Patterns impulse patterns corrective pat

Cap I Introduction What the ‘hand’ that writes the charts of market prices reflects is precisely the sum total of the will of millions of participants in the negotiation, which second by second, hour by hour, day by day, takes place on the market: millions of hands writing the same line, the line which we are going to try to decipher with the aid of Elliot’s techniques Millions of hands which aim at capturing the longed-for benefit: weak hands, strong hands, fearful hands, greedy hands, audacious hands, poor hands, powerful hands, all in all, hands which leave their mark in the sinuous line of the price According to the Elliot Wave Theory, what charts reflect is, as we have said, crowd psychology, and when this crowd comes together on the same stage, some fundamental features of our human nature become evident, such as behaviour associated with fear, panic and excess of optimism or greed This is the fundamental idea Example (Fig 33 and 34) We will start with an easy one: the fourth is simple and clearly shows the exhaustion of the fifth As you can see we are dealing with a 1-minute chart of a crude oil barrel future, a liquid product par excellence It is an impulse pattern with the extended wave The wave is second in size and represents 62.8% of the price development of wave There is no overlap between and 4, but there is alternation both in price and in the percentage of retracement1 There would not be alternation in the structure as both waves are similar, though the fourth is more extended There is no equality between the fifth and the first either in price or time: wave is shorter and slower than They both approximate the Fibonacci ratio of 61.8% in time, but they not comply with the rule of equality The time taken in the formation of the fifth wave is 33 periods, thirty-three minutes in this case, and from the moment when wave gets exhausted until the moment line 2-4 is crossed, 27 periods pass Therefore, we can positively conclude that, as we have just said, the time until line 2-4 is crossed (downward in this case) is shorter than that taken by the fifth wave to unfold This is the moment to adopt short positions Price development of wave is by 50% superior to that of wave and the retracement of wave over wave is of 76%, whereas that of wave over wave is of 50% If we took an even closer look at the fifth wave (Fig 35) we would find another extended third, in this case with an extremely short wave 1, something that we are going to observe relatively frequently When the first one is so small, the price development of wave tends to reach around 38.2% of segment 032 (0-iii in Fig 35) The alternation between wave and wave is clearly evident Wave is a triangle formation However, the crossing of line 2-4 took a longer time here than used by the fifth wave to develop xiii v b d e c iv a i ii Fig 34 Crude oil continuous 1- chart I have chosen a rapid pattern and a 1-minute chart to demonstrate the importance of working on liquid products This impulse pattern we have just analyzed in Figs 34 and 35, a pattern which maintains its impulse structure to the limits of visibility, is the fifth wave which we saw in Fig 22 when we talked about alternation There is a practical consideration that should be made while dealing with such small patterns whose movement has to be observed on an intraday chart; it is by no means orthodox, but eventually we can sacrifice orthodoxy for the sake of practicality It is possible that the pattern we have just analyzed appears within an impulse pattern of major degree, but it is also possible that it shows up in ‘isolation’, ‘lost and lonely’ within a complex corrective pattern, in which flat patterns form one after another and whose price structure is unknown to us (see Fig 35) The segment (03) is the result of joining the origin of wave with the end of wave In that price structure whose formation takes more than a month, there are dozens, literally dozens, of impulse patterns, whose structures have common characteristic features Fig 35.Dow Jones Industrial 15 chart The question is whether we can apply this technique when the pattern analyzed is not part of an impulse structure In other words : if it is a minor wave impulse pattern not included in a major degree pattern In my opinion the answer to this question is: yes If we come across a matrioshka which has escaped from its older sisters, it will still be the same as the others, with only the difference of size This opens the possibilities of detecting a major number of patterns and, consequently, of opportunities This can offer us good results for intraday trading in futures markets Chapter II Introduction The term “corrective pattern” includes all patterns that are not impulse patterns This definition is so general that it leaves an immense number of patterns among which we can distinguish three groups: flat patterns, triangles and zigzags The principal objective of now is the same as that of the first part in the series, namely to help you identify the patterns at a glance, as we know that this constitutes the main difficulty that someone with theoretical knowledge of these techniques will have, when faced with a real chart We will identify the common typical features of a large number of patterns in order to identify them more easily, although I must emphasise, that the task will be much more complicated than in the case of impulse patterns, Flat Patterns II.1 Definition - The Elliot Wave Theory defines a flat pattern as that formed by three waves (a, b and c), of which the first two have a corrective structure and the third has an impulse structure Apart from that, the retracement of the second wave over the first has to be of at least 61.8% and the price development of the third wave must be more than 38.2% of the price development of the first PB >PAx0.618 AND PC>PAx0.382 Flat patterns are continuation patterns, that is to say once a flat pattern is completed, the trend previous to the beginning of the pattern will manifest itself again In the first chart we can see the first of the twenty flat patterns that we are going to analyze in this chapter Fig A flat pattern II.3 A flat and a trend As we have already said, flat patterns are considered to be continuation patterns of a trend We will often find flat patterns in waves two and four of impulse patterns As we can see in Fig once a pattern ends, the trend continues and the price returns to the direction it followed before the beginning of the correction We know that in impulse patterns, waves two and four are corrective patterns and therefore it will be in them that we will be able to find flat patterns Fig NIKKEI 221 Index Daily chart The first objective of technical analysis is to identify which trend underlies the movement of the price Sometimes it will be easier to identify that trend than other times, but there will be situations when it will be impossible, because there will be no trend at all Our interest will concentrate on those situations where an identifiable trend stops momentarily to unfold a corrective movement If this corrective movement is a flat pattern, we will look for its end before we see the trend continue In other words, we will look for the exhaustion of the third wave (wave c), which will always be, as we have already said, an impulse pattern, and when we confirm its exhaustion we will have a signal to enter the trend In the following chart you can see another example of how a bearish trend continues once a flat has ended You can see this in more detail in Fig Fig USD-YEN 15- chart Thanks to the impulse structure of waves c and to what we have already learnt about them, we can detect the exhaustion of the minor and major degree flats, namely waves c and -c-, respectively Fig 7.- USD-YEN 10- chart It is obviously major degree (-c-) which interests us in this case because it ends the correction and we can adopt positions again in the direction of the trend; bearish in this case II.6.3 An ideal figure.- On numerous occasions, we will find it difficult to see a clear structure of wave c, the last of the flats On some occasions it will be even more difficult to have sufficient visibility to clearly identify the end of the fifth and last wave of that wave c, as sometimes gaps will be produced which will ‘take away’ a part of the chart Also, the increase in volatility will provoke rapid movements, which will make it hard to see the formation of all the waves That is why, as we have just seen, we will always look for the support of the moment indicators Fig 38 IBEX-35 5-min chart MACD RSI (14) In Fig 38 we can see the end of a flat in which the upward divergences between the price and the moment indicators are anticipating that IBEX is reaching a trough The RSI enters the oversold zone and leaves it when the price continues to drop to new minimums, which produces an upward divergence Simultaneously, from the end of wave 3, MACD also forms an upward divergence with consecutive failures in its attempt at cutting downwards When we see the following figure: divergences with a failure in MACD and an upward divergence in the RSI after entering the oversold zone, we can be fairly sure that a trough has formed and that the price is going to bounce up significantly If, apart from that, the analysis of the pattern indicates an exhaustion and the crossover of line 2-4 confirms it, this is the moment to open long positions with a protective stop above the minimum reached by the fifth wave and to enter the trend because the correction has finished In Fig 39 we can see a similar figure but on the rise.7 It is exactly the same situation: during the development of wave the price is moving laterally and after that, once the fifth wave has ended, a downward divergence with a failure in the MACD is produced as well as a downward divergence in the RSI, this time leaving the overbought zone Fig 39 IBEX-35 5- chart MACD RSI (14) In this second case, the moment indicators acquire a special significance because the crossover of line 2-4 occurs in more time than that taken by the fifth wave to form, which would normally cause doubts about the confirmation of the pattern´s exhaustion Nevertheless, we interpret the signal given by the two moment indicators and assume the pattern has reached exhaustion The price as peaked, we can now expect a fall We would have been able to adopt short positions with a stop above the level reached by wave five and enter the downtrend in this case Let us see yet another example: it is the Dollar/Yen relation in the section of an uptrend in which a halt occurs and we are going to watch the unfolding of two flat patterns, separated by an impulse pattern As you can see in the figure, these two flats are two waves of different degrees and the impulse pattern is the fifth wave of  The more important of the two flats that we are going to see is the second, because it permitted us to enter the trend again or to add more positions, if we had not already closed long positions at the end of  Fig 40 Dollar-Yen 30-min chart impulse pattern which marks the end of suffered losses of any kind with a halt at the minimum, I would not have II The triangle and the direction of price As we can see in Fig 46, the price of an ounce of gold was impelled by a strong uptrend in November 2007 On 16 August it changed to 646.40$ and on November it reached 847.80$, a price increase of 31% in less than three months As a consequence of this strong rise, the ADX3 reached the value of approximately 50, which indicates great strength Let us see what happens next: the price starts to zigzag up and down without altering the price levels significantly, but weakening tremendously the strength of the direction of the price Imagine a car were cruising along a long straight motorway at high speed and all of a sudden it enters a winding mountain road It has to slow down and due to the conditions of the road it will travel long stretches without moving in a straight line The trend continues bullish, but the value of the ADX has fallen from 47 to 12: the strength has vanished The price is perfectly defined on both directrices and the vertex of the triangle In spite of a lateral slide the trend has not weakened as a direction and it pushes up violently at the very moment when the price breaks through the superior straight directrix of the triangle At that moment the ADX turns upwards and crosses the –DI: bearish forces give way: the winding mountain road has finished and we are back on the motorway The triangle broke up on 26 December at the price of $816.30 Three months after that the price of a troy ounce of gold4 surpassed $1.000 We have noted two characteristics of triangles then: the direction is suspended during the development of a triangle and the trend pushes sharply up or down with the crossing of the directrix Let us see now an example of a downward trend, namely the Dollar Index We are in July 2002, a month after John Snow5, then US Treasury Secretary, declared his intention to implement a strong Dollar policy with the Dollar at 107 The ADX (Average Directional Movement Index) is an indicator which measures the strength of the direction of a price and it is usually used combined with other two other direction indicators: the +DI and the –DI When the ADX reaches values higher than 30 it indicates a strong trend If the value of the +DI is higher than that of the –DI, the direction of the trend will be rising and vice versa, if the value of the –DI is higher than that of +DI, the direction of the trend will be falling A troy ounce equals 31,10 gr Fig 47 Dollar Index Daily chart ADX (14) +DI We can see that the Dollar Index stops slightly above 105 with the ADX above 50, unfolding over the following months a big triangle whose directrices can be definitely traced by mid-October The directional strength ceases completely, dropping in value on the ADX from 52 at the beginning of the triangle to on the days prior to the break down It is at the end of October when a downward break of the triangle occurs, coinciding with the crossing of the ADX and the +DI Unlike the previous figure, in this case the ADX falls below the +DI and remains in that position for a long period of time This type of situation anticipates sharp movements when the ADX crosses the ±DI, no matter whether the pattern formed by the price is a triangle or not In short; if the ADX crosses the +DI we can expect a fall If the ADX crosses the -DI, we can expect a rise John Snow was the Secretary of the Treasury with George W Bush from February 2003 to his resignation in June 2006 He was followed on in the post by the CEO of Goldman Sachs, Henry Pulson III.3 A bullish trend and the correction in a zigzag The example we are going to study now is a zigzag formed on the Euro stoxx 50 in the second trimester of the year 2005, within an uptrend of the index We are going to follow the formation of wave C until its exhaustion in order to find a signal that will indicate the moment to enter the uptrend which reformed anew after the correction In Fig A15 and A16, in the appendix, we can see the Fibonacci relations between wave A and C Just as in the previous example, they are almost equal and the external relation practically equals 61.8% Let us subdivide the pattern into its different various figures to see it “on the inside”: Fig 84 DJ Euro stoxx 50 Daily chart The charts of Fig 85 and 86 show the situation before the development from the point of view of the moment indicators: a strong downward divergence between the MACD and the price on a daily chart announces the probable beginning of a correction The hourly chart shows a strong loss of momentum with a failure of the MACD about to take place, which marks the development of the first wave of A which will unfold its five waves as shown in Fig 88 Unlike the example we saw in the DAX at the beginning of this chapter, here wave B could have been a flat, which would have permitted us, with the exhaustion of its wave c, to have followed wave C of the zigzag from the beginning (Fig 87) It is a flat with a complex wave b and whose wave c was not easy to identify In Fig 89 you can see a possible count in a fifteen minute chart However, let us not forget that our objective is not wave B, but wave C and that it is there, if the conditions are appropriate, where we will be able to detect the end of the correction A very aggressive strategy can lead to adopting short positions at the end of wave B, in this case We will have two things on our side: the fact that wave C is an impulse pattern and we can detect the moment of its exhaustion, and the fact that it is very probable that the price development will be a long extension6 Nevertheless, let me repeat that a better strategy in such situations is to wait for the exhaustion of C before adopting long positions Fig 85 Zigzag Wave A Hourly chart Fig 86 Zigzag MACD Daily chart In fact, in Fig 90 we can see the zigzag in more detail and it is possible to identify the withe structure of C, which took 165 periods (hours, in this case) to form The lower arrow on the chart points out the first signal of exhaustion The first signal? No, the second Because if we take an even closer look, we can see the formation of the fifth wave of C and the moment of its exhaustion quite clearly (Fig 91) Even in a 15 minute chart there is sufficient visibility to be able to see the fifth of the fifth: quite a luxury indeed If we follow the price development we can see a series of three consecutive crossovers of line 2-4, which confirm, one after another, the exhaustion of the three impulse patterns from minor to major degree Price development of C with respect to that of A in a zigzag can reach as much as 161.8% in an external relation (Section III.1) Finally, with the gap at 2,985 on the opening of 18 May 2005, line OB was crossed by the price, definitively confirming the end of the correction and the return of the trend The time which the price took to cross line OB was 143 hours, less than that taken to form C, which as we saw earlier (Fig 90) was 165 periods Fig 87 DJ Euro stoxx 50 Wave B of the zigzag Hourly chart The price took longer to correct wave C completely than to form it (183x165), for which reason this second requirement of pattern confirmation was not fulfilled, which as we have said, occurs relatively frequently In the case we have just analyzed it was irrelevant Our objective was attained and we were able to enter the trend as we had intended Fig 88 Wave A count 60- chart Fig 89 Wave c of the B count 15- chart Fig 90 DJ Euro stoxx 50 Daily chart Fig 91 DJ Euro stoxx 50 15- Chart Chapter III Introduction The terminal patterns (from now on TPs) are for me, without a doubt the best part of the Elliott Wave Theory Why? Because they are simple, frequent, foreseeable, quick and above all, because they offer great profit They are simple because they don’t have to meet too many requisites, only four of the Fibonacci ratios among its waves They are impulse patterns, but their structure is not as confined by the rules as them They are patterns that appear under special situations, thus we can expect to see one of them, even though as we will see later on, this has a counterpart They are quick because after they are confirmed, the price moves very suddenly in the opposite direction And, finally, they are very profitable because they yield excellent earnings in very little time So without a doubt, for these reasons we are facing the most attractive patterns of all those we have studied up to now What is the most difficult part about them: as always to identify them and to know when they’ve ended My objective here, as in the previous chapters, is to present a wide variety of true examples which will help you identify the figures when they appear on your screen I have selected more than thirty different patterns and I hope that after you’ve studied them, it will be less difficult for you to recognize them Characteristics of the Terminal Patterns Where to expect them Even though there is always a possibility of an unexpected encounter, TPs are generally going to form within the five waves of an impulse pattern or in the C waves of flats and zigzags As we pointed out in the second part, in flat patterns ones as well as zigzags, the third wave which we named Wave C is an impulse pattern It is in these C waves that a TP can form Form Figure 29 shows a black triangle and its vertices are points A, B and V Let’s imagine moving that vertex V of the triangle upwards over a parallel line to the ligther line of triangle (AB) until we obtain point V1 Doing the same thing with point V, but sliding it down the vertical line A-B-V, we would obtain point V2 which together with vertices A and B would create a new diagonal triangle The structure of a TP, will almost always be contained inside one of the three triangles we have just seen Let’s look at some real examples: imagine an upward trend TP like the one shown in Figure 30 If we could grab vertex (V) with the tip of our fingers and slide it upwards, the triangle and the pattern contained therein would become distorted and the result would be similar to figure 31 Fig 30 Upward trend TP 30 chart The same thing would happen with the downward TP in Figure 32 If we were to move its vertex (V) downwards, the triangle as well as the figure contained therein would be deformed, and the new figure would look like the one shown in chart 33 So, within the TP family, we could make certain distinctions regarding these features and there would be some “horizontals” (Figure 30 and 32) and more “diagonals”, (31 and 33) Fig 31 Upward TP chart Fig 32 Downward TP 30 chart x1 V Fig 33 Downward TP 10 chart The difference between these two types of triangles is marked by the bisector1 with the horizontal We will call the triangle with a horizontal bisector a “flat” triangle If we project the vertex of a flat triangle, over the A – B straight line, we would reach a point upon the AB segment (Figure 30 and 32) If we project the vertex of a diagonal triangle, upon that same segment, we would obtain a point which would be higher than A if the pattern is upward (Fig 31) or below B if it’s downward (Fig 33) It seems reasonable to think that the more diagonal the pattern is, the more resistant it is to exhaustion which, in turn, will cause the formation of growing maximums when it’s an upward TP or of decreasing floors when it’s downward Should we expect the retracements subsequent to exhaustion to be sharper if the resistance to exhaustion increases? I can neither confirm nor deny it A last thought on the features: It’s very frequent that before the last upward segment is displayed (the fifth wave) the price takes its time We know that this is a typical characteristic of impulse patterns, which we have already talked about in the first part Generally, the fourth waves take more time to form than the second waves The same thing usually happens in the TPs Furthermore, we have frequently observed that the fourth wave is usually made up of three segments, while the fifth wave is normally a quick wave formed by a single segment Example Third wave in the S&P 500 At the end of a Christmas rally In this second example we’re going to analyze another TP that as in the previous example was formed at the end of an impulse pattern, but in this case with an upward trend Fig 56 S&P 500 Daily chart At the beginning of 2000, after the explosion of the “dotcoms”, the S&P 500 index, as with the rest of the stock exchanges, suffered severe retracements In July 2002 the formation of a floor between 700 and 800 points was initiated The maneuver to turn the index in which the 500 main companies of the NYSE are listed is not easy and it took approximately nine months until in March 2003, the S&P started from 788 points on the way towards the next bubble which was to explode in October 2007, after reaching a maximum of 1,576 Since the beginning of 2004, the long term trend of the S&P is upwards and the figure that we’re going to study in this example would mark its exhaustion, the start of a corrective phase, and at the same time would define the upper directrix of the upward trend channel which would be responsible for the price movement until the end of 2006 (Figure 56) We said that this came about at the end of an impulse pattern, however it wasn’t at the end of a fifth wave, but at the end of a third, as the chart shows Fig 57 S&P 500 15 m chart This is an exemplary TP Let’s look at it in detail (Figure 58): we can see that its features are typical of a diagonal triangle as a consequence of the maximum rises the price develops until its exhaustion Also the typical and “compulsory” retracement of 100% is produced in less time than would be used in the formation of the entire TP, which formed as we said before, in the fifth wave of the third in an impulse pattern, on the S&P 500 between August 2004 until March 2005 Our figure developed its first wave on December 2004 and reached exhaustion the last day of the same month We can say that it was the typical Christmas rally, but in this instance it was interrupted very brusquely Fig 58 S&P 500 15 chart P2 is 40 % of P1 P3 is 62 % of P1 P4 is 60 % of P2 P5 is 62 % of P3 T4 is 78% of T2 The retracement of the second over the first is only 40%, which indicates that there’s only a little selling pressure for the moment Bear in mind that the maximum retracement is 61.8% Coherently with this, the third finishes its projection quickly and runs upward 62% of the first The fourth, as occasionally happens, relates to the second with a ratio very close to 61.8% The only relation requirement as regards time is, as we said, 61.8% between the second and the fourth Depending on where we consider it ends, the fourth is 40%, or almost 80% of the second Neither of the two proportions is close to 61.8% I’ve seen very few TPs in which waves and abide by what the theory of Elliot’s Wave Theory establishes Finally, the most probable ratio between the third and the fifth is 61.8%, and in this case it is Besides, we can see how it develops upwards, concluding the figure with that typical wedge form, with which it reaches a new maximum in the first session of the year, at a rate of 1,217.90 Dollars Before we conclude our discussion about waves, let’s look at the crossing of the 2-4 line which without doubt is the main aspect, and that in TPs is more complicated than in impulse patterns with a trend, due to the greater volatility that usually goes along with these figures Besides the volatility, there’s another element that adds uncertainty, like what we commented in section 1.5.5: There is no minor degree exhaustion, meaning you can’t wait until the end of the fifth wave of the fifth because there are no five visible waves here There can be one, three, two or seven Fig 59 Crossing of the 2-4 line But first, let’s have a look at the indicators: as always, divergences go along with exhaustion We see them in a time chart, and in the last stretch the development of the fifth wave coincides with the divergence of the MACD comes with a failure In the RSI, the maximums marked by the third and the fifth not enter the overbuy area, and since the two downward minimums of the indicator which correspond to the last price maximums, show that the rise is quite forced and immediately afterwards starts to crash Fig 60 S&P 500 Horly chart MACD RSI (14) In the following chart we see the TP in relation with the ADX (14) As we’ve commented before, it’s at the beginning where the trend is strongest that it often happens From that point on the pattern develops losing the trend and then again strongly “pushes” towards the opposite direction of the previous trend This doesn’t happen here At the moment where the price crosses the 2-4 line, the ADX doesn’t cross the +DI as it does on the right side of the chart Neither does it have a lower value There was no shark This is the only aspect of those pointed out as being characteristic of the TPs and which is not present in this example In general, however, this example represents very well the type of TP that we’re studying x1 Fig 61 S&P 500 Hourly chart ADX (14)