S&P 500 Trade Set Up 7/26/10

On these pages we have suggested selling short every rally since May.  For some time this strategy seemed to be paying off as a new downtrend (lower lows / lower highs) emerged.  Now a deep upwards retracement in the S&P is really testing our wearwithall in this stance, and we may indeed have to take our lumps (part of trading).  But before any dunce hats are put on and we relegate ourselves to the corner, there is one more opportunity for stuborn S&P bears to set up a new unit of trade in this market. 

Any break below 1061.00 in the sept, e-mini futures, or 1065.25 in the cash index, would be an early indication that the downtrend is returning to the S&P 500 stock index.  If prices break down from current levels to below this mark, stop loss orders on current shorts can be brought down to the turn high and new shorts can be added.   

Notice this is a trade set up, so prices have to move in favor of current positions and prior downtrend in order for the trade to take effect.   

(click chart to expand)

 
The blue indicator at the bottom of the chart is a velocity / momentum oscillator known as the Relative Strength Index (RSI).  It measures the strength of recent price gains against recent price losses.  Currently there is a bearish divergence where the oscillator is not exceeding a previous high, while price is.  Prior divergences of this sort have indicated looming changes in trend.  We will keep an eye on this one to see how it plays out.     

Clearly, if prices move above our stop loss level at the 6/21/10 intraday highs, it will be back to the drawing board and the secret lab we go.

Quadrillion Dollar Debt: 'Day of Reckoning' Looms

What Will Happen as $1,000,000,000,000,000 in Global Debt Winds Down?

By Elliott Wave International A thousand trillion in debt can't be wished away or swept under the rug. No one can "forgive" the debt. The consequences of unwinding this debt could be as massive as the dollar figure itself... Read more.

S&P 500: Which way will it break?

If you are coming here for the first time, then you can find a reverse chronological listing of my S&P 500 posts by clicking here.  

Stop loss orders for our short positions remain one tick above the 6/21/10 intraday high of 1127.50 (Sept Futures) / 1131.23 (cash index).  If the stop is taken out, we will have to start looking at alternate counts, one of which is shown on the chart below in blue.  Another possibility would be a more complex wave '2' up.     

Any break below 1093.25 (Sept Futures) would be an early indication that the downtrend was returning.  If prices dropped below 1059.75 (Sept Futures), then the bearish case would be strengthened further.  Confirmation of the bearish case remains at a break below the July 1st intraday lows.    

(click chart to expand)

It seems like a new bearish divergence has developed in the RSI at this time frame. 

Next week should be exciting!

S&P 500 Continues to Hold Trend

Holding the down trend that is.  While not currently a linchpin in my decision to continue holding short positions in this market, I find it interesting the way prices are holding below the down trendline we first started mentioning in the 7/16 S&P 500 post. 

Of course, this could change tomorrow, but  is still interesting for now.  It is definitely one measure of price trend -lower highs and lower lows.  

(click chart to enlarge)

If prices are able to break down below the intraday low reached yesterday (1053.50 -Sept Futures), I will probably be looking to tighten up the stops/loss orders that are currently in place. 

IRS Answer to Bear Market: Become More Authoritarian

Socioeconomics teaches that bear markets bring with them more authoritarian rule by government and more polarization in the populace.  This seems to be the case on many fronts, including an new effort by the IRS to increase the scope activities covered by 1099s for the purpose of siphoning more money off the populace.  

According to ABC News, starting January 1st, 2012, 1099s "will become a means of reporting to the Internal Revenue Service the purchases of all goods and services by small businesses and self-employed people that exceed $600 during a calendar year."  Some are calling this a hidden gold coin tax, since gold coin purchases would obviously fall under this ruling.

This new squeeze by the IRS comes via a provision added onto the health care legislation.  It makes me wonder what else might be in those thousands of pages none of the legislators ever read.      

