A traditional graphic representation of an impulse wave is as follow:

The three gospel rules of Elliott wave formation have to be satisfied:

1. Wave 3 is never the shortest wave.
2. Wave 4 never breaks wave 1 high/low.
3. Wave 2 never retraces 100% of wave 1.

Other than the basic rules, there are four important concepts in impulse wave formation and I’m going to go through them one by one in more details below:

1. Rule of Alternation

This guideline states that wave 2 and 4 of an impulse wave always have distinctive feature(s) either in price retracement or shape/structure. I will discuss corrective wave structures in the next series so just consider there are different corrective wave formations for now. The figure below is one example of rule of alternation:

In this example, wave 2 and 4 are different by their shapes: wave 2 is a zigzag and wave 4 is a sideway triangle. This is a guideline, however, when the rule is not adhered to (i.e. the two corrective waves appear similar to one another), it is highly suspect that the five wave structure could be a corrective wave.

2. Rule of Wave Extension

Most likely than not, there is one extended wave (usually much longer than the rest) in every impulse wave, however, wave 3 is never to be the shortest one even if wave 1 or 5 extends. An extended wave will subdivide further to another impulse wave and its length will be longer by usually a fibonacci ratio (1.618, 1.382)  to the next longest wave. The following figure shows an extended wave 3 (the more common one):

This guideline is useful for forecasting because the other two non-extended waves would usually be about the same length (wave 3 will always be the longer one of the two when it is not extended).

3. Terminal Impulse Wave

Terminal impulse wave formation occurs as a subdivision of a wave 5 or wave C of a corrective wave. Only in this formation a motive wave is divided into 3 – 3 – 3 – 3 – 3 instead of 5 – 3 – 5 – 3 – 5 (usual subdivision). Another common name for this formation is an ending diagonal triangle.

This formation signifies an end of a trend and it is commonly followed by a swift retracement.

4. Failed/Truncated Impulse Wave

There are times when the crowd sentiment becomes extreme and the trend seems to be out of breath. When this occurs, wave 5 of the impulse wave can ‘fail’ or not exceed wave 3 high/low. This commonly occurs after a strong wave 3.

Note that the subdivision of a failed wave 5 is still a 5-wave structure.

Knowing and practicing these concepts in real life will help you identify where the stock market is at. An impulse wave can be:

• A part of a larger impulse wave in the direction of the trend
• The beginning or the end of a zigzag (5 – 3 – 5) corrective wave.
• The end of a flat (3 – 3 – 5) corrective wave.

Finding a completed impulse wave is usually the first thing I do to recognize a new pattern. Once I find one, I can trace the one before or after to determine where the larger trend is. The good thing is that impulse wave is usually very clear as well, unlike its counterpart, so spotting it should not be difficult.

If I think or find of something else factual about impulse wave, I will add it here. For now, I hope this is a good introduction for anybody who’s interested in Elliott wave.

RH

I have to admit this rally to new high does not make sense and unexpected to me, but the probability was getting higher when I saw the Nasdaq breaking 61.8% retracement line two weeks ago. With US dollar turning up and gold turning down, I was certain that it would be a turning point for the stock market.

That was the past now and I’m looking at the long term picture now whether this rally is a new bull market or still a bear market rally. Fundamentally, every country in the world appears to be drowning in debt and even communists like China is hoping for a hot market growth to ensure the flow of money is smooth. Europe is battling major deficit in 4 out of 16 Eurozone members and many US states are practically bankrupt if their lenders force loan repayment next week. Canada, Australia and New Zealand appear strong despite having their own budget deficit, but the scale is much smaller (in percentage of GDP) compared to US and Europe. Add this to reduced tax income to all those countries above because of high unemployment.

Technically, the whole bear market structure between 2000-2007 can be considered complete with the last bear market (2007-2009) so this rally can really be the next bull market. I’m still counting the rally (in S&P 500 and TSX above) since March 2009 as an ABC in my charts above, but if the wave structure since Jan 19 is going to form a flat (meaning that the next move will be a 5-wave down), then I may count it as an incomplete impulse wave. Wait until this rally and the subsequent counter-trend wave are complete before jumping back to the bull bandwagon.

CBOE S&P 500 volatility index (VIX) has come down a lot since the big drop in January and it appears likely that it will form a new low, unless the market starts to turn around early next week.

This year is an important year because it will decide whether we are plunging into the next great depression or the next great bull market in the following 5-10 years. My take is that it should be clear enough by end of summer which way we are going.

In order for this rally to become a new bull market, people have to have confidence in the economy i.e. it will keep on growing so the surplus tax receipt can be used to pay government debts. That way, maybe our current debt will be paid in about 30 years when the next generation is wondering why their taxes are still high. Logically, this is the wrong way to run the economy. A country is assumed to ‘live’ forever so having lots of debts and paying them slowly are okay in theory (as long as it still pays), but its population grows old and die, and the new generation will not always understand why they are forced to cut back (in many forms) to pay for previous generation’s debt. In the end, when times are good like in the 90s, next generation governments may relax economic rules again in order to rack up more income, which will again lead to an economic bubble. This cycle just keeps on repeating and it forms the basis of many cycle forecasting method including Elliott wave theory.

This recent forecast mistake reminds me again on how hard it is to use Elliott wave theory (even in conjunction with fundamental indicators) in pinpointing the turning point. Maybe I shouldn’t do that as per many trading books advices, but my inner greed and fear still find it difficult to wait on the sideline until a clear sign appears. So that’s my homework this year.

Safe investing,

RH

If this rally makes another new high, it will be the 2nd time (first one in July 2009) I was wrong calling the turn and surprised with the resiliency. Just like a marathon runner, there has to be a time when the stock market has to take a breather and we haven’t seen a similar degree breather in almost a year. Now whether that ‘breather’ will take us to a new bear market or just a short correction is a foggy subject for me. I hope it is just a short correction, which means the worst of the bear market was over in March 2009. But it would also mean that our fiat money economy will still be in play in decades to come, and it is not a good news for future generation. On the other hand, if it starts a new bear market that carries us to new low and perhaps a financial system revolution, it will be painful (perhaps very) to all of us but the coming bull market will be based on perhaps a sounder financial system.

Back to the current situation,

S&P 500 has been retraced by about 61.8% and VIX has dropped to the 20 point mark again. As I mentioned before, trading volume has been slowing down significantly in this rally compared to the volume during the drop, which indicates that a strong move is coming. Is it up or down ? I’m leaning towards down since there has not been any strong market news coming out during the rally. I’m not one who usually makes forecast based on news but news writers usually can be very convincing with their articles e.g. stocks up with good news and vice versa. However, when the US Fed Reserve increased their emergency interest rate (not the overnight lending rate), I saw Western news trying to justify Asian market drop the day after with the news, but when the US market ended up higher, they seemed surprise as well. Mixed up condition like this usually fuels speculative trading and also conspiracy theories in many blogs, which basically means, it is unclear where the market is going right now. When some big money comes in or out and moves the market to one direction big time, I believe trading volume will pick up again to that direction.

The stop here should be 1,130 on the upside and 1,080 for the downside. Any movement beyond those points would change or reinforce my forecast that the market is going in that direction even though it would not satisfy any Elliott wave rules yet.

Similar juncture is happening to the Canadian TSX index only amplified. TSX has retraced over 61.8% of the drop in this rally. Commodities and commodities stocks have rallied strong in this rally, which fueled TSX rally, and Canadian dollar has been resilient as ever. Although US dollar has move a lot against other major currencies (GBP, Euro, Yen, AUD – less but still strong), Canadian dollar has been holding its value. Our strong currency is probably a big factor in our strong real estate and stock markets as well. One thing I learn in the last few years though, Canadian market tends to amplify US stock market movement. So if the US stock market crashes again, our market will follow in stronger moves.

Safe investing,

RH

To explain what a wave is, the first thing I thought about is what makes a wave. A wave is formed by a combination of many trading actions in a period of time (can be 5 minutes to a month). According to Glenn Neely in his book “Mastering Elliott Wave”, at its simplest form, a wave is a price movement of the market starting from a change in price direction to the next change in price direction occurs. Glenn calls this a monowave. Bob Prechter wrote in his “Elliott Wave Principle” book that a wave is any one of the patterns that naturally occur, as described in the rest of his book. To elaborate, Bob wrote that market’s progression unfolds in waves, which are patterns of directional movement.

In my own words: a wave in stock market is a one directional price movement within a period of time, which is caused by a combination of emotion-driven trading action.

I find that my dictionary definition does not really help me in my forecasting. In fact, Glenn Neely’s definition is by far the most descriptive. Here is what he meant by a wave:

In graphical sense, a wave ends when the price moves to a different direction, however, it would have to be confirmed by another movement in the different direction that exceeds previous extreme.

If there is a slight change in the slope (as long as it’s not going to the other direction), it would still be called a wave. Glenn goes more in depth in his book to explain what is the best way to plot the data so that the wave pattern is clearly visible. Since Elliott wave count requires a full view of market activities, one must consider the whole price movement in the trading period during the wave count i.e. do not use only the high, the low or the close data only. As you can see in my market analysis section, I have been using the bar chart as my chart view. By using the bar chart, I am able to see the high and low of the day as well as the open and close data, giving me a good summary of what happen during the day. I also found that if my trading horizon is daily for example, I should look at the price movement in smaller time frame (60 min let say). So the time frame of your chart depends on how far you want your forecast to be. The longer it is, the longer you may have to wait for the pattern to show up.

As you plot your data, you will find that there are many smaller monowaves in terms of price movement and time spent. These are still monowaves. They are just probably in different degrees, which is what I usually call wave subdivision in my analysis. When you see all the monowaves in your daily chart, you will see that in general, the waves move in one big direction, which is the general direction of the market at that period of time. All monowaves have to be categorized into either a 5-wave group (impulse) or a 3-wave group (corrective) according to the rules that Elliott stated in his work (see Introduction).

RH

The structure so far is looking like S&P 500 has finished wave 1 (i) of 1 and 2 (ii) of 1, and wave 3 (iii) of 1 is currently unfolding. I was quite surprised that wave 2 only lasted 3 days (Feb 1 – 3) and it retraced less than 38.2% of wave 1. But, since wave 1 low was convincingly broken, RSI is still not oversold and retracement level is just a guideline, I’m going to call that wave 2 is over now. This premise will be proven next week: if wave 2 high (1,104) is broken, then this drop is just part of wave 2 otherwise, S&P 500 will probably drop below 1,000 next week.

VIX has also made new high with the recent drop, which usually coincides with an impulse wave not a correction. VIX should be making new high as wave 3 unfolds.

Nasdaq composite pretty much mirrors S&P 500 price movement.

Similar comment to Canadian TSX index.

Economic news have been mired with bad news lately with Toyota’s problem (which appears to affect Nikkei index badly), the newly infamous acronym PIGS (Portugal, Italy, Greece and Spain) that showcases Europe’s economic problem, and lets not forget Dubai is still hanging on a debt lifeline. However, there are also still some good news like the unemployment rate drop in the US and Canada. At this stage of the game, the stock market and main street economy are expected to go their own way since fundamental economy always lag the stock market. Really bad news would not probably come up until the big wave 3 is unfolding. I still expect to see more recovery news in the coming weeks.

Safe investing,

RH

Well, this feels like my first post again. Many things in my blog are still not quite working like it used to be (e.g. the categories), but I’m trying to fix it as much as I can. Either way, I’m going to start building my archives again. My last post was about three weeks ago and I was expecting for more rally points before the corrective wave structure since March 2009 appears complete.  On Wednesday Jan 20, 2010, US major indexes started a three-day significant (>1%) down moves. With gold and US dollar started their respective moves in early December and financial stocks like JPM and GS also didn’t make new high in January 2010, I am expecting this current downturn to be significant and will mark the end of the bear market rally.

I call it significant because I don’t know how far it will fall. Bob Prechter has called in his books that this bear market will bring the stock market to below 1,000 in DJIA (and similar ratio to other indexes), while Glenn Neely has called for a drop to around 4,000 – 6,000 in DJIA. My opinion ? It is going to be a long bear market and I will not call an end to it until the wave structure and other market forces (commodities, currency) turn around pretty much in sync like now.

S&P 500 appears to finish their bear market rally just above 50% retracement of what it has lost in the 2007-2009 bear market. As far as I see, the last three days have been the strongest down days in this rally, which shows in the 2nd chart (VIX) above. VIX shot up about 10 points in 3 days just like the 2008 bear market days.

On the technology side, Nasdaq appears likely to finish their rally just above 61.8% retracement of what it has lost in the 2007-2009 bear market. Although it appears stronger than S&P 500 and DJIA in this rally, we have to remember Nasdaq did not make new high in 2007.

Our commodity-rich Canadian stock index (TSX) has also turned around just before achieving 61.8% retracement of what it lost in 2008-2009 bear market. With commodities expected to turn lower, this index will also be affected unfortunately. Plus, Canada still relies heavily on US buying most of our products and natural resources.

One of my good friends and I have been following some of the most famous financial stocks like JPM and GS. In the chart above (red – Goldman Sachs, black – S&P 500), GS has been resuming its downward turn since mid October while S&P 500 has been rallying further with DJIA and Nasdaq Comp. This phenomenon also occurred with other major financial stocks like JPM and WFG, which indicates a weakness in US financial sector. Since financial is the major theme in the current bear market, I think this can qualify as a warning especially since gold and US dollar made their move already in December 2009.

