Elliott Wave Theory
Taso Anastasiou Director: FX/PM Global Technical Strategy Group UBS Investment Bank Phone : +44 (0)20 7567 6870 E-Mail :
[email protected]
Elliott Wave theory 5 b
3 a 4
c
1 2
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Market Psychology SECTION 1
A Quotation Traders of my generation armed themselves with charts and computer-generated graphics that predicted future price direction. We sat day after day in front of these screens, mesmerised by blinking lights and ever-changing numbers in a deafening cacophony of information overload. With the possible exception of Elliott wave theory, an intellectual framework for understanding the course of social, political, and economic events was noticeably forgotten in favour of just making sure that one was part of the ever quickening process.
Paul Tudor Jones II, The alchemy of finance by George Soros
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Dow Theory - Important Elements ♦ The averages discount everything ♦ The market has three trends ♦ Major trends have three phases ♦ The averages must confirm each other ♦ Volume must confirm the trend ♦ A trend is assumed to be in effect until it gives definite signals that it has reversed
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Anatomy of Price Action W eak r e s u m p t io n
W e a k te st
C o n s o lid a t io n
se
…
♦ Reversal
p ri
but
♦ Consolidation
sur
♦ Trend
Stro n g re ve rsa l
Stro n g r e s u m p t io n Stro n g d -tre n d
C o n s o lid a t io n
Stro n g re ve rsa l
t… bu
su
rp
r is
e
C o n s o lid a t io n
W e a k te st
W e a k r e s u m p t io n
Market will always be in one of these 3 modes 3070446AL.ppt
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Psychological Make up of a trend - Phase 1 ♦ A trend is very difficult to detect at this stage
♦ Very few traders and
investors will actually open positions in this phase
♦ Economic news and
cycles are generally still bad but improving
♦ No public participation 1
♦ Most traders will still be trying to sell into the rallies 3070446AL.ppt
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Phase 2
2
♦
Market exceeds previous top trend is now identified
♦
Traders begin to buy as bearish sentiment fades
♦
Economic news generally improving
♦
Media starts to report a new bull phase
♦
Public begins to participate
♦
Traders are now buying the dips
♦
Is the most powerful phase of the three and most profits are generated in this phase
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Phase 3
33
2
1
♦
Market once again exceeds previous top as trend is confirmed
♦
Fear of intervention makes traders wary
♦
Fundamental factors peaking
♦
Media still reporting positive news but now wondering how far we can go
♦
Increased public participation
♦
A few scares and profit taking causes concern stops are raised
♦
Blow off occurs as stops triggered
♦
Generally the weakest of the three phases 3070446AL.ppt
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Awareness of market psychology and how it affects trading activity is essential for a greater understanding of the Elliott Wave Theory.
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The Basics—Building on Dow theory SECTION 2
The Building Blocks ♦ Elliott isolated 13 waves, or price patterns of directional movement that recur in markets and are repetitive in their form
♦ His descriptions constitute a set of empirically derived rules and guidelines for interpreting market action
♦ First we must look at the basic structure or the five wave pattern
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The basic five wave structure ♦ Any major movement will
5
b
3
4
1
unfold in a pattern of five waves and in turn will be corrected by a pattern of three waves going in the opposite direction
♦ The five wave movement can be
a c
split into two distinctive segments — the numbered phase — the lettered Phase
2
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The impulse Impulsive segment
♦ The Trend phase is known
5
as the impulse
♦ This the numbered phase
b
3
♦ An impulsive segment (1-5) 4 1
a c
is itself constructed as a series of five waves of which 1–3–5 are impulses of a minor degree
2
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The impulsive segment 5
Zoomed in
b
3 5
Phase Impulsive segment
5
2
3
b
4
a
c
5
3
1
3
1
b
4
a
c1
4
1
b a
4
a
2 c
2 c
2
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The corrective phase 5
Correction
4 1
peaks and troughs
♦ The lettered phase is
b
3
♦ Trends move in a series of
known as the corrective segment and is always counted in threes, a–b–c
a c
♦ Wave 2 corrects Wave 1 ♦ Wave 4 corrects Wave 3
2
♦ a–b–c corrects Waves 1 to 5
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In Practice ♦ Your start point
should always be a significant high or low
♦ Start point is
labelled 0, the impulse segment in this phase is labelled 1 and is corrected by the lettered phase labelled 2
1
2 0 3070446AL.ppt
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Summary of wave structure 5 3
4 1
2
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Summary of wave structure (continued) Waves 1–3–5 are impulses moving in the direction of the trend 5
5 b
3 4
1
a
3 c
2
4 1
2
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Summary of wave structure (continued) Waves 2–4 are counter trend movements 5
3
4 1
2
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Summary of wave structure (continued) The complete structure
5 5
3
2
3
5 4 b
3
1 5
1
4
a
c
2
a
3
b 2
a
c
4
1
1
4
5
a
3
4
b
3
1
4
1
b
5
c
2 c
2
2
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USD/CAD 1 5 3
b
1
1
4
2
a 2
c 2
11
2
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Impulsive waves 1–3–5 SECTION 3
Rule 1 ♦ There are three basic ground rules used when defining an impulsive phase
1
♦ The first inviolable rule is that from your start point at 0 (major high or low) Wave 2 must never move below the start of Wave 1 at 0
0 2
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Rule 2 Incorrect count
3 1
Alternative count
5
♦
Wave 3 can never be the shortest wave in the impulse
♦
This doesn’t mean that it is necessarily the longest
4
♦ 2
In the example the alternative count provides the clue as Wave 3 is probably extending
iii
i 1
ii
2
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Rule 3 5
♦ Wave 4 should not overlap Wave 1
3
♦ There are two exceptions to this rule: ♦
1 ♦
4
Wave 1 can be a leading diagonal triangle and price action can overlap (wedge) Wave 5 can be an ending diagonal triangle where price action overlaps (wedge)
2
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Impulse waves—the extension ♦ An extension can only occur in one of the impulse waves 1–3–5. Most extensions will actually occur in the 3rd wave. Extensions may also occur in the extending wave itself 5 3 v
iii 4 iv
i
1
ii 2
5 b
3 4
1
a
c
2 3070446AL.ppt
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Labelling the cycles 0
1
3
4
0 1 2
3
4 5
A B C
Super cycle
0 I
II III IV V
A B C
Cycle
0
2
A
Primary
1
3
4
5
5
(0)(I) (2) (3) (4) (5)
A
B
B
C
Grand super cycle
2
C
(a) (b) (c)
Intermediate
0 1
2
5
a
b
c
Minor
0 i
ii iii iv v
a
b
c
Minute
0 1
2
a
b
c
Minuette
3
3
4
4
5
0. i. ii. iii. iv. v.
a. b. c.
Sub-minuette
0 I
II III IV V
a
b
c
Micro
0 i
ii iii iv v
a
b
c
Sub-micro 3070446AL.ppt
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Extensions 5 3 1
5
3
5 7
4
3 1
1 2 2
2
1
1 3
4
1 2
2
22
5
6
4
1 1
4
8
4
2
6
3
3
3 5
4
1
4
5
3
4
2
9
8
5 5
7
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28
Example of an extension B 2
1
A
ii
i
2
1
iv
4
1 3 5
4
iii
v 3 5
C 0101092L.ppt
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In Practice - GBP/USD
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In Practice - GBP/USD 5 3
4 1
2
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In Practice - GBP/USD 5
3 b
a c 4
1 b
a c 2 3070446AL.ppt
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In Practice - GBP/USD 5
3 v b iii a iv 1
c 4
b i a c 2
ii
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The ending diagonal triangle An ending diagonal triangle is counted as a five wave up but sub-divides into threes
♦ Diagonal triangles are 5 v
iii i iv
3 ii 4
formed by two converging lines, in its usual form. This pattern occurs in fifth wave positions
♦ The only exception to the overlap rule between Wave 1–4 can occur in a diagonal
♦ A diagonal can also be
1
2
located in the C wave positions. As in a rising wedge this is to be considered a termination pattern 3070446AL.ppt
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Ending diagonal triangles 5 iv iii i iv
3 ii 4
1
2
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Ending diagonal triangles 5 3
5
3 1
4
2
4 1
2
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Leading diagonal triangles 5
♦
In normal circumstances this pattern would be referred to as a rising wedge and is a bearish pattern as it is assumed that the pattern will break the support
♦
The target on the break would suggest a re-test of the base
♦
This pattern is only found in Wave 1 or A
♦
All other rules apply e.g. Wave 3 is not the shortest and 2 doesn’t break below the start point then you must buy the dip as it will turn out to be a bullish pattern
3
4
1 v
iii i
2 iv ii
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The failed fifth wave 3 5
3
4
♦ As Wave 5 is the weakest
part of the trend it sometimes has a tendency to fail early, creating what we traditionally call a double top
♦ The Internal wave
1
structure must still count up in five
2
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Failed fifth waves & leading diagonal 5
3
1 5
4
3
1
4 2
2
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Failed fifth waves (continued) Incorrect counting as Wave (5) would only count up in 3 100 3
90
5
4
80
70
60
1991
1992
1993
1994
1995
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Failed fifth waves (continued) Correct count where (I) is a leading diagonal triangle, (III) has extended and (V) has failed 100
2 91.22
90 1
80
4
(II)
2
c
1
a 4
3 3
5
b
5
(I)
70
(IV) c
a
60 (III) 1991
1992
1993
b
1994
(V) 1995 3070446AL.ppt
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The Trap...
