Market Harmonics
 Energy Watch

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February 8, 2010

Five Waves Down in the Energy Stocks Complex

When trading with the Elliott Wave Principle, a decline that develops in five waves is always something to take note of.  When it occurs in various sub-indices within a particular sector, it's definitely something to be noted.  Five waves in an Elliott pattern generally define the one larger trend, and if that development occurs in the early stages of a downtrend, it could be indicative of a larger downward pattern that is unfolding.

We've observed recently the formation of downward 5-wave patterns in an array of energy-related indices and ETFs.  These all followed upside Fibonacci retracements between the 38.2% and 61.8% levels:

Beginning from the top down (pun intended) the AMEX Oil Stocks Index (XOI) retraced 38.2% of its bear market decline from 2008 back in October.  In our December report, we thought the XOI would attempt to retrace and exceed its October high of 1133, and the index came within 4 points of doing so before its rally failed.  The AMEX Natural Gas Stocks Index (XNG), which had retraced 55% of its bear market decline, dropped more than 12% following this accomplishment.  Drillers and riggers were also not exempt, with the Oil Services Index (OSX) falling an even sharper 16% after retracing just over 38.2% of its bear market drop.

Even coal company stocks felt the sting of the recent energy sector declines, with the KOL ETF falling 26% from its January peak.  The drop is also significant for having followed a full 61.8% retracement of its bear market.

Five wave declines are normally followed by corrective 3- wave rallies.  The common target is usually the level of the previous fourth wave, although that level can be either missed or exceeded.  Following particularly sharp selling and deeply oversold conditions, the rallies may be sharper, but unless they result in the takeout of the high, they are still considered corrective and countertrend.  If our outlook is correct, this is a pretty bearish development for the energies, and one that investors should not dismiss. 

Trade crude futures or ETFs?  Want daily market forecasts on energy?  Then please visit our friends at Elliott Wave International for a risk-free trial of their specialty services.

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