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How Do You Know If You Have the Right Wave Count?
By following the rules in this lesson.
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By Editorial Staff
Wed, 31 Aug 2011 13:30:00 ET |
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A common question from EWI subscribers is: "On an unlabeled price chart, how do you identify the start of the Wave pattern?"
That's a good question, and its exactly the kind that Senior Commodities Analyst Jeffrey Kennedy loves to answer. His passion is teaching, and every month Jeffrey's Monthly Futures Junctures presents a lesson in technical analysis via his "Trader's Classroom." This excerpt, first published in October 2005 (hence the low wheat prices!) and edited for brevity, comes from an old favorite: "How Do You Know If You Have the Right Wave Count?"
More often than not, while patterns are developing, we are faced with questions like these: It looks like a five-wave advance, but is it wave A, 1 or 3? Here’s a three-wave move, but is it wave A, B or X?
How can we tell when we have a correct labeling? The useful answer to this question is that prices will move in the manner they should, or they won't. For example, within a five-wave move, if wave three doesn’t travel the farthest in the shortest amount of time, then odds are that the labeling is incorrect. Yes, sometimes first waves extend and so do fifth waves (especially in commodities), but most typically, prices in third waves travel the farthest in the shortest amount of time. Ultimately the personality of price action will confirm your wave count.
Each Elliott wave has a distinct personality, and personality supports labeling. As an example, second waves are most often deep and typically end on low volume. So if you have a situation where prices have retraced a .382 multiple of the previous move and volume is high, odds favor the correct labeling as A-B-C and not 1-2-3. Why? Because what you believe to be wave 2 doesn’t have the personality of a corrective wave 2.
Here's a shortcut list of the personalities you should be looking for:
- Impulse waves always subdivide into five distinct waves, and they have an energetic personality that likes to cover a lot of ground in a short time. That means that prices travel far in a short period of time and that the angle or slope of an impulse wave is steep.
- Corrective wave patterns have a sluggish personality, the opposite of impulse waves. Corrective waves are slow-moving affairs that seemingly take days and weeks to end, and, during that time, price tends not to change much. Also, corrective wave patterns tend to contain numerous overlapping waves, which appear as choppy or sloppy price action.
For an example of how you can apply this “wave personality” approach in real time, let’s look at two Daily Wheat Charts, reprinted from the August and September issues of Monthly Futures Junctures. Chart 1 from August shows that I was extremely bearish on price action at that time, expecting a massive selloff in wave three-of-three.
During the first few weeks of September, though, prices traded lackadaisically. Normally, this kind of sideways price action would have bolstered the bearish labeling, because it’s typical of a corrective wave pattern that’s fighting against the larger trend. However, given my overriding one-two, one-two labeling, we really should have been seeing the kind of price action that wave count called for: sharp, steep selling in wave three-of-three.
It was precisely because I noticed that the personality of the price action didn’t agree with the labeling that I decided to rework my wave count.
You can see the result in Chart 2, which calls for a much different outcome from Chart 1. In fact, the labeling in Chart 2 called for a bottom to form soon, followed by a sizable rally. Even though the moderate new low I was expecting did not materialize, the sizable advance did: Wheat has since rallied as high as 353.
So that’s how I use personality types to figure out whether my wave labels are correct. Keeping the big picture of energetic impulse wave patterns and sluggish corrective wave patterns in mind helps to match price action with the appropriate wave or wave pattern. How will you know if you have the right wave count? Become a matchmaker by paying more attention to wave personality types.
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