Armchair Elliott Analysis

January 28, 20225 Comments

I am not an Elliott Wave analyst. Sure, as part of the role of Technical Analyst, I do need to have an understanding of the concepts behind EWT. I find from a practical point of view, EWT is best used to get a feel for the market’s current stage or cycle. EWT assists me in understanding the market from a big picture, macro-view. Its less effective in determining targets  – at least for me it is. I find that the famous Fibonacci targets and retracements used by EWT purists are of little use for determining price objectives compared to viewing actual proven support/ resistance levels.

However, there are some very pragmatic aspects of EWT. In my new course on Technical Analysis, I touch on EWT and the pragmatic application of its principles. EWT suggests that the market moves in 5 main waves that make up the larger trend, followed by 3 counter waves. In between, you can get zig-zag patterns – but I tend to focus on the 5 & 3 pattern. Particularly when applied to a traditional Bull/Bear cycle.

Each of these 5 main waves and 3 counter waves (labeled A, B, C) has a behavioral aspect to them. By identifying the behavior of the crowd, we can get a feel for where we are in the market cycle. To put it in EWT language – the behavior of the crowd tells you which wave we are probably in. Below are the basic characteristics taken from two of the illustrations in my Technical Analysis course. The first shows the participation by various groups during each wave, and the second compares the smart vs. dumb money reactions during the progression of each wave:

 

 

 

  • Wave 1: Smart money and savvy pros step in early
  • Counter 2: Crowd sells – “See – it was a false start”
  • Wave 3: Positive news begins. Crowd buys with conviction, Pro’s keep buying. Everyone is in! Longest wave, most of the money is made here.
  • Counter 4: Weak corrective wave. Crowd chants “buys the dip”.
  • Wave 5: Dumb money more bullish than smart money. Concentrated breadth. Speculation.
  • Corrective A: Smart money & savvy pro’s sell.
  • Counter B: Crowd “buys the dip”.
  • Corrective C: Eventual Dumb money Capitulation.

 

There are a few things I would like to illustrate in the current view of the market since the breakout in 2009. Please refer to the above illustration, and the notes that followed it. Then look at the chart of the SPX (monthly) below. Of note: please take this analysis for what it is. Its a thought exercise. Charts rule, and the following are more casual observations. Anyhow, on the chart below you will find:

  • There was indeed a Wave 2 pullback in 2011 as the crowd illustrated disbelief that the bull market had begun. The market corrected in 2010 as well, but the larger correction (which was 20% +) occurred in 2011.
  • Wave 3  (2012- 2020) was indeed the long, long bull market trend that Elliott spoke of. Beyond the 2016 pullback, it was not too volatile, and the crowd was taught to buy any dip – because, well, you know, dips don’t last long – so for gosh sake, buy the dip!
  • The market was already setting up for a Wave 4 correction in 2018 with a renewed level of chop. Then COVID gave the crowd its reason to panic. As is the characteristic of Wave 4, the crowd buys that dip. Boom! Back up goes the market. But this time, its changed a little….
  • Wave 5 brings in a huge level of speculation after the COVID crash. I will name just a few such signs: SPACS,  Stay-inside stocks, FAANG valuations, Green energy valuations, Redditt Meme trading, Concentration of breadth in SPX weightings, TINA, the ARK ETF. Etc.

 

 

So what’s next?

If we have recently witnessed that final Wave 5 burst of speculation – then we should expect a decent pullback lead by smart money selling.

According to the SentimenTrader Smart/Dumb compilation, that may characterize the recent pullback. Note the trend (red arrow downtrend) after the COVID crash.  Smart money was leaving the market during their speculative frenzy. Note how the trend reversed to see Smart money buying–with strong conviction as markets got volatile starting in the fall of 2021. Note that the Smart/Dumb compilation has signaled a buy as Dumb money capitulated this week. Remember, smart money will move in and out of the market – taking advantage of capitulation and re-investing of the dumb money crowd.

I’d say there was a good chance that we just witnessed Wave A of the retracement process.  But then again, I may be wrong. The charts will tell us the truth as time progresses. I trade the charts, not my conceptualized  scenarios like this. So please take this EWT analysis for what it is. Its a thought exercise.

The next thing that should happen, if I am correct about the recent selloff being Wave A (and I very well may NOT be correct!) is for a counter trend move. The dip is bought, markets rally again. I bought this dip. I am playing it – following the smart money! Whatever the case, if markets retrace their loss to a maximum of their old highs – or close to them, (possible small overshoot) – this is labeled as Wave B.  See my description above. Once again the Smart money will leave the market if this happens. The indicator above will go back below the red horizontal line.

From there, we may enter into one of those “complex” EWT Zig-Zag patterns. In my world, that’s just a period of consolidation. Consolidation patterns are great ways to make money. Buy support, sell resistance. Repeat. Again, I’d encourage you to visit my Technical Analysis course to learn more about how to play that strategy.

If we don’t enter into such a Zig-Zag consolidation, then (if this scenario is correct – and it may not be!) we would simply see a final washout. That process is called Wave C. As my notes above suggest, it is where retail (Dumb) money sells in a panic. You do not want to be that guy or gal. You are smarter than that. You read this blog and took my course. You will profit by this angst – should it occur.

For now, I am playing the bump up. It may not happen. If 4300 breaks by more than 3 weeks, I will be forced to start selling (leg out).

But- lets assume Smart Money is right to be buying, and we get a bounce. We can profit by that. This might last into the spring. I usually take some profits in the spring anyhow, given seasonal tendencies. So we at ValueTrend will sell some stocks in the spring. However – If I get a bearish/risky Bear-o-meter reading at any time, I will reduce my equities. Right now, that is absolutely not the case. Quite the reverse, actually.  More importantly – If at any time, I witness a break in trend (lower than 4300 by 3 weeks, continued break of 200 day SMA) I will aggressively sell. This would imply that the Wave A decline has more to go before we see a Wave B counter-rally.

So there you have it. Armchair EWT. Take it for what it is.

Happy trading!!

quote-teal

5 Comments

  • Keith, thank you for your analyis. The January 3rd release predicting a correction in the coming weeks sure hit the nail on the head. I just signed up for the TA course. Haven’t started studying yet. The EWT note is really interesting food for thought. Does anyone have a theory on why the market RIPPED up in the last hour of Friday trading (January 28th)? I know even bear markets have big rips up. Im puzzled why this would happen in the last hour of trading before a weekend with big geopolitical risk hovering. I would have thought people would run to safety before the weekend.

    Reply
    • Hard to say Gary–could be program trading. But, it is not for me to ask WHY – but to ask WHAT is it doing! I continue to hold faith that my buy-in early last week was a good move. So far it seems ok, but I am keeping an eye open.

      Reply
  • Seems interest rates will be increasing soon due to the “transitory” inflation. What is your opinion of life insurance companies (i.e. FLI etf)? Could they be a more profitable and less volatile financial sector trade compared to Canadian and/or US banks?

    Reply
    • We own both insurance and banks. Insurance is the least volatile. Banks have the leverage –the higher the rates, the better their spread on loans!

      Reply
  • This makes sense to me. Counter trend rallies can be traded especially when they start from a deeply oversold level and at support, but recognizing that it is a counter-trend until price levels prove otherwise. Could just treat the bounce as a swing trade for now vs long term positioning.

    Reply

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