Posted on April 27th, 2009 at 11:30 AM

Today's topic will be what I consider to be the most likely scenario to play out in the markets over the next few months. Remember that we are NOT in the business of being market PREDICTORS, but rather market REACTORS. We simply need to be PREPARED for all the possible scenarios so that when the evidence presents itself and it's time to ACT, we won't have to THINK about what our reaction should be.

A wise mentor of mine, Andy Bushak, was an All-American linebacker at the Naval academy, and, once his tour of duty was over with, was a 28-year-old rookie in the NFL for the Cleveland Browns. He talked of the preparation for games in his football career, and related it to trading. This has stuck with me over the years, and is the best explanation I know to relate why we need to be prepared in trading. He simply stated that, at that level of football, they did not practice long enough to simply get the plays right. Anyone can do that. They practiced at that level until they could not possibly get the plays WRONG! They prepared to the extent that, when they saw a play materializing before them, they did not have to take time to think about what their movements should be...all they had to do was REACT. We can be the same in our trading, if you want to trade at a PROFESSIONAL level.

All that being said, here is Scenario 1 for the coming months. I will use the $INDU as the model, but the $SPX looks much the same.

Daily

The Daily chart currently shows a Wave 3. I believe that this is actually going to turn out to be Wave 1, as we have not really displayed a good Wave 2 yet on this time frame. The software shows a 3 because of the magnitude of the move off the low back in early March. Wave 2 is typically a 50-62% retracement of 1, and we have not seen anything near that yet in the form of a pullback since March. A pullback of this magnitude from the current high brings us down to somewhere between 7125 - 7330.

After the Wave 2 pullback, we should see Wave 3 kick into gear. At current levels, assuming we are entering 2 this week, and have a 62% pullback, 1.618 extension of Wave 1 (which is typical of a wave 3) extends to just over 9900. We have resistance from the previous Wave 4 in the form of a MOB at 9500, and another MOB from the pivot BEFORE the previous 4 at 10150. Any of these levels could serve as the ultimate resistance for the Wave 3.

Wave 4 is where things get interesting with this Scenario, and where the Daily starts to reflect the things needed for the Weekly to shape up. The Weekly chart of the Dow is showing a Wave 3 down, with the need to build a Wave 4 up. Using Fib Retracements, and knowing that most Wave 4s are a 38-62% retracement of Wave 3, we show that Wave 4 on the Weekly chart should pull up to between 9020 and 10600. In fact, 50% retracement would land us at 9800, which is right in the range of the possible Wave 3 on the Daily. Keep in mind as well that a Wave 4 (in fact, any EVEN numbered wave) needs to have an A-B-C pattern inside of it. Our 1-2-3 from the Daily chart should serve nicely for the A-B-C on the weekly inside the 4 on the Weekly. It is for this reason that I believe the Wave 4 on the DAILY chart will FAIL!

As we start to pull back for Wave 4 on the Daily chart, after having tagged one of the resistance levels between 9500 and 10150, we will see one or more of the Wave 4 characteristics fail. Either the PTI will drop below 35, or the Oscillator will pull back greater than 140%, or we will break the Wave 4 Channels, or a combination of those things will happen. That will be our indication that the Weekly SELLING opportunity is overtaking that Daily BUYING opportunity. At some point, Wave 4 will overlap Wave 1, and we will have to change the Daily wave count to an A-B-C up instead of a 1-2-3 up, and the Weekly will be confirmed.

I know that all sounds very elaborate, and difficult to see now. However, if you consider what needs to happen to satisfy both time frames, this seems the most likely scenario to me, long term. It could take the rest of the summer, if not the rest of the year to play all this out, and it is NOT the ONLY possible scenario. Again, we will discuss other scenarios throughout the rest of this week, and you can decide for yourself which one YOU consider the most likely. However, I stress again, we are not going to simply BET on one of them taking place. We will only REACT when we see the evidence present itself.

Be Prepared!

-Nate McCartney

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