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One classic theory could be hinting at a short-term drop for stocks

Annie Pei

Todd Gordon of TradingAnalysis.com says one classic market trend could be pointing to a short-term drop for stocks.

Gordon points to the Elliott Wave Theory, which posits that stocks and indexes generally travel in a successive series of five up and down moves. On a chart of the S&P-tracking ETF (SPY ), Gordon points out that the market is currently on a third, uptrend wave, and a fourth wave would imply that the SPY is about to move down.

"I think we have one more drop down to go here, which gives us opportunity to be short before the market gathers itself and we continue on higher to new highs," he said Thursday on CNBC's "Trading Nation."

To determine how big that drop could be, Gordon brings up a second part of the Elliott Wave Theory. The theory also states that as the market is moving in those waves, it is doing so in a consolidating triangle with lower highs and higher lows. After connecting the highs and lows, Gordon says a SPY drop would fall to the lower line on the triangle to around $260.

Therefore, Gordon wants to buy the May 2 weekly 265-strike put and pair that with the sale of the May 2 weekly 260-strike put. The trade cost him 73 cents, or $73 per options spread.

Should SPY close below $260, Gordon could make up to $433 on the trade. But if it closes above $265, Gordon would lose the $73 premium on the trade.

Stocks fell Thursday, though all three major averages were still up over 1 percent this week.