Saturday, October 3, 2009

EW Q & A

Anon wrote: "Trying to grasp the elliot wave idea but it is impossible to determine what wave count because it keep changing depending on when you start. Looks great in the rear view mirror but going forward, how do we possibly now if where we sit?"

It is true that the public stock market fits the description of a giant 5th wave. That is why so many IPOs zoom up into a sharp 5th wave advance, then go right into an ABC that takes the price lower than the debut. To label these properly, you have to call the starting point "4." Certainly the whole era of paper stock ownership could be viewed as a large degree Wave 5 extension layered on top of the historical price action of capital markets.

That's not really important when counting waves in the macro market, because we still have complete 12345ABC cycles within the one big public mania that defines "the stock market." But you are right, every wave count within our modern stock market is up for interpretation. With that in mind:

The way I start--to put a stake in the ground--is to match known macro waves with known Elliott wave personalities. This is where the fundamental usefulness of EWs rests, in that we know human behavior imparts wave personalities on price action as it unfolds. From there, we extrapolate a fractal pattern, which is never a simple "to scale" exercise and why every other form of technical and fundamental analysis eventually flops.

In important ways, EWs are actually "more fundamental" than simple fundamental analysis, because EWs alone take into account that humans operate these companies with predictable human nature. So trends are never perpetual straight lines as financial fundamentals force one to believe. Only EW analysis, because it is more natural, cyclical, and comprehensive than extrapolating simple straight-line growth, can reliably call reversals of trend at specific points.

Calling reversals, both up and down, is where the real money lies, because you capture both the price change and the premium baked into the erroneous belief that things will never change. We are sitting on one, today.

So where do we start? By manually matching wave personalities, a known analytical solution, to the known empirical solution derived through experience.

Let's do it. Here are the 8 wave personalities:

Wave 1 - A "good idea" takes flight.

Wave 2 - After some degree of success, bigger investors are attracted to the idea. The overhead of consolidation usually decreases the price by some common Fibonacci ratio.

Fibonacci ratios are just a natural manifestations of how groups come together and split apart, with respect to the last group's

0 - 1 - 1 - 2 - 3 - 5 - 8 - 13 - 21 - 34 ...and so on...

Each number in the series is the sum of the previous two. The comparison of each number to the previous one homes in on the golden Fibonacci ratio of Phi, or 1.618... The inverse of Phi is 0.618... Skipping a number in the series, then comparing, gives differing ratios that we also commonly see in stock market price action, like 2.618...

Wave 3 - The "smart money" takes the idea as far they can. The 3rd wave is usually the biggest wave of price advance when analyzing stocks.

Wave 4 - The smart money wants to sell high, so they offload the idea to less savvy buyers, let's call them the "dumb money" or the general public. This is often (but not necessarily) a relatively orderly sideways price action. Wave 4's often take the form of a contracting triangle, as the most savvy investors get out, then the lesser savvy take a little more convincing. When the least savvy of the smart money gets out, Wave 4 terminates.

Wave 5 - A public mania surrounds the idea, and the price shoots up quickly but unsustainably, as the idea has already been spent. Fibs continue to apply.

Wave A - The unwarranted price spike (some might call it a bubble) inevitably leads to a big correction. The A wave crushes the fickle first.

Wave B - The most staunchly convinced of the "dumb money" buy back in, now. They view the A wave termination point as a great buying opportunity, but the smart money stays away. The resulting Wave B peak is typically even more maniacal than the Wave 5 peak, and sometimes exceeds the Wave 5 price on even lousier fundamentals.

Wave C - An even more devastating collapse occurs, often a pure Phi Fibonacci, or a 62% decline from the Wave 5 top.

So there we have the basic personalities of a complete "market cycle," at least as I explain them. It is important to understand that within each wave are fractally self-similar subwaves, down to second-by-second ticks, which trace out clear Elliotts.

The above is a recap of R.N. Elliott's genius, from this point forward is nothing but my opinion.

I believe that we know a few things. I will call them facts:

- From 1929 to 1932 there was a 90% correction.
- Since then, we've witnessed a pretty clear Wave 1, 2, 3, 4, 5
Some sort of correction from 1929-1932
Wave 1) 1932-1939
Wave 2) 1939-1942
Wave 3) 1942-1966
Wave 4) 1966-1974
Wave 5) 1974-2000
Let's match EW personalities to these waves:

Wave 1) 1932-1939. The "good idea" (or, the "New Deal") is government peddled inflation to ensure that markets will never go down in any significant way (which of course, EWs prohibit). The collective can insure the individual investor. Private central banks are the sellers and profiteers from the inflationary cash. FDR was their salesman. The general public was the buyer.

So immediately, I see something interesting. The original "good idea" has a strong Wave 5 flavor. So my thought is that 1929-1932 was actually a rather disorderly Wave 4 correction. That makes 1932-2000 a very large scale Wave 5. Continuing to subdivide that Wave 5:

Wave 2) 1939-1942. Sharp zig-zag (ABC) correction. Takes the Dow back below 100.

Wave 3) 1942-1966. Best fundamentals of the advance. The glory days.

