Stuart, a reader, asked me an excellent question that I wanted to share with you all which raises some interesting questions we may need to discuss. he noted that the proposed Elliott Wave count in 2002 was very similar to the current structure, and noted that the bottom – using Elliott Wave – could not have been predicted. Let’s take a look at what he means and then try to determine if we can apply this lesson to today’s Elliott Wave count (and add an additional viewpoint to the current “Which Wave 4″ debate that continues).
Stuart asked me to take an objective – no bias – look at the market from 2000 and stop early October 2002. I’ve tried to do that and recreate how I would have interpreted the Wave count at the exact – though clearly unknown – bottom of 2002 in the S&P 500.
SP500 Elliott Wave Count in 2002:
Click for larger image.
I suspect we could have had yet another spirited and valid “Which Elliott Wave 4 are we Currently In?” debate then just as now. I have applied my best, objective analysis, and would have stated something similar to these lines:
“We see the moving averages are in the most bearish orientation possible, and we may have just completed the final fractal wave 5 of the larger Wave 3 impulse. This means we’re likely to launch into a larger fourth wave which could take us up to 950 or perhaps 1,000 where we would meet resistance from the falling 50 period EMA and from the September 11th price lows. Also, the 38.2% Fibonacci retracement of the entire Wave 3 impulse lies at 980, so the 950 to 980 level would reflect confluence initial resistance. Note the development of a multi-swing positive momentum divergence, which further clues us in that the 3rd wave is complete at this time and a corrective “ABC” Fourth Wave may be emerging soon.”
After Wave 4 completes around these levels, we would have another 5-wave fractal impulse to the downside, which would roughly equivocate Wave 1, which took us from roughly 1,500 to 1,100 – a 400 point move. If Wave 4 terminates near 980 to 1,000, then the Final 5th Wave should take us down to 600 or so on the S&P (these are rough approximations of course without the finer details).”
I suspect there were even more bearish price objectives than 600 at that time – I was not applying Elliott Wave analysis at all during this time period, but rather had a more fundamental analysis view of the market sprinkled with basic chart reading (I had not fully discovered or embraced technical analysis at this point, though the 2000-2003 Bear Market forced me to seek alternate sources of investment/trading knowledge).
Stuart’s point was that – applying classic Elliott Wave counts would have most likely (if not certainly) caused the analyst to miss the bottom fully, particularly if he or she held rigidly to the most likely wave count (as I interpret it – I have not sought other sources on their wave counts at this time) that I have labeled above.
Update: Reader Andrew in the comments portion suggested that instead of ‘fishing’ for 5 Waves, we should have been looking for 3 Waves – ABC – for a larger scale Corrective Phase. That would be in keeping with the larger-scale notion that we are currently in a large-scale Expanded Flat (Where A would have 3 waves, B would have 3 waves, and C would have 5 Waves. More on this later).
Here is a possible “ABC” Three Wave Corrective Phase Count that may be more in line with proper Elliott Analysis than the 5-Wave count above:
Under this count, Wave A terminated at the September 11th 2001 price lows with Wave B swinging up into EMA resistance and then Wave C terminated at the absolute bottom in October 2002.
Now, let’s step forward one year and see how this played out. Remember, at this point – the exact 2002 bottom – we have a highly probable and internally valid Elliott Wave count that has us at the terminal point of Wave 3 down.
I’ve taken away all the fractal waves and focused on the major Waves. Keep in mind I’m now labeling waves with hindsight.
Sure enough, Wave 4 played out as expected, finding overhead resistance actually shy of my target of 980 to 1,000 (based on the 50 week EMA and 38.2% Fib retracement). One can see a small-scale “abc” pattern that terminated at the highs.
Now, one can count out a 5-wave fractal impulse down that terminates at the 5th wave lows, so technically this wave count would be correct, but would it have been realistic and expected? That’s the heart of Stuart’s question.
Objectively, I have to conclude “No.” The way I interpret Elliott Wave, I would never have anticipated or thought of the March 2003 lows as the termination point of Wave 5. I would have had terminal targets closer to 600 than 800, and I would have had a full expectation that the final 5th wave would terminate at new price lows beyond the 2002 “Wave 3″ bottom.
To make matters worse, I could see a decent argument for a Wave Count that has us at the terminus of large-scale Wave 4 right where this chart ends. Instead of the circled “4,” place an “A” there, and instead of circled “5,” place a “B” there and then place a “C” at the top of the current price swing as the chart ends. This would have had the Elliott analyst expecting a large-scale final 5th Wave just above the official confirmation point (meaning, the moving averages have crossed and price has formed a higher high and higher low) of the fresh Bull Market that launched exactly at that time.
However, this – to me – is why you do not apply Elliott Wave in isolation. Despite the bearish analysis, notice in July when the 20 and 50 week EMAs crossed “bullishly.” Just like they crossed “bearishly” in November 2000, this large scale technical signal is sort of a “Line in the Sand,” meaning when this Golden (or Death) Cross occurs on a weekly chart, it is a major technical signal and many funds take notice of such a simple yet effective structural change.
By this I mean it would have been fine to hold bearish price targets and objectives UNTIL this cross occurred. Of course, there was a multiple swing positive momentum divergence setting up as well that preceded the reversal, as well as a Triple Bottom-style bullish pattern, among many other more complex forms of technical analysis.
All that being said, what might that mean for Today’s Market?
We have realistic price projection targets that take the S&P 500 down to 600, and more aggressive targets that take it to 400. We have a spirited and valid debate about how far this corrective phase will go, but we have near universal agreement – among Elliotticians at least – that we will crack the November 750 lows and push on lower once the final large Fifth Wave completes (perhaps completing a large-scale “C” Wave in which the “A” Wave was 2000 – 2003; the “B” Wave was 2003-2007; and the “C” Wave was 2007 to present). Keep in mind that if we are in a large-scale Expanded Flat, then the “C” Wave actually has to play out in a 5-Wave terminal fashion, so we cannot expect a “Three Wave ABC” Corrective period for the current environment.
I believe we will see a Final 5th Wave. I believe we will break the November 2008 lows sometime in early 2009.
However, I do not need to let these views color (bias) my analysis such that I close off other possibilities of price action. I feel this is the most likely price course of action and it is based on a growing faith in Elliott Wave Theory, but my faith in Elliott is not absolute – my belief in price structure (and supply/demand forces) is. My belief (a la Mark Douglas) that “Anything Can Happen in the Market” is stronger than my belief that “We Have to Have a Terminal 5th Wave Which Will Crack the November 2008 Price Lows”.
In sum, apply your analysis including Elliott Wave as best you can, act on it in a risk-controlled environment/method, but do try to keep an open mind with a healthy respect that anything can happen at anytime in the market – it may be frustrating at first, but I suspect it’s a much more profitable way to trade than being caught blind when the market does something you never foresaw happening.
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