Crude Oil Update

The July 7th post on Crude Oil included a trade set up to the short side.  Specifically, a break of the 6/7/10 low of 69.51 would have signaled us to sell this market short (or go long an inverse ETF such as SCO).  Today, we are tightening the parameters on that set up.  Now a break of the 7/6/10 low at 71.09 (red line on chart below) would trigger us to sell this market short.  Initial stops would be at the turn high, possibly near the 6/28/10 high of 79.38.     

(click chart to expand)

How to Manage Risk

Because there are so many misconceptions about risk management regarding investments and trading, it seems important to talk about how to manage an investment or trade's risk properly.  Many believe the key to profitable investment and trading endeavors is accuracy, but this is not the most important factor.  Risk is far more important in regards to the long term success of a trading operation.   

This post is not going to cover aspects of money management that include diversification across markets and market selection.  Directional diversification is also not going to be covered here.  Instead, I want to cover the process of managing the risk of every trade or investment you put on.  

After you select the markets you are going to enter positions in, you need to answer the following questions: 

1) When will I exit for a loss 

2) How large should my position be

Notice I did not include: 'when will I exit for profit'.  That is because this should take care of itself as long as you are using processes that respect price trend.  You will exit when the trend or technical price movement ends.

When will I exit for a loss?  This is the stop/loss level.  You need to identify the price level that would negate the technical (price trend) reason(s) for the initiation of the trade / investment.  You need to identify this price level BEFORE your put the trade on. 

Once the price level for your stop/loss is identified, the next question is how many contracts or shares you should be trading.  This is referred to as position size.  There is a simple way for figuring this out, and it is not equal to how much you can afford (margin for futures, price for stocks, etc...) with your current capital.  Instead, we are going to take the current capital base of the trading account and risk a small percentage of this at the stop level.  

For long term success we have to be able to weather the inevitable losses that come with any business, including investing and trading.  In fact, it is necessary to design your practice in a way that it is possible to take a long string of losses and still be in business.  The stop / loss helps, but position sizing is equally, if not more, important.  

Each position should risk somewhere between 1% and 3% of total account capital.  Sometimes higher octane systems will risk up to 5% per trade, but this is not recommended in most cases.  Its easy to understand that the higher the risk profile, sometimes referred to as "heat", the more volatile the balance of the account will be.  Part-time, and smaller traders / investors are probably best at the 2% and lower levels for sure.     

Use this list to determine position size for a trade:
1) Identify stop/loss level using technical / price trend measuring methods.
2) Calculate the amount of capital loss that would equal the decided risk profile.
3) Calculate the risk between planned entry and the stop/loss level for one share or one futures contract.
4) Divide the risk profile amount from #2 by the risk for one contract / share from #3 to determine the number of contracts / shares it would take to achieve your planned risk profile -this is your position size. 

That's it.  Pretty simple. 

Let's look at a simplified hypothetical example to see what this looks like in practice.  We will use a stock / ETF type example in order to avoid the further calculations required with tick values in futures contracts.  I'm also going to use a buy long example to further simplify, but all of these techniques are to be used with short sales as well.

Suppose you plan to enter a long position (buy) in stock XYZ at $20 with an initial stop/loss exit at $18.  Your current account's capital value is $20,000.  You are running a 2% risk per trade.
1) Stop/loss identified at $18
2) 2% risk to capital would equal $400.  
3) Risk for one share between planned entry and initial stop/loss = $2
4) $400 divided by $2 = 200 shares needed.

So your trade set up in this scenario calls for 200 shares.  Notice the cost to purchase and hold the shares is $4000, while actual risk at stop/loss is $400.  Although no real leverage was applied in this example, it is the basic methodology that allows successful traders and investors to move on to using leveraged vehicles such as futures contracts.  Once you practice this enough, the cost to purchase and hold the position is usually just an after thought.

Below is an example of the trade by trade percentage gain or loss to capital in a short-term system that I do not blog about, but have been working with since 2007:

I love this chart because it is easy to visually see that the goal is achieved.  Risk is kept at a linear level, while profits are allowed to become exponential.

