Sunday, July 3, 2011

Understanding the Labeling and Where Patterns Start

Click on Chart to Enlarge

One of the concepts I have used on this blog as far as market pattern analysis is Elliott Wave structures and some other more objective rules to determine where patterns start and end. The basic concept is that the trend is the direction of the highest velocity moves. Corrective moves against the trend will either be slower velocity or smaller in size, or both, than the trending moves. A change in trend, and by extension a new pattern, starts when a prior trending move is completely retraced in less time than it took to form. So think about the logic on that. It means that the opposite direction is now showing stronger price movement. That is the new trend direction. So once a move like that occurs, the labels of the next patterns, or successive waves, will be grouped together until there is again a change of direction.

So on the charts I post, the labeling is not always like standard Elliott Wave labeling. There will be some differences. A simple way using a chart to visualize this is to draw a rectangle around certain areas of price movement, then copy the rectangle and drag it to an adjacent area to see if the new price move happens in less time than the prior one. This type of rectangle also can be used as a hypothesis or a litmus test (in combination with a few other rules) for whether a proposed pattern labeling is correct and whether a pattern has completed or not.

The chart below shows some such boxes and the arrows point out where prior waves are completely retraced in less time than they took to form. Another instance I didn't box is from the June 2010 high to the July 1st 2010 low which retraced the immediately prior wave in less time than it took to form. Now while I don't have boxes on here to visualize this, a new downward patter could possibly have started on June 1st of this year. However, based on what has happened since then, it probably was of a smaller degree and the upward pattern from mid-April is still forming.

Click on Chart to Enlarge

Now when you start putting the patterns together and building them into Elliott Wave structures, you can track the unfolding progress as such (see below). There are some other rules like "b" or "2"must be more time consuming than "a" or "1" in flats, zig-zags, or impulses, that determine whether I label something as "a" then "b" or "w" then "x", etc. But I will not go into all those here.
Click on chart to Enlarge

Sentiment data can at times be very useful in confirming a labeling sequence or give you insight into the psychology behind the waves. For instance, last summer, the AAII survey hit its most bearish level of the correction right at the end of August even though price was at a higher low than the July low. This is good confirmation that the psychological price trend was still down until then, and no pattern had completed at the July low. Then the move to follow retraced the prior wave down in the same amount of time than it took to form, indicating the trend had then changed.

Click on the Chart to Enlarge

On a shorter time frame and more technical note, there is not any bearish divergence on the 60 min chart of the stock averages right now, suggesting that there needs to be some time and consolidation before a significant pullback will occur. But based off of the larger pattern implications, it could be a very significant high when it occurs, and should lead to a very explosive downward move if the pattern labeling above is correct and an upward flat pattern is completing.

A couple of the other rules are that after a flat pattern completes, the following price action must completely retrace wave "c" of the flat in less time than it took to form. Also, the trendline from the beginning of the pattern to the low of wave "b" in this case, should be broken in less time than wave "c" took to form as well. Since that trendline is downward sloping in this case, the following move should be very explosive if this is correct.

1 comment: