Market Correction

/ August 8, 2011

The bad economic news coupled with the downgrade of USA’s AAA rating to AA+ by Standard & Poors have contributed to the worst August start ever. In the first six trading days in August the S&P 500 saw a drop of -13.37% — from the July close of 1292.28 to August 8th close of 1119.46. According to the StockTraders Alamanc, August has been historically second worst month for both the Dow and S&P. The first nine trading days of August are historically very weak.

Fibonacci series provides a very interesting analysis. Vas Madhava — a trader in Washington DC area, who has given many very compelling and informative presentations to various Capital area traders’ events – uses a high probability reversal zones (PRZ), which is a area between 70.7% to 78.6% retracement of a prior move. This zone is usually a very reliable indicator that the market or the security in question will either reverse or pause the current rend within this area.

Using the fall from October 2007 high to March 2009 low, the May 2011 high took Dow and S&P 500 in this PRZ. NASDAQ Composite was in this zone with April 2010 high.

Oct-07
Mar-09
Drop
PRZ
May-11
High
Low
Pts
%
70.70%
78.60%
High
S&P 500 1576.09 666.79 909.30 57.69% 1309.67 1381.50 1370.58
Dow 14198.10 6469.95 7728.15 54.43% 11933.75 12544.28 12876.00
NYA 100387.17 4181.75 6205.42 59.74% 8568.98 9059.21 8718.25
April-10
High
NASDAQ 2861.51 1265.52 1595.99 55.77% 2393.88 2519.97 2535.28


Similarly, $SPX is also within the PRZ of the move from June 2010 low of 1010.91 to May 2011 high of 1370.58

June-10
Low
May-11
High
Pts Drop
% Drop
70.7%
78.6%
S&P 500 1010.91 1370.58 359.67 35.58% 1116.29 1087.88

The index is also touching the 38.2% (1101.73) retracement of its rise from March-09 low of 666.79 to the May 2011 high of 1370.58

Another calculations point is based upon the 2010 April-June correction from a high of 1219.80 to 1010.91 – a drop of 209 points. Its 1.272 Fibonacci extension would be 266, which would give the target for $SPX to be around 1105.

So we have following Fibonacci retracements and extensions in play at the moment:

  1. PRZ based upon the high on Oct-07 to low on March-09 move — potential reversal within 1309.67 to 1381.50 range (which happened in May 2011)
  2. PRZ based upon the June-10 low to May 2011 high — potential reversal within 1116.29 to 1087.88
  3. 38.2% retracement of the move from March-09 low to May-11 high
  4. 1.272 Fib extension of 2010 April-June correction — potential move of 266 points to 1105

Confluence of these four make a compelling case that the $SPX is making at least a short term reversal.

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