Look: I am eager to learn stuff I don't know--which requires actively courting and posting smart disagreement.

But as you will understand, I don't like to post things that mischaracterize and are aimed to mislead.

-- Brad Delong

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Everything that appears on this blog is the copyrighted property of somebody. Often, but not always, that somebody is me. For things that are not mine, I either have obtained permission, or claim fair use. Feel free to quote me, but attribute, please. My photos and poetry are dear to my heart, and may not be used without permission. Ditto, my other intellectual property, such as charts and graphs. I'm probably willing to share. Let's talk. Violators will be damned for all eternity to the circle of hell populated by Rosanne Barr, Mrs Miller [look her up], and trombonists who are unable play in tune. You cannot possibly imagine the agony. If you have a question, email me: jazzbumpa@gmail.com. I'll answer when I feel like it. Cheers!

Sunday, August 21, 2011

Doing the Wave

In comments here, Art asks about the significance of wave 3 vs waves 4 and 5.  As a rank amateur wave-rider, I'm no Elliott pedagogue.  You can get a primer on Elliott Wavery here.  For now, suffice it to say that Elliott wave analysis is a protocol for assigning order to the apparent chaos of movement in financial markets.  In this system of order, movements fall into repeating patterns, as Art alludes to here.  But in the real world, things are never really simple.  The patterns repeat in a generalized way, not often in ways that are super-imposable with some scale factor - although that is sometimes the case.

They also repeat at various levels of trend.  Strip the time scale from a stock chart and there is really no way to tell if the scope is an hour, a day, week, month, year, decade, or century.  A pattern that repeats its general form at all levels of magnification is called a robust fractal, and that is a pretty useful way to think of the stock market.

Ralph Nelson Elliott devoted a big chunk of time to studying the historical movements of stock prices, and discovered the wave patterns that bear his name.  Briefly, the current main up or down thrust of the market takes the form of an "impulse" wave.  The impulse is divided into 5 subwaves of alternating direction.  Waves 1, 3, and 5 are in the direction of the impulse (either up or down,) while waves 2 and 4 are counter-current, or corrective, and fight against the main thrust of the impulse.

Waves 1, 3, and 5 - since they are in the direction of the impulse - are also impulse waves, each with its own 5-subwave structure at a level of trend that is one degree lower.  At every level of trend there are relationships that occur probabilistically among these waves.  Wave one is often the smallest.  Wave three is NEVER the smallest, and is often the largest.  The lengths of these waves in price terms are often related by Fibonacci ratios: wave five might be 0.62, 1.00 or 1.62 times the length of wave 1, for example.  Even to a rather casual observer, the directional thrust of an impulse is often quite easy to discern.

Waves 2 and 4 are more dicey in their form and interpretation.  Since they are going against the impulse, they struggle, and that can give them complex contours, with no easily identifiable shape or direction other than sideways.  In fact, Elliott was the first to recognize that a large scale sideways motion is a bear market manifestation (since the highest level trend is up.)  Ulimately, waves 2 and 4 can each be resolved into a 3 subwave pattern, with the subwaves labeled A, B, and C.  So, its numbers for the impulsive waves, letters for the corrective waves.

One of Elliott's "rules" is the principle of alternation.  If wave 2 is a simple A-B-C, then wave 4 will be complex, and subdivide in ways that I will not attempt to describe.

The numbers that are most important in Elliott Wave analysis are Fibonacci numbers and Fibonacci ratios.  The retracement of a 2 or 4 wave is often a Fibonacci fraction (.382, .50, .618, etc) of a related impulse wave.  Third waves are generally the big movers, which is why I highlighted the third wave that started this conversation.  C waves are also third waves, and when they point down, can be devastating.  There's a lot more to it than this, but I hope this simple explanation is helpful to anyone who wants to understand how I interpret the market movements.
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3 comments:

Suzan said...

Damn.

Tell us more, babycakes.

Majid Ali said...

Please for Christ sake help this poor boy from Haiti

The Arthurian said...

Thanks, Jazz. A little context to go along with your frazzled-market posts.