Saturday, April 9, 2016

False 5: A lesson in CWT

The basic rules behind Elliott Wave counting aren't difficult to understand.  The rules are all over the web.  So why is it so hard to do very well, even for the most experienced among us?

I examine this question pretty much every day.  I believe that I have put in enough time with Elliott waves that I should, as I have done in engineering, be able to make contributions to the science over time instead of simply being a consumer and practitioner of it.

In any case, some have commented on my willingness to teach.  I do this as much for myself as for the audience.   They say that those who "can", do; while that those who "can't" resort to teaching.   At the same time, the greatest sense of mastery I've felt for subjects has been the result of preparations I've had to make as a result of being called upon to teach it.  And one must master a subject before attempting to make contributions to it.  I guess it's a long way of restating the old saying that when you teach you also learn.

So today's self-learning episode will center around the false 5 concept.  This is not a formal EW construct but it in fact leverages my own GOE concept.  In case you never read me refer to GOE before, it stands for Galaxy On End:

It's part of my self taught pattern matching method for EW. GOEs are associated with penultimate waves, just like HT (Horizontal Triangles) are.  So just as the HT is either a 4th wave or a B wave (both of them being penultimate) GOE is also often seen in the same capacity.  However, while HTs are more often found in the 4th wave position than the B wave, GOEs tend to be in the B wave more than in the 4th.

With this in mind, consider the wave sequence below.  This chart is not directly applicable to a current trade.  This is from 2012-2013 and is part of my research back into months and years of wave formations that play into the counts that I provide in my daily analysis.

Before going into the main point, note that the chart is log scale.  This is generally required on leveraged tickers like FAZ because log scale removes the visual deformation of time value from the Y scale of the charts by converting the Y scale to relative percentage moves instead of absolute price moves.  In log scale of a derivatives (options) levered ticker, the $$ scale is almost meaningless in everything except the very short term.  This is because options, like any insurance policy, lose value as the insurance term plays out.  But the wave relationships are percentage relationships and so a log view of the wave structure is relevant in terms of wave analysis.  If you want to read more about log charts, here is a simple explanation.

So now to the main point.  Each time we see 3 waves down we have to wonder if it is going to end up being a "3" or  "5".  Generally, when you see 5 up following 5 down, that is the EW signal for a trend reversalThe typical trickery we see with 5 up during a larger downtrend is not 5 down and then 5 up but rather the 3-3-5 expanded flat correction.  This is not a trend reversal because a 5 up is not following a 5 down but rather a 3 down.

Sometimes these expanded flats can be very powerful counter-trend moves during the C wave such that they look like a new bull market.  That is of course their job: to suck in more participant interest once previous participant interest has been killed.  So below is a case study.  From red 2 we had a clear 5 waves down into red 3.  But then we had what looks like 5 waves up.  In hindsight that was clearly a corrective move as the correction ended and then the primary downward trend re-asserted itself.  But how would we have a clue about this in real time?  Hindsight is of no use in trading...

The above question is typical of new or would-be EW analysts.  EW is all about odds and it is all about the details;  putt for dough.  Doing detailed analysis is not the human norm. We tend to want fast results (instant, work free gratification) and we reject anything that makes us think or do low level analysis.  Instead, we put "leaders" on pedestals and then follow them wherever they might take us.  This is herding 101 but one need look no further than global politics to see the truth in this statement.

So lets do the deeper dive to see why in fact that apparent 5 wave move was really correction.   The wave below can be counted in two ways.  A good EW counter would count green A as shown and green B as shown and I would agree in both cases.  But then they could count the move up into red 4 as a "5".  Thus they would have their 3-3-5 expanded flat as shown below.

I see that count.  But I do not feel that it is the most natural one to for pattern matching because of the out-sized wave blue 4 relative to wave blue 2.  They don't look like they are part of the same scale of wave and thus I count them as two separate waves.

This is why I came up with CWT (Captain's Wedge Theory) which says that wedges are 3rds or Cs.  So I have re-counted red 4 below using a CWT-centric count which, I think, is much easier to predict and to recognize when it occurs.

Note how a wedge should be made up of five 3s.  That is a-b-c-, a-b-c, five times.  Now if we add in my GOE construct and consider that it is most often found in the B wave you can see that wave B of 3 and B of 4 are GOEs, right as my proprietary wave counting methodology says they should be.
Furthermore, 1, 3 and 5 all respect the same resistance line.  Thus, if you see a 3-3-3 wedge forming, draw the line between 1 and 3 to get the resistance line for 5 which will usually either:
- stop right on the button as shown at left
- stop mid channel on the way to blue 5
- do 5 waves up to the top rail instead of 3 and then 5 more as the throw over

Bottom line, what RN Elliott has called the expanded flat is what I generally call WC meaning a corrective wave (AKA "C wave" because they are a-b-c) and it often appears to be a motive wave up when in fact future hindsight will show that it was in fact a correction.  So in this case since the entire wave forms red 4 you will see me shorthand this as WC4.  It simply refers to as a C wave wedge that formed wave 4.

If all these nuances sound complex, you now know why wave counting is difficult to do.  The concepts are easy but the devil is in the nitty gritty details that make most people's heads spin and they grow bored or they lose patience.  But if you want to increase your odds of winning with EW, this is where to spend your time IMO.

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