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Big Dogs Exposed

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Newsletter: Elliott Wave Theory

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Elliott Wave Theory:

This Theory posits that waves one, three and five are impulse waves in the direction of the main trend (bull or bear). They are fractal in nature, meaning that each of these larger waves, particularly wave 3s, can be sub-divided into five further waves of lesser degree (labeled i through v). Each of these waves can be further subdivided. Sometimes the sub-waves are easily visible only during wave three.

Wave three is usually the longest and most powerful wave and the one with the strongest momentum, as reflected in MACD. The strongest momentum is normally attained during sub-wave iii of wave three, as perhaps reflected by the MACD hitting record oversold levels in a bear move. Waves two and four correct the main trend, and break down into lesser structures (overlapping a-b-c waves). Wave four cannot overlap the top of wave one, and normally takes longer to unfold than wave two.

Symmetrical triangles are normally found in the wave four position. On a chart, such a triangle looks a normal triangle, where the top line slopes down perhaps on a 45-degree angle, and the bottom line slopes up on, say, a 30-degree angle – forming a symmetrical shape. Price tends to exit this consolidation pattern in the same direction as it entered it and to travel a distance equal to the height of the triangle at its highest.

Wave five normally generates less strong momentum than wave three. Just as the bull wave five is in most cases accompanied by a negative divergence between higher price and lower momentum highs signaling the end of the bull wave, a bear wave five is normally accompanied by a positive divergence between lower price and higher momentum lows. Wave five normally forms negative divergence with wave three. Wave five typically takes price to a new extreme, while momentum does not confirm that price move, setting up a divergence that warns of an impending change in trend.

When price falls through wave one, the Wave theory bull phase is negated. This often precedes the breaking of the uptrend of higher highs and lows. Once a correction moves through the low of the previous bull wave four, it is fairly safe to assume that it has transformed into wave three of a full-fledged bear phase. It should be noted that not every bull or bear move is completed.

A tradable can undergo higher-order waves. For example, waves one and three sub-divide into waves one through five, and each of these in turn sub-divide in fractal fashion into waves of lower degree.

Waves two and four correct the main trend, and sub-divide into over-lapping a-b-c waves.

Even if price continues to form a series of higher highs and lows, as long as these swings overlap, there is no bull trend, only trading range action.

During a bear phase, rallies may not form new bull phases, as overlaps by correcting waves four through one highs negate potential bull phases. These up-trends are viewed as corrective A-B-C forms.

A bear phase followed by a rally, and potentially another sell-off, is consistent with a "measured move." In this pattern, the move after a corrective or rally phase tends to be in the same direction, and of the same length, as the move before the intervening rally.

Occasionally, two bull or bear phases occur separated by an intervening correction.

Regarding the symmetrical triangle consolidation pattern mentioned in the first paragraph above, if we're in a bear phase, and should price push up through the falling upper line of this triangle, as well as a long-term falling zone of resistance, the bear phase would more than likely be ended, and price would have room for a significant rally to the next visible zone of supply. However, more often than not price exits this consolidation pattern in the same direction as it entered it. Thus, the most likely scenario is a fall out of that triangle to new lows.

Want analysis that works? Elliott Wave International's Financial Forecast was recently named among the top five market-timing publications that have consistently beat the markets over the last twenty years. Go to elliottwave.com.

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