Armchair Elliott Wave

Elliott Wave Theory (EWT)  gives us a rough map of where we are in the investment cycle. It’s kind of like looking at a globe. You can identify the country and the region and perhaps even find a major nearby city that approximates your location on a globe. However, a globe is pretty useless at pinpointing your exact location. So too is Elliott Wave analysis insofar as precisely pinpointing where you are in the investment cycle. I recently covered Elliott Wave on this blog.

Despite its failings, EWT can offer excellent insight into the market’s macro positioning. Here’s how:

Elliott Wave helps us identify where we are in the investment cycle: Each wave of the 1-2-3-4-5-a-b-c sequence has a characteristic. By noting the characteristics of the current market, you get a good feel for which of the waves the market is in right now.  I covered those characteristics in my book Sideways.

Elliott Wave Theory - Diagram shows the basics of the 8 wave cycle

Just as a globe doesn’t help you pinpoint the neighborhood and street you are on, Elliott is not very good at pinpointing how much longer a wave will last. Elliott Wave seems to inspire an almost cult-like belief system amongst some market prognosticators. They insist that you CAN in fact predict price turning points by using Fibonacci measurements within an Elliott Wave sequence. But, as I noted in this blog – these Fib. Retracements and targets turn into moving targets as they fail. So I place no weight on such “target practice.”

Here’s a chart with some notations that might help us identify the market’s current wave:

Elliott Wave Analysis of S&P500 to October 2017 showing waves 1 through 5

From Wikipedia (who referenced various EWT experts for this definition) “ Wave five is the final leg in the direction of the dominant trend. The news is almost universally positive and everyone is bullish. Unfortunately, this is when many average investors finally buy in, right before the top. Volume is often lower in wave five than in wave three, and many momentum indicators start to show divergences (prices reach a new high but the indicators do not reach a new peak). At the end of a major bull market, bears may very well be ridiculed.”

 Does this sound familiar? Note the incredibly tight, low volatility environment over 2017, along with the falling volume on the chart above. The MACD indicator (bottom pane) clearly shows us that momentum is waning even as the US markets make new highs. This is called divergence—another sign of a “Wave 5” environment.

The big question

With this in mind, I pose a problem to you, the good readership: Do you agree we are in a Wave 5 environment, based on this and other evidence of the current investment climate? I’d love your input and reasoning on this. Your comments below will add some discussion to this unanswerable question. I’ll look forward to reading them.


  • I think we are in wave 5. It could go quite a bit higher ie. S+P 2600. Then I think it could turn down quickly by an easy 10%.

  • Hi Keith:
    I am not a “wave” enthusiast but will contribute. You make a good case for being in wave 5 but when this ends, as I understand it, we should make it back to the low of wave 4 eventually which is about 1900 on the SPX or a 25% correction from now. I don’t see that coming too soon. So maybe more upside for awhile to come.

    • Yes- if we are correct about the current wave being “5”–and it does appear that’s the case–its not any assurance as far as knowing when this will end.

  • Hi Keith!
    Glad to see you are discussing EW!
    Been following EW since 2002.
    EWI supports wave 5.
    Anthony Caldaro of OEW indicates that SP500 could be in wave 3!
    So I go back to your own advice: the trend is your friend until the trend ends!
    Enjoy the trend!

    • Yes i read today a commentary by an EWT specialist that we are in wave 3.
      Being an armchair EWT guy myself–i will usually bow to a more diligent and knowledgeable EWT experts’ prognosis. Having said that–I think its pretty hard to quantify where we really are in the investment cycle – so EWT is just another input point. All I can say is that the characteristics that I can identify such as low volume, low volatility, divergence in momentum and the “nothings going to stop this train” mentality raises some flags.

  • Hi Keith,

    Thanks for reminding of this TA tool. I should probably read more about EW theory in your book.
    Speaking of divergences, I played with a few $SPX indicators in Stockcharts and found that MFI on a weekly chart is in a clear decline since March 2017:

    Based on your extensive knowledge of TA, do you know if there are any stats that predict, with certain probability, the time period from when divergence occur to the beginning of reversal?


    • That’s a tough one Eugene–there is no specific time frame for divergences to last before the market will reverse. Rule of thumb –a slower moving momentum indicator like MACD can diverge for months on a weekly chart. A mid-termed momentum indicator like RSI or MFI (which is volume-weighted RSI) may only diverge for many weeks. A quick mover like stochastics will signal smaller moves and should be expected to diverge for only a few weeks at the most.
      This assumes a weekly chart, BTW.

  • I also think we are in wave 5 but Keith , I’d like to know what levels you looking at on SP500 and DOW for first indication we are starting the wave “a” and what ” bear” etfs you like to use to make money on this knowledge ?

    • A small correction could easily bring the S&P down to 2450 or even 2400
      An ending to a wave 5 movement could retrace to 2200–but that’s a moving target, and depends on how long wave 5 (if we are in fact in that phase) lasts.

      Or, the market could keep going up to infinity and never, ever, fall again. That seems to be the consensus…

      I wont worry about bear ETF’s at the moment, but should the trend change (via the usual signs–MA break and peak/trough breaks) then single inverse ETF’s with Horizons are a good start. So is HDGE–an ETF that trades in the US–it shorts stocks–read the prospectus on both to get an understanding of their risks etc–but as I said–its too early to be thinking of using these at this time.

  • This wave 5 will continue for a few years because interest rates and the yield on bonds are lower than large-cap dividend paying stocks. I predict we if we get 1 more interest rate increase from both Canada and US then that will be the last one for next 2 years.

    There is little wage inflation, so the economy will grow slowly, keeping interest rates low for next 2 decades. High dividend stocks with covered call options is your best bet for next 5 years.
    Check out these tickers ZWH ZWA ZWU ZWC ZWE

    Forget that stock/bond percentage split rule. It no longer applies.
    Safe strategies are for the people, who don’t understand, who don’t want to learn, so they give up and blame others.

    Take charge, find an adviser or learn to do it yourself.


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