When the FTSE 100 rallied in January I could sense that 80% or 90% of traders were short. The rally was not a normal rally and this is why it caught many people by surprise. The FTSE 100 seldom closes up for so many consecutive days, the normal pattern is a rally interrupted by some short term pullbacks. This did not happen from mid December to mid January. Something had changed and the reason it was rallying relentlessly was because traders expected the pound to drop as Theresa May’s speech on Brexit drew nearer. The pound is negatively correlated with the FTSE 100, when GBP/USD falls the FTSE 100 rallies.
The rally ended on 16th January, a day before Theresa May’s speech. That was a typical buy the rumour, sell the fact scenario. Very often when people anticipate good news they will buy ahead of the announcement. On my wave count the December-January rally was wave 1 of a five-wave advance. The 34-day BTI, an indicator identifying major market turns became overbought on 18th January, two days after the FTSE had peaked. That was a signal the FTSE 100 would turn down. In general the 34-day BTI will become overbought before the FTSE 100 peaks.
The trend did turn down and we are now in wave 2. This time GBP/USD is rallying, this is weighing on the UK index. There are two main key drivers, the S&P 500 and the GBP/USD, in order to get an accurate FTSE forecast, I need to study both S&P 500 and GBP/USD. Elliott wave can be applied to any market, if the wave counts on the S&P 500 and GBP/USD confirm the FTSE wave count the odds of making a profit are high.
The reason I think we are in wave 2 is because I believe the pattern from the bottom of wave (4) is an ending diagonal [1,2,3,4,5]. An ending diagonal is a terminal pattern appearing in the fifth and final wave of a bull market [we are in wave (5)] and each wave up subdivides into three waves [a,b,c (circle)]. Here wave 1 is in three waves [a,b,c (circle)]. I also believe there is more downside in the next four weeks. I think the pound will continue to rally. Second waves are deep, in general they retrace more than 50% of the first wave.
At today’s low the FTSE 100 has retraced 38.2% of wave 1, this is not enough for a second wave. This is why I think we are in wave 2 of an ending diagonal. Like wave 1, wave 2 will also be in three waves [a,b,c (circle)], if we assume that the current decline is wave a (circle) inside wave 2, the next move will be a rally above 7200 in the next few days for wave b (circle). Thereafter the FTSE should decline to 6920-6940 to complete wave c (circle) inside wave 2.
We see a weak FTSE at the moment and the majority of trader can’t wait to short it. But when the FTSE is near oversold and starts tracking GBP/USD as it did yesterday and today, there is a good chance we are near a bottom. My advice is wait, there will be a better opportunity to short above 7200. Based on my analysis, the odds of a short term rebound have increased significantly. This rebound will be a counter trend move, so upside is limited.
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