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Sunday, November 8, 2009

Box Method, RSI low and More Wave Theory

In a previous couple of posts I discussed wave 2 retraces and such and their seemingly inherent ability to find that big down candle of the previous "third of a third" structure and retrace to it as a general target.

This is somewhat different, as someone pointed out, that wave 2's can often retrace into the previous subwave 1's price range. I rather take that "guidleine" and refine it to a more narrow target range and hence my post on finding the "third of the third" candle as the true wave 2 target in general.

Why is this important? Because if we use the price range of the previous subwave 1, that would indicate that the SPX could and should indeed retrace back into the price range of Intermediate (1) of Primary [1]. That Intermediate (1) low is 1256.98. Hrmm. Likely? Thats an awful lot of rallying left to do. I never rule anything out, but it would seem that if the SPX can work its way back up through all that resistance, why would it stop at 1256? Wouldn't we be in a truly new bull market?

So sometimes that "third of a third" does lie inside that previous sub wave 1 price range. But often it does not. And this area seems to "govern" to where a wave 2 rally retraces in general.

This whole dictum I describe of where wave 2's retrace above is basically an expanded thought process on Robert Prechter's observation that bear market rallies tend to retrace to a subwave 4 of 3 of the previous wave. Basically I am saying the same thing he is however I am taking this one step further and not just talking about big rallies in general (P2) but almost every wave 2 no matter what degree.

You'll often see me use my "box method" to help find the likely "third of a third" wave. This is the spot on the chart in which no previous, nor subsequent waves trace into. Basically your finding that one sweet spot on a 5 wave structure that has a lone candle area that is "virgin" territory. Place a box to eliminate the previous wave bottoms and subsequent wave tops to isolate this narrow price range. This works on Primary sized waves all the way down to microwaves.

And yes, this "box area" typically always resides on that big down candle that I was talking about in my other posts.

Why is finding this area crucial and worthwhile? Because it helps identify and "tag" the wave structure. Its like a compass. A key marker is like a roadsign pointing the way for potential further price moves.

But more importantly, in my observations, I have come to find out that the subsequent wave 2 rally usually always hits this box area as a minimum! Note how that identifying this box zone would have saved us all a lot of trouble on P2!

To me, this always seemed obvious but I think I need to discuss it more. On any 5 wave bear structure there exists an RSI low. This RSI low almost without any variance, lies in one of the last subwave price lows within the wave 3 of the referenced structure. So usually it should not reside exactly at the wave 3 low but a subwave within the wave three.

Then the slowly developing positive divergence typically signals the subsequent wave 2 rally that retraces the entire 5 wave structure to some degree.

Putting it all together, counting 5 waves down, you can use the box method for finding the "third of a third". This is the "vigrin" sweet spot of the down move. Usually somewhere near the middle of the structure.

You can then verify your count by looking at RSI low and diverging behavior patterns to confirm your count.

Then, almost by magic, the subsequent wave 2 rally will hit in that box area, at least a piece of it. Sometimes it goes above it a bit and "covers" a "breakaway gap" that creates the downdraft candle sweet spot in the first place.

It seems the entire mission of a wave 2 rally is to see if it can challenge this very "third of a third" area. I think this works well from the smallest waves up to the largest (like P2)

Also as I said, this works on waves of all sizes. You however must use the correct time scale chart to help you determine things like RSI and wave structure. It just depends on the size of the wave structure. A wave that takes months will need to be a daily chart at least. A smaller wave of only a few days duration, you would use a 5-10-15 minute chart to help you identify the proper overlaps and such and RSI lows. A couple of weeks you could use both a daily and 60 minute. I usually use a combination of time scales depending on my needs and what data I wish to gleam.

Also one last point: The wave 2's I am generally talking about are wave 2's that retrace an entire previous 5 wave structure. Wave 2's that occur in succession as in a rapid series of 1-2, 1-2, 1-2 in an extended wave structure won't of course follow these exact retrace rules as there is not yet a 5 wave structure to retrace (although sometimes there is) . Just don't want to confuse anyone on that point. Just use common sense and good wave judgement. However the subsequent wave 2 that retraces the entire 5 wave structure will follow these guidelines. The key of course is mapping an accurate and complete 5 wave structure to begin with which is where BOX method and RSI lows help us determine.

I included a couple of charts to help explain things and included another BKX bank chart to see if it pans out this week.

PS - If this stuff is mentioned anywhere in any literature, I didn't read it and my apologies. The only book I ever read on markets and trading is Elliott Wave Principle by Prechter. I have some books, but never found the time just yet. These are my own observations I have made from studying waves and every squiggle for well over a year. I am now trying to refine these techniques because there is evidence that the primary trend (down) has reasserted itself so they could turn out to be very useful indeed.

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