In my last lost article, I believe I wrote three possible scenarios: deflationary depression, inflationary depression and bull market continuation at this time. As far as I see right now, the conditions seem ripe for a deflationary depression plus the similarities between our current condition and Japan’s in 1990 are plenty, which adds another supporting argument for a deflationary market. However, I like to add again that inflationary condition will happen after a few years when world governments effort to inflate the market will finally work once more. I guess all this is just a matter of balancing the money supply, which I don’t think can be achieved in a much subtle string of events with the way we define our currencies right now.

Safe investing,

RH

As you can see, my blog has reverted back one full year…Due to my newbie-ness in blogging, my blog has been hacked and because I have no backup on my computer (only on the server), I had been forced to restore a much older backup files.

Again, because I don’t know too much about website development, I didn’t know if I could have restore it better. I will salvage what I can and restart in 2010. For those of you who has your own websites, please back it up often so this doesn’t happen to you.

Although my website doesn’t have anything that I can’t rebuild, it still sucks to be hacked. If the hacker reads this, man…do your prank somewhere else please.

Admin

Dow Jones Industrial Average (DJIA) is still staying between the high and low extremes I set last week as an indicator for whether wave 5 is still coming or it is over. Although I can’t rule anything out yet, it seems that wave 5 is still coming considering how far the price went down last week.

Nasdaq 100 ETF (QQQQ) has broken the low extreme I set last week, which could be a sign that further low is coming soon. Note: Sometimes when such an extreme is broken, a short rally comes right after it. This happened a few times in the last year and as far as I have seen, more likely than not, this is a good position to make a bear trade. QQQQ should trade lower next week.

S&P 500 has also broken its low extreme, albeit in smaller scale than Nasdaq. Again, once this rally is over, S&P 500 should go lower and start wave 5.

CBOE Volatility Index (VIX), which tracks volatility in S&P500, raised slightly through last week, but nothing else is catching my eye so far. I’m curious to see whether wave 5 will bring VIX to a new high.

Toronto Stock Exchange Index (TSX) has not broken its extremes yet, but it got close to it last week. As with DJIA, wave 4 is probably tracing its last leg (likely to finish a triangle formation) before wave 5 starts. Wave 5 could start as early as monday this coming week. TSX weekly chart (lower chart) is showing the clearer picture from higher up that TSX needs to finish another wave to complete the impulse wave.

The storm is not over yet, but after wave 5 is done, there should be a lasting rally for a few months.

Safe investing,

RH

We are in a confusing juncture at this moment in the stock market (US and Canadian). I’m pretty sure that there are many different valid wave counts that may be happening right now but so far I have narrowed down my focus to just a few.

There are 2 wave counts that I’m focusing in DJIA. First, we are still in wave 4 (italic red) that is tracing a flat formation. If this is true, we are probably in wave ii of 5 (italic red) and DJIA will pull down sharply next week.

Second count: this one came from looking at the possible wave count in Nasdaq 100 ETF (QQQQ). In this count, DJIA finished wave 5 (italic red) last week on Oct 27 (at ~8,144) and we are in wave 4 (bold red – larger degree). Yes, this is a truncated wave 5, which according to Elliott Wave Principle (Frost & Prechter) usually happens after a strong wave 3 (true in this case). If this is true, the market should rally in the coming weeks. Even if this count is true, the market will have more downward potential in the near future.

I have included two extreme points, if DJIA passes the high extreme (~9,800), then the larger wave 4 (bold red) has started. If it passes the low point (~7,880), then wave 5 (italic red) is still in force.

As mentioned above, the wave structure in QQQQ is showing that wave 5 (italic red) may have ended last week. Again, there are two useful extremes here, if QQQQ passes the high extreme (~36.2), then the larger wave 4 (bold red) has started. If it passes the low extreme (~28), then wave 5 (italic red) is in force.

S&P 500 index has the same story as DJIA. The high extreme in this case is ~1,046 and the low extreme is ~839. At this point, VIX is still beyond the normal range (that I know of in the last 5 years) so I can only use this as a supporting indicator. In any case, US market will still go down and VIX should make new high next year.

TSX (Toronto Stock Exchange index) is at the same juncture as DJIA at this point, but if I look at the weekly chart, it seems that a corrective wave is forming right now.

I wish it’d be clearer because I’m thinking to trade the larger wave 4, but this is just how Elliott wave principle works.

Safe investing,

RH

http://cgi.ebay.com/Elliot-wave-Trading-Software-for-Personal-Investing_W0QQitemZ250321793149QQihZ015QQcategoryZ3768QQssPageNameZWDVWQQrdZ1QQcmdZViewItem

I do not have any relation, link or endorsement over this product and I did not know about how my blog is being used so far. As of now, I still use this blog as my personal practice tool in building a website and exercising my wave counting technique. I do not have any business interest off this website yet.

Just a precaution for you who visited my blog through this ebay link.

RH