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?"

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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 size:

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.