around the bottom. In my estimation sentiment has yet to turn fully bullish with most traders and analysts only reluctantly and newly bullish but ready to turn bearish at the slightest provocation. The public still remains almost entirely on the sidelines and out of the picture. If this decline should fail to become a significant downtrend, then the reversal should be powerful and lead to a bit of a buying panic as shorts scramble to cover and sidelined long money tries to get a position. The subsequent peak could lead to a more substantive correction.

Is it possible that we are in the beginning stages of a Wave 3 decline following a C wave high? Yes, it is possible. But I will be watching closely for the market to tell me what it is doing and what it will likely do going forward. If it says "bear market" then I will be more than happy to follow its instructions and flip to the other side.

HERE is a prime example of how few real bulls there actually are. One hiccup and he is running for the exits with wild imaginings of some impending doom around the corner. My sense is his line of rationalization is representative of a larger psychology at work.

The Egypt situation acted as the catalyst for this correction and I would call that a bullish factor. Corrections that are sparked by event fears are generally reversed sharply. They can be sharp and scary but short. There really isn't any resolution to Egypt's troubles that can change the underlying bull trend in US stocks. It can in the short term chase some of the fast money and bullish sentiment out and thereby prepare the stage for the next leg higher. If an Islamic Fundamentalist group should seize power and spark a war with Israel, it may occasion a deeper and longer correction but it wouldn't change anything about the bullish underlying market dynamics.

Right now, capital is steadily flowing from safe havens to risk. This is a process that is in its early stages and is largely unrecognized. Most market participants are still framing the current market dynamic as a tug of war between inflation and deflation. This is what drives the Wave 3 move. When the point of recognition is met, the flood of capital will propel markets much higher.

Last week I commented that the best trade setup on the radar was short gold, and that was borne out by market action. If you traded that with me you are now well into a profitable position. Gold permabulls can't even bring themselves to contemplate the possibility that the bull market is over and are treating this bearish move as a buying opportunity. This is the type of psychology which prevails at the end of a trend. In my estimation gold has traded as a risk hedge for some time now and its decline is part of the unwinding of the fear trade. It's possible that the next leg down in gold will correlate with a broadening recognition that the primary market dynamic has shifted to an unwinding of safety trades and a move into risk plays.

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Disclosure: No current positions.

By Steve Vincent

Steven Vincent has been studying and trading the markets since 1998 and is a member of the Market Technicians Association. He is proprietor of BullBear Trading which provides market analysis, timing and guidance to subscribers. He focuses intermediate to long term swing trading. When he is not charting and analyzing the markets he teaches yoga and meditation in Los Angeles.

© 2011 Copyright Steven Vincent - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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