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Saturday, November 7, 2009

Yet Even More Wave 2's Theory (Corrected)


Corrected : Corrected the Fib 78.6 spots. (I had a brain dump and was calling it 76.4)

I have been pondering even more on wave 2's of all degree and it dawned on me that there seems to be a very simple concept of wave 2's that one can almost postulate a solid EW guideline from.

Most everyone knows that wave 4's can retrace back toward the previous subwave 4 spot.

Robert Prechter often says that bear rallies revisit the previous subwave 4 of 3. I'd rather think this concept applies to all wave 2's in general. The simple postulate would be:

"Other than second wave's in extended third waves, Wave 2's will inevitably trade back into the previous subwave's "third of the third" candle bar price range to some degree. However, rarely are they able to trade the entire candle range"

This seems obvious somewhat but I have never really thought of it in this manner. So how does this apply to the current Minute wave [ii]? Well, the big down candle of the 23rd is likely the "third of a third" candle bar where the most intensive downward move happened. This is also known as the "point of recognition" for minute [i].

And the candle of the 23rd has yet to be traded back into. So how can this information be useful? For instance suppose the financials are in a wave (iv) and thrust downward come Monday and drag the entire market with it. Many would be proclaiming "this is it! Minute [iii] is here!" But I would rather be cautious because the big candle of the 23rd had yet to be revisited and traded in.

So even if the market opens very weak and turns red Monday, one would have to have pure faith based on my postulate above that the market will indeed eventually go higher and trade into that big down candle bar, even if just for a few points.

Anyways, I must give my usual cautionary statement and state that nothing is set in stone!

However, looking at my provided long term Wilshire chart, you can see the big "third of a third" candles were all revisited on the next larger degree wave 2. Again how is this useful?

Well lets suppose that Minute [iii] does come and indeed Minute [iv] and [v] and we think we identify a Minor 1 bottom. In this instance, we can set a Minor 2 retrace target by finding the big "third of a third" candle bar residing in the previous Minute [iii] and bet that Minor 2 will revisit that area and trade within it. Its about that simple. At least that worked for P1. I don't see why it wouldn't for P3.

The flipside is that these wave 2's that revisit the "third of a third" candle area rarely trade above. In this manner one can see why the weak August 2008 rally never retraced as high as many postulated it should. It simply got stuck in the third of a third candle which was at a low spot on the previous decline.

In addition, you can see why we are proclaiming P2 likely over: Why? Because the Wilshire has almost traded to the high end of the previous "third of a third" area and our postulate states that this is rarely traded above.

But maybe the MM's know this and they take the markets back to revisit the harshest down move area of previous subwaves. Maybe they are simply trying to recoup unexpected lost monies. After all, this wave [ii] up is their chance to do so and keep the rally going. They seem to know that they need to revisit this candle area in some form or fashion and at least try.

So based on this observation, the bet to be made (not that I am recommending anyone go long here - I'm not!) is that the SPX will trade back above 1072.48 which of course it has yet to do. One can also make a decent bet that the top of the candle will not be breeched (1091.75).

Retraces over 78.6 [edit:corrected] are also rare for wave 2's on the SPX and that is 1085.95.

So the range to short lies somewhere in between 1072.48 and 1085.95 If I had known this stuff a few days ago, heheh....

Ok now lets see how things pan out and see if this is a valid postulate to propose.
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