A note on diversification:

Although we have discussed managing risk for a single position here, one needs to also do the work to make sure that position does not have a high correlation of trend with another planned or implemented position.  It goes without saying that if you use the methods we have discussed for the purpose of limiting risk at 2% for 10 stocks, commodities, or ETFs that have a high directional correlation to each other, then you really have a not so diversified risk profile of 20% rather than 2%.   To solve this problem, it is possible to take the per trade risk profile you decide upon and split it up among several highly correlated markets.  Additional risk units of the of the proportion of capital that you have decided should only be used in loosely or non-correlated markets.  

Gold, Kids and Rulers

Many times great trees of knowledge and wisdom are conveyed in simple nuggets and seeds that reveal elements of truth.  Those participating in financial markets have certainly heard some of the many that circulate among traders and investors.  Two of my personal favorites are: 'cut losses short' and 'let winners run'.  Another one I really like is: 'A kid with a straight edge can outperform the markets'. 

This simple statement about a kid and a basic tool is really a summary of knowledge gained by some of the most dedicated of market students.  Summarized is the simple fact that all the sophisticated analysis and gadgetry in the world will not change the price trend of the markets you are considering investing or trading in.  Directional price movement, being the primary area of profit opportunity in financial markets, should be the main area of study.  One of the best tools for identifying a directional price trend's beginning, continuation, and end is in fact a straight edge.

Today, the straight edge might be providing new clues into the next directional move in a market that has been net sideways for two consecutive months.  I'm talking about the gold market.  

(click charts to expand)

 
As can be seen in the chart above, gold is testing an upwards sloping trendline.  We can also see prior examples of trendlines that defined new and existing trends by either holding or being violated by price action.  If the current trendline holds, or is not violated significantly to the downside, then it could indicate at least a short to intermediate term upwards move in the yellow metal.  

I am going to let this market prove itself to me on this one.  If gold moves above 1218.8 (thick blue horizontal line) without first moving below 1145.8 (thick red horizontal line), then I will consider it a signal to go long (buy) the gold market.  Should this event occur, initial stops will be right below the turning point that lead to the break above 1218.8. 

S&P 500 update 7/16/10

This post is for the purpose of updating the chart and visual representation of what happened in the S&P 500 index this week. 

(click charts to enlarge)

Looking at the same 90 minute chart we have been following in the most recent S&P 500 posts, a few things pop out.  First of all, the strong rally has not (yet?) been able to take out our stops for short positions.  We have to limit our risks, and a move above our stops at the 6/21 intraday highs would mean a need to go back to the drawing board, at least temporarily.  

Secondly, prices have recently turned down at an area the allows for a downward sloping trendline to be drawn across the recent peaks of the decline.  A parallel trendline pasted below price action happens to also show what seems to be somewhat of a downward trend channel.

Thirdly, the moving average convergence divergence indicator had a bearish divergence in its histogram prior to Thursday and Friday's turn lower.  This does not necessarily indicate the larger downtrend is now reemerging, but it is something we can continue to watch for more clues during this short-term battle between bulls and bears.

Fourthly, we can see that volume has consistently been increasing during declines and waning during advances.  

The red proportional measurements you see in the chart above are not measured against the 7/01 lows, but rather from the 7/06 lows.  This is simply because of possible internal Elliott counts I am keeping in mind.

A couple of things on the weekly chart also caught my attention.  

In the past we have looked at the 13 & 40 week moving averages to help us recognize the broader trend in this market.  As of this week, the 13 week is now lower than the 40 week.  This is a sell signal set up that would, depending on the trader / investor's preference, either be filtered with a break below the 7/1 lows, or just taken on its own.  It does not really affect new positions for this blog, because we have been selling all of the rallies short already.  Regardless, the prior uptrend as measured by these moving averages alone is no longer in place.  

I used a candlestick chart this time to show what I also think is interesting about this week.  Candlesticks are more visually informative than OHLC bars.  Check out this week's candle, which shows how this week closed compared to how it opened.  The red color means it closed lower than the week's open.  In other words, bulls could not hold prices above the week's open into the close of the week.  

Similarly, you will notice a long wick at the top of the this week's candle.  A long wick is another clue that buyers had a hard time keeping prices at the levels they were able to push them to during the middle of the week.  

S&P 500 near likely proportional resistance

In the post on 7/7/10, I suggested that we were in another bear market rally that could be sold short.  That rally has taken place, and is not coming up a likely proportional resistance area.  I believe this is yet another opportunity to position for possible downside action.  

(click charts to enlarge)

My stop loss orders currently remain one tick above the intraday highs on 6/21/10 (e-mini futures: 1127.75).

You can view all of my S&P 500 posts in reverse chronological order by clicking here.

Significant Moving Average Cross in Dow and S&P 500

Fifty day moving averages for both the DOW and the S&P 500 now are now below their 200 day counterparts.  This is yet one more sign that a downtrend is possibly emerging.  

I also noticed that volume in the DOW Jones has been stronger during declines and weaker on advances.  There are no certainties in the markets.  Instead, we just have to measure probabilities.   This is one more indication that a downtrend might be emerging.

Learn Basics of Elliott Wave Analysis -- Free

By Elliott Wave International

Ralph Nelson Elliott discovered the Wave Principle in the 1930s. Over the decades, his discovery was kept alive by a handful of individuals. A few of those, such as Bolton, Prechter and Frost, educated investors on how to use pattern analysis in financial markets.

To help out Elliott Wave International's readers in learning the basics of the method, we put together a free 10-lesson online tutorial. Here's an excerpt. To get it in full, look for details below.

EWI's Basic Elliott Wave Tutorial
Lesson 1, excerpt

At that time [of his discovery], with the Dow in the 100s, R. N. Elliott predicted a great bull market for the next several decades that would exceed all expectations at a time when most investors felt it impossible that the Dow could even better its 1929 peak. As we shall see, phenomenal stock market forecasts, some of pinpoint accuracy years in advance, have accompanied the history of the application of the Elliott Wave approach.

Under the Wave Principle, every market decision is both produced by meaningful information and produces meaningful information. Each transaction, while at once an effect, enters the fabric of the market and, by communicating transactional data to investors, joins the chain of causes of others' behavior. This feedback loop is governed by man's social nature, and since he has such a nature, the process generates forms. As the forms are repetitive, they have predictive value.

The market...is not propelled by the linear causality to which one becomes accustomed in the everyday experiences of life. Nor is the market the cyclically rhythmic machine that some declare it to be. Nevertheless, its movement reflects a structured formal progression. In markets, progress ultimately takes the form of five waves of a specific structure.

Three of these waves, which are labeled 1, 3 and 5, actually effect the directional movement. They are separated by two countertrend interruptions, which are labeled 2 and 4, as shown in Figure 1-1. The two interruptions are apparently a requisite for overall directional movement to occur.

At any time, the market may be identified as being somewhere in the basic five wave pattern at the largest degree of trend.

Read the rest of this 10-lesson Tutorial and see multiple charts now, free! All you need is to create a free Club EWI profile. 

Read the rest of this 10-lesson Basic Elliott Wave Tutorial online now, free! Here's what you'll learn:

• What the basic Elliott wave progression looks like
• Difference between impulsive and corrective waves
• How to estimate the length of waves
• How Fibonacci numbers fit into wave analysis
• Practical application tips for the method
• More

Keep reading this free tutorial today.

This article, Learn Basics of Elliott Wave Analysis, was syndicated by Elliott Wave International. EWI is the world's largest market forecasting firm. Its staff of full-time analysts lead by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.

S&P 500: Another bear rally to sell short

In recent posts it was mentioned that bear market rallies can be large and fast.  I believe today's action is representative of that.  From my outlook, this is yet another opportunity to sell short the stock indexes.  

(click charts to expand)

 
My stop loss orders are at one tick above the intraday highs on 6/21/10, which would be 1127.50 in the September e-mini S&P futures contract.  When we were selling the last rally short, the stops were at the 4/26/10 highs.  Following the current rally, assuming the outlook gets confirmed by the market, it will basically be time to just strap in and ride the big wave -a major 3rd wave in Elliott terms.  

If the market succeeds in rallying above the 6/21 high, then my short to intermediate term outlook will have been incorrect at this stage, requiring I go back to the drawing board.  Taking losses is part of trading, and it is best to recognize it as a potential while you are still winning, rather than after you are already losing.  Remember to always limit your risk to no more than around 2% or so of capital at the stop.  

It would still be satisfactory to have a stop at the original 4/26/10 highs as long and one's risk was limited accordingly at that level.  I have moved mine down in order to reduce risk and open the opportunity for building a larger position (exponential profits) while keeping risk linear.  This was not an arbitrary decision, but one based on the market's own basic trend as well as valid Elliott Wave counts that would be negated at the stop level.        

This latest stage of the outlook will be confirmed if prices break below the 7/1/10 intraday lows without first exceeding the 6/21/10 highs.  A break above the 6/21/10 highs would not necessarily eliminate the bearish scenario against the 4/26/10 highs, but it would cause us to have to cut some losses short and reassess the opportunities should such an event occur. 

Ultimately, I expect the 2009 lows to be taken out significantly, but we just have to come to the market and see what it is telling us in the meantime.

Illinois Can't Pay Its Bills

Source: The New York Times.

They are in the red by $5.01 billion.  They owe this money to their own government agencies - schools, rehab centers, child care, and the state university.  According to the article: "their pension is the most underfunded in the nation", and "they can't grow their way out of this." 

Expect more of this as the Depression moves forward. 

20 Questions with Ropert Prechter: Devaluation Won't Work

 By Elliott Wave International

The following article is an excerpt from Elliott Wave International’s free report, 20 Questions With Deflationist Robert Prechter. It has been adapted from Prechter’s June 19 appearance on Jim Puplava’s Financial Sense Newshour.

Jim Puplava: In 1933 at the bottom of the crisis, the Roosevelt administration comes in. In its first week they declare a bank holiday, they reopen the banks with the FDIC, they sever gold, they come in with massive fiscal stimulus and they devalue the dollar substantially. The result was from 1933 to1937 we have positive CPI, economic growth, a robust stock market. If fiscal and monetary measures fail to revive the economy and the market, could the government try devaluation to change the deflationary outcome the way they did 1933?

RP: Well, you have to have a benchmark in order to devalue a currency. Our currency isn't pegged to anything, so I don't understand even what the term devaluation would mean. What would they do to do create a devaluation?

Editor’s Note: The article you are reading is just one small excerpt from Elliott Wave International’s FREE report, 20 Questions With Deflationist Robert Prechter. The full 20-page report includes even more of Prechter’s insightful analysis on fiat currency, gold, the Fed, the Great Depression, financial bubbles, and government intervention. You’ll learn how to protect your money -- and even profit -- in today's environment. Read ALL of Prechter's candid answers for FREE now. Access the free 20-page report here.

JP: Maybe they come out with a formal saying: the dollar is now worth a half a euro, X amount of yen or it’s a formal statement. They just declare it formally.

RP: Yeah, but everybody already knows what it's worth, because it's floating freely against these other currencies. And they certainly couldn't fix it to a lesser currency like the euro. And then the managers of this other currency would simply make another decree and negate it. That’s not going to work.

Let's take your example, because it's very important. The whole idea of the government being ahead of the curve is bogus. You know the collapse was from September 1929 down to July 1932, right? The government did not act until it was over. They waited for the bottom of the collapse—of course—and then they finally decided they're going to do something about it. So, months after the low in 1932, they finally shut the banks and pass laws such as Glass-Steagall, which created the FDIC, and the Securities and Exchange Act, and that sort of thing, to bring confidence back into the banking system. I think the same thing is going to happen here. They're going to try the same old stuff, more and more lending, more and more borrowing—which is the problem, not the solution—until everything collapses, and then they'll go, “Oh maybe we should try something else,” and by that time we'll already be at the deflationary nadir, and it'll be time to look for an inflationary outcome.

