A Fibonacci Bottom in Sight...

Executive Summary: The bearish retracement is still in force.

The last time we wrote, the Dow was at 10,800 and had already bottomed off the 'flash crash'
low of roughly 9900. We stated at the time that we hadn't seen the last of this down move,
that it was altogether too short a correction and there was more to come. It has come.

We also noted that oil was likely to fall and put downward pressure on stocks. To be precise,
on May 3rd we wrote:

Look for a pullback in the crude pits until current stockpiles drop back to seasonal norms.
Look, too, for the oil drop to exacerbate the fall in equities – as it did in 2008.

Oil has dropped from over $85 at its April high to below $70 last week. That's a fall
approaching 20%. The drop in equities hasn't yet reached that proportion, but we're getting
there.

Dow(n) We Go
The Dow now sits at 10,200 after plumbing the 9900 level in last Friday's trade for the second
time in less than a month. The question now on everyone's mind is whether Friday's rebound
might mark the bottom for the current correction. Let's go to the charts for an answer.
There are a great many reasons to doubt that we've seen a bottom, despite the protestations of
the bulls. They maintain that Friday's trade held above the action of the 'flash crash' of a few
weeks ago, and taken alone, they're right – it is a bullish sign. But given that nearly all the
other major market averages, including the S&P 500, Russell 2000 and NASDAQ have
violated their 'flash crash' lows, means, in our opinion, that the bulls are now grasping at
straws.

Even by Dow Theory (the details of which we'll explore in an upcoming issue) the bulls are
holding a weak hand. The Dow Transports have failed to hold above their 'flash crash' lows
and any parallel violation by the industrials will likely bring sellers into the market from that
camp, too. Dow Theory is one of the oldest technical systems around and has a significant
number of devotees.

The bulls also point to support that appears to be holding at the moving average shown in
orange above. We concede there's a certain strength to that argument, but we would have
them take a gander at the more relevant long term moving average (circled, in blue) that has
failed to turn higher since rolling over in the summer of 2008.

That line is currently acting as a draw on price action and will continue to do so until the
market moves lower to 'pay its respects', by touching or even temporarily violating it.

More Certain Signs and a Fibonacci Primer

You can be sure that when the current correction is over, readings on the RSI and MACD
indicators will be above the telltale, midway 'waterline' levels (on chart, above) and that we'll
have passed through a tremendous turnover in volume – first selling, then buying. Until then,
we're holding to our assessment made a fortnight ago that the Dow will continue to fall until
Fibonacci levels 9436 or 8311 have been reached.

We now make a brief departure to explain how these two numbers were calculated.

Not the latest pasta dish

Fibonacci was a mathematician who determined a ratio that recurred with great frequency in
nature and which market technicians have subsequently applied to their readings of charts.
Without going into too much detail, the ratio produces the figure 0.618 (rounded), a number
that can be used to determine where market retracements should ultimately stop.

Note well that the Fibonacci retracement methodology is but a single tool in the technician's
kit and shouldn't be relied upon exclusively to determine where major intermediate turning
points will occur.

That said, here is a chart of the S&P 500 showing the bottom set last March, 2009. You can
see that the index climbed a total of 554 points from that point, until it topped out last month
at 1220 (all figures rounded).
To determine the Fibonacci retracement possibilities, we perform the following functions:

1. We take the overall gain and multiply it by the Fibonacci ratio of 0.618, giving us a
product of 342.

2. We then add 342 to the market low point of 666 and subtract it from the market high
point of 1220 to produce two possible retracement scenarios: 1008 and 878.

According to Fibonacci retracement rules the market should descend to one of these two
numbers before turning to push higher in a bull market scenario This is important. Our
view is that the current pullback is a correction in an overall bull market, and that we will see
higher highs in the months ahead. Should the market penetrate the lower level SPX 878, we
will have to re-evaluate our current bullish posture.

We have drawn the two Fibonacci retracement lines on the chart above. Our view is that the
lower of the two is the likelier destination for the current pullback, depending, of course, on
how terrified market participants are when these levels are reached,.

A final note on Fibonacci technicals

There are a great number of Fibonacci retracement lines that analysts draw using the basic
information that we've provided above, i.e., high and low prices for a move and their
difference. We at Wall Street Elite, however, prefer to keep it simple. Generating six or
more potential retracement lines becomes more an exercise in 'covering your behind' rather
than offering investors signposts they can actually use. Our experience is that the market
most often moves in eloquent fashion – in line with the simplest Fibonacci calculations.

A Very Short Term Trade

With the VIX orbiting the moon, it's not normally judicious to recommend options purchases,
but that's exactly what we're doing now – sort of.

If the Dow moves back up to the 10,600 level, or the S&P 500 climbs to 1140, we
recommend September Put purchases on either. Buy the higher of the two Fibonacci strikes
for your trade: DIA September 94 Puts or SPY September 100 Puts.

Do not execute the trade until the upside targets have been hit and volatility levels back off.
Premiums on the options should be a lot more reasonable at that stage.

With kind regards,

Hugh L. O'Haynew, Analyst, Oakshire Financial