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

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.

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Trading Nation is a multimedia financial news program that shows investors and traders how to use the news of the day to their advantage. This is where experts from across the financial world – including macro strategists, technical analysts, stock-pickers, and traders who specialize in options, currencies, and fixed income – come together to find the best ways to capitalize on recent developments in the market. Trading Nation: Where headlines become opportunities.

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Sara Eisen joined CNBC in December 2013 as a correspondent, focusing on the global consumer. She is co-anchor of the 10AM ET hour of CNBC's "Squawk on the Street" (M-F, 9AM-11AM ET), broadcast from Post 9 at the New York Stock Exchange.

In March 2018, Eisen was named co-anchor of CNBC's "Power Lunch" (M-F, 1PM-3PM ET), which broadcasts from CNBC Global Headquarters in Englewood Cliffs, N.J.

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