My whole thesis is exactly along those lines. We want to stay prepared for a deflationary crash, and when it’s over, we're going to convert whatever money we have to stocks, and raw land, and gold, and whatever else we want to buy. That's when—if the government makes a political decision to inflate through currency printing—it would make the decision. They're not going to make it before the bottom. The government has never acted before the bottom, never acted in a new way. Right now these bailouts and other schemes are simply pressing the accelerator harder on what we've been doing since 1913.

Editor’s Note: The article you are reading is just one small excerpt from Elliott Wave International’s FREE report, 20 Questions With Deflationist Robert Prechter. The full 20-page report includes even more of Prechter’s insightful analysis on fiat currency, gold, the Fed, the Great Depression, financial bubbles, and government intervention. You’ll learn how to protect your money -- and even profit -- in today's environment. Read ALL of Prechter's candid answers for FREE now. Access the free 20-page report here.

This article, 20 Questions with Robert Prechter: Devaluation Won't Work,was syndicated by Elliott Wave International. EWI is the world's largest market forecasting firm. Its staff of full-time analysts lead by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.

Is Crude Oil about to break down?

Crude Oil is giving some signs that it might be entering into a significant downtrend.  Rather than a forecast, this is just taking current cues from the market.  Let's take a look.

(click charts to enlarge)

As seen on the weekly chart above, a downside action from what was an intraday high of 87.09 on 4/6/10 broke below prior lows within an uptrend.  Following this, prices rebounded upwards starting on 5/20/10.  Now, prices appear to be breaking down again, starting with the penetration of a short term upwards trend line accross the lows from 5/20/10 to 6/24/10.  

This is a possible trading opportunity.  We have a couple of defined stop loss areas that could be used to protect a short position.  Those would be either the 5/2/10 highs or the more recent 6/27/10 highs.  

If the short term trend line penetration is not enough to convince a trade (very understandable and a valid argument), then one could decide to filter the decision to enter a short position with a requirement that prices either break below the 6/7/10 low of 69.51 or the 5/20/10 low of 64.24.  Doing so is basic trend following in practice -letting the prices lead you. 

What if you don't trade futures contracts?  There is still a way to participate in this market on both the long and short side.  These days you can use commodity tracking exchange traded funds (ETFs).  These are accessible and easy to use, even for the retail investor.  

As I have mentioned before, you can even use inverse ETFs to effectively sell short a market without actually directly putting on the short yourself.  Buying the inverse ETF is that same directional market position as selling short the underlying market.  In some cases, there is even leverage involved.  One example of this is the ProShares UltraShort Crude Oil ETF, symbol: SCO.  

Look at the SCO chart below, and you will see that it is basically an inverse chart of the regular Crude Oil futures chart we looked at above.  

    

Tightening Stop on S&P 500 Short Position

In the last S&P 500 post, we covered the fact that the bearish outlook for the S&P 500 which had led us to sell short into the rally off the 5/25/10 low had in fact been confirmed.  This blog has been tracking the S&P since inception, and you can always view a reverse chronological list of my S&P 500 posts by clicking the SandP 500 tag.  

Today I am posting to say that my protective stop / loss orders for short S&P 500 positions are being moved down with trend to one tick above the 6/21/10 intraday highs.  The intraday high for September Futures contracts on that day was 1127.50.  Previously, as we were selling into the rally, stops had been at the 4/26/10 high.

The decision to tighten stops is mostly because all the other major indexes, such as the DOW and the NASDAQ 100, have all confirmed the break below the late May / early June lows.  While large bear rallies can always be expected in a major downtrend, any move above the intraday highs on 6/21 would leave three waves behind and indicate either sideways congestion, or more upside pressure on the market.  

 (click chart to zoom in)

Many of the recent posts have used 60-min bar charts.  The one above is a 90-min chart.  I just needed to squeeze the growing picture in a little more.
 

20 Questions with Robert Prechter: Long Decline Ahead

 By: Elliott Wave International

The following article is an excerpt from Elliott Wave International’s free report, 20 Questions With Deflationist Robert Prechter. It has been adapted from Prechter’s June 19 appearance on Jim Puplava’s Financial Sense Newshour.

Jim Puplava: I want to come back to government spending, but first I want to move onto the stock market. In your last two Elliott Wave Theorist issues, you laid out a scenario that would put the Dow and S&P, which in your opinion may have peaked on April 26, as the top from here. You feel that this top is the biggest top formation of all time, a multi-century top and we could head straight down in a six-year collapse that would end in 2016 that could see a substantial portion of the S&P and the Dow wiped out in a similar way that we saw between 1929 and 1933. Let's talk about that and the reasoning behind it.

Editor’s Note: The article you are reading is just one small excerpt from Elliott Wave International’s FREE report, 20 Questions With Deflationist Robert Prechter. The full 20-page report includes even more of Prechter’s insightful analysis on fiat currency, gold, the Fed, the Great Depression, financial bubbles, and government intervention. You’ll learn how to protect your money -- and even profit -- in today's environment. Read ALL of Prechter's candid answers for FREE now. Access the free 20-page report here.

RP: Yes, you're exactly right. I did a lot of work on technical forms, cycle forms and Elliott wave forms in April and May and put them in a double issue. Let’s talk about the cycles first.

The 7¼-year cycle has been quite regular since the first bottom in 1980. The next bottom was at the crash in October 1987. The next one was November 1994, which is when the economy went through four years with lots of layoffs; it was a recessionary period throughout until that cycle bottomed. The next one was between September 2001, which was the 9/11 attack, and the October 2002 bottom. And the latest one was at the low in March 2009. All those periods are 7¼ years apart, so we are in the uptrend portion of the 7¼-year cycle.

However, notice for example that in 1987, the market went up until August of that year and then bottomed in October, just a couple of months later. So the decline occurred very, very late in the cycle. This time it occurred a little bit earlier in the cycle, topping in '07 and bottoming in '09. In the current cycle, prices should peak the earliest of all of them. It's what we in the cycle prediction business call “left-hand translation.” The market’s already gone up for about a year, and I think that's just about enough. I think we're going to spend most of the cycle going down. But the important thing to note is that the next bottom is due in 2016. That means I think we're going to have a repeat of what happened between 1930—which was the top of the rally following the 1929 crash—and the July 1932 low. Instead of taking two years, it's going to take about six years.

It's going to be a very long decline. It's going to be interrupted by many, many rallies, just as the decline from 1930 to 1932 was. And every time it bottoms and rallies, people are going to say “OK, that's enough; it's over.” But it won't be over. It's just going to be a long, long process. I think you and I will probably be talking a few times during this period. One of the interesting aspects of this process is that optimism should actually remain dominant through the first three years of the cycle. That will carry us into 2012. Even though prices will be edging lower, most people are going to think it's a buy, and you shouldn't get out of your stocks, and recovery is just around the corner, probably for the next three years. And then, for the final half of the cycle, the final three years, that's when you'll get the capitulation phase when everyone finally gives up.

Editor’s Note: The article you are reading is just one small excerpt from Elliott Wave International’s FREE report, 20 Questions With Deflationist Robert Prechter. The full 20-page report includes even more of Prechter’s insightful analysis on fiat currency, gold, the Fed, the Great Depression, financial bubbles, and government intervention. You’ll learn how to protect your money -- and even profit -- in today's environment. Read ALL of Prechter's candid answers for FREE now. Access the free 20-page report here.

This article, 20 Questions with Robert Prechter: Long Decline Ahead,was syndicated by Elliott Wave International. EWI is the world's largest market forecasting firm. Its staff of full-time analysts lead by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.