Three Corrective Waves

I was calling for this pullback for over a week. I knew that SPY would not be able to break through trendline C on the first attempt and would back off. I wasn't expecting it to back off this much though. And I believe that it sold off this much today in part because it was options expiration following an 8 day relentless rally. Furthermore 106.5 marks the 38.2% retracement from 101.13 to 110.1 so I'm expecting a bounce soon.

So next week SPY may drop to support at 106 but the 105-106 area is strong support and I expect it to hold. Trendline D may also serve as support, but I wouldn't necessarily count on it. From ~106 I expect SPY to rally back to 110 at the very least (this is where I will take profit), and most likely will hit 111.7-112 area of resistance.

My arguments for expecting a bounce are justified by elliot wave. From the April 2010 high we had 5 distinct waves down. Very easy to label and it's clear that wave 3 was the longest wave per elliot wave principles. Now from the 101.13 low we've had a very impulsive looking rally. So I am tentatively assuming this is wave 1 up. Today SPY dropped which is part of wave 2 down. And next week I expect wave 3 up to begin. This is the longest wave so it should be at the very least as long as wave 1 up from 101.13 or 9 SPY points. That would put SPY at ~115. Now this is where I lose faith in elliot because I'm very risk averse and like to take profits early. So I will begin taking profits at SPY 110.

It's true that wave 2 is allowed to retrace almost the entire length of wave 1 and so in the worst-case situation SPY may drop as low as 102.87 to fill the gap there. But I don't think we drop that far because of the strength of wave 1 up from 101.13. It kicked bear ass. That kind of rally doesn't come from nowhere. And given that the next trading day is mutual fund monday, I wouldn't be surprised to see SPY gap up on Monday.

Even if the rally from 101.13 is not a wave 1, but is a corrective wave A instead, then today's drop counts as wave B and we should still be beginning wave C soon. This is the scenario that I am expecting to take place. Five waves down from April 2010 highs is wave I down on a larger time scale. Three corrective waves from July 2010 low to 111.7-112 would be wave II. This would set the stage for a gigantic wave III down.