Wave 4) 1966-1974. A long, more sideways correction. Great Society extends the original idea. US dollar is removed from the gold standard in 1973 to facilitate the original "good idea." But that kind of price growth (pure inflation sans fundamental strength) clearly isn't a sustainable way to advance.

Wave 5) 1974-2000. The public buys in. Mutual funds encourage mindless check writing. "Buy and hold" is sold to transfer maximum wealth. No one knows where their monthly checks are going. A mindless stock mania ensues. The government is used to pin public money down for the taking via IRAs and 401Ks. It's a set up; a dumb money disaster looking for a time to happen.

Wave A) 2000-2002. The dumb money gets clobbered by half. But the declaration of an A wave completion is certainly up for debate. W12345 took 78 years. Is two years long enough to complete a suitable Wave A?

Wave B) 2002-Oct 2007. Definitely fits the personality type of an even more intense public mania, coupled with a nearly vertical price culmination. But this could also fit into a larger scale, subdividing Wave A.

Wave C) Oct 2007-Present Day. You can see my labeling as it unfolds, posted on this blog. So far, C has been a very predictable cash cow. I hope it stays that way. One trait of the entire ABC corrective phase is poor predictability, so no guarantees.

Interestingly, we aren't done yet. That Wave C can't end this decline, based on my interpretation of 1929-1932 being a larger degree Wave 4.

...more on how this unfolds, later.


  1. Hey FDR,

    Thank you for the intro to EW.

    I personally am convinced that we are going to have a combination of monetary inflation and asset deflation with the ratio of each to still be determined.

    What are your thoughts on this and, what ways would you refute or support it?

    I gather you are leaning more towards a collective deflation.

    I'd love to hear your thoughts!


  2. Don't you just love socio-economics and divining the zeitgeist. That B wave stuff sure fits the last few months to a T. Now is it all just going to go to pieces for years and years? The suspense is killing me.

  3. "I gather you are leaning more towards a collective deflation. I'd love to hear your thoughts!"

    Ok here they are:

    There is no reason to think; we already know.

    I believe that 1929-1932 was a large degree Wave 4. Therefore, we should be able to locate Wave 1, 2, and 3.

    Wave 1 should be the original "good idea" of central bank peddled inflation, and sure enough, we have exactly that in the FBUS/SBUS.

    Wave 2 was Andrew Jackson's single handed defeat of SBUS (thank you, God, we could use another AJ about now) and it was was in fact massively deflationary. The entire U.S. cash supply was extinguished. Worst depression ever; the 1930's were mild by comparison.

    Wave 3, 1841-1929, is not that important to this discussion.

    Wave 4, 1929-32, was obviously deflationary as well.

    Both W2 & 4 are, by Law of Nature, "pilot programs" for the larger but fractally self-similar A-B-C we are undergoing now. Particularly W2, above. That is, our A-B-C will form a larger degree W2.

    That means our Fed ultimately dies to usher in our mammoth Wave 3. Yay! The bad news is that it will take years-to-decades to complete.

    Our future is already known; there is nothing new under the Sun. Deflation wins because our first W2 (1836-41) tells us that deflation wins.

    Think that's crazy? Well, a lot of people told me I was crazy for "forecasting" an imminent and certain deflation as stocks roared past Dow 14,100K. But the up-count was complete, W2 has already been demonstrated so there is no guess work involved.

    I wasn't "predicting" a thing; I knew human history and where to look, and they didn't.

  4. Thanks for the blog FDR, I've been a reader since around inception, by chance. I am a builder in Maine, not much invested but always thinking of business and applications. EWT is intriguing, it seems it would apply to business ventures and other entities run by humans, my question is on it's own scale where is EWT? I don't want to invest my time if Elliot wave is on it's own Wave 4.

  5. Nice piece of writing !

    Above on wave 5, who was the architect behind ending company retirements and shifting to the 401k and mutual funds era. Perhaps a bigger ponzi than social security.

    With the trillions of dollars that were fleeced out of peoples 401k, where did most of that money go ? Would a good start be the people that live in the Hamptons?

  6. Price of gold is right where it should be.

  7. "Price of gold is right where it should be."

    Wrong thread. Another way to look at not selling expensive suits is a reason their stock dropped 80%.

  8. There is a very good, albeit long read posted at Zero Hedge this weekend entitled Kessler Market Commentary( Absolutely required reading for anyone doubting the deflationary future we face.

  9. Great EWT posting!!

    Excellent information needed to be read and re-read several times to fully grasp and understand.

  10. This guy looks at elliot wave too and says we are going to new highs...

  11. oops looks like you called a 9500 bye bye too early:-).I hate to see you go wrong since you have been on mark on almost everything till now.

  12. FDR the australian RBA has hiked the interest rates.What do you make of it? Harbinger of things to come globally and what are its ramifications?

  13. FDR - today gold hit a new record high. What level would gold have to reach to make you change your mind about shorting it?

  14. FDR- P2 looks a live and well. Do you still think 9500 is gone for good? My shorts are getting fried and inflation in the market is alive and well


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