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Successful Trend Definition Is Essential
♦Analysis and therefore positioning must be biased in the direction of the prevailing trend
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Trend Definition Is Essential
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Ground Rules ♦ You can quantify trends and market positioning by biasing your position base in the direction of the underlying trend
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Corrective waves a–b–c SECTION 4
Corrective waves ♦ We have seen that movements against the trend are known as corrective waves, sometimes referred to as consolidations or lettered phase
♦ Identifying and fitting corrections into particular patterns in advance is very difficult
♦ The complexity of corrective waves can increase or decrease without warning
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The three corrective wave types Corrective waves fall into four categories
♦ Zig-Zag
5–3–5
includes three variations single, double and triple
♦ Flats
3–3–5
includes 3 variations, regular, expanded, running
♦ Triangles
3–3–3–3–3
four types, ascending, descending, contracting, expanding
♦ Double and
triple threes
(combined structures)
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Zig-Zags 5–3–5 Bull market correction
Bear market correction
c
ii b c
i iv
a ii
a
iii
b
i
iv
v a
b iii
v c 3070446AL.ppt
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Zig-Zag corrections ♦ Zig-Zags have a 5–3–5 wave structure ♦ These formations are usually found in Wave 2 position ♦ It would be fair to assume that they would also occur after Wave 5 as a traditional head and shoulders reversal pattern is formed
♦ Wave C of the Zig-Zag will typically extend the same distance as Wave A
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Example of a Zig-Zag correction 2
B2
1
4 1 3
4 5
A 3 5
C A=C
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Flat corrections 3–3–5 Bull market correction
Bear market correction
a
c
a
b
c
b
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Example of a flat correction B2
ii
b 1
4
i iv
a iii c
A
v 3 5
C
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Irregular flats 3–3–5 Bull market correction
Bear market correction
b c a
a c b
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Flats 3–3–5 ♦ Flats are counted as 3–3–5 ♦ There are standard flats which are typically ranges ♦ There are irregular flats where the B wave exceeds the high, but can only be counted as a 3-wave affair
♦ Last but not least there are running flats ♦ Flat corrections are typically found in fourth and B wave positions and tend to have lower retracement values
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Triangles 3–3–3–3–3 Bull market correction b d
♦ Five waves – a / b / c / d / e e
♦ Each wave subdivides into 3waves
c a
♦ Each wave tends to be related to a preceding wave by the 0.618 ratio.
Bear market correction a
— —
c
b
e d
Wave d will be 0.618 of wave b Wave e will be 0.618 of wave c
♦ This correction is typically found in wave-4
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Complex corrective forms (double threes) Zig-Zag Zig-Zag -x- Zig-Zag Bull market correction ii i
b c
iv iii
b v a
x
ii
a
ii b c
iv
i
i
iv
ii
a
iii iii v c
b v a
i
iv
iii v c 3070446AL.ppt
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Complex corrective forms (double threes) Zig-Zag Zig-Zag -x- flat Bull market correction
x
ii
b
b c
i iv
a
iii
ii
b
i
iv
v a iii
v c
a
c 3070446AL.ppt
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Complex corrective forms (double threes) Zig-Zag Zig-Zag -x- triangle Bull market correction
x
ii
b
b c
i iv
a
iii
d
ii b
i iv
v a
e c
iii a v c
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Complex corrective forms (double threes) Zig-Zag Zig-Zag -x- irregular flat Bull market correction b
x
ii b c
i iv
ii
a
iii
b v a
i
iv iii v c
a c 3070446AL.ppt
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Complex corrective forms (double threes) flat Flat -x- flat
x
b
a
c
b
a
c
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Complex corrective forms (double threes) flat Flat -x- Zig-Zag
a
c
x
ii ii b b cc
ii iv iv iii iii
bb v va a
b
ii ii
aa ii
iv iv iii iii
v cv c 3070446AL.ppt
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Complex corrective forms (double threes) flat Flat -x- triangle
x
b
b d
e c a a
c
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Complex corrective forms (double threes) flat Flat -x- irregular
x
b
a
b
c
a c 3070446AL.ppt
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Complex corrective forms (double threes) Irregular -x- irregular b
x
b
a c a
c
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Complex corrective forms (double threes) Irregular flat -x- flat b
x b
a c
a
c
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Complex corrective forms (double threes) Irregular flat -x- Zig-Zag b
x
ii b c
i a
iv iii
ii b
i
iv
v a iii a
v c
c
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Complex corrective forms (double threes) Irregular flat -x- Zig-Zag
x
b
b d
e c a
a c
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Complex corrective waves To date we have looked at standard corrective waves as well as double complex waves. There is a third type of complex correction which is called the complex triple three.
i
b
b
ii iv
a
iii
b v a
x
b c
x
ii i
a
d
iv e iii
c v c
a
a
c Zig-Zag
b
c
x
Irregular flat
x
Triangle
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Examples of complex corrections i
B
b
B X
B
B
b
1
a c
a
A A
A c
C FLAT
A
IRREGULAR FLAT
FLAT
c
2
C ii ZIG-ZAG A=C
C ZIG-ZAG
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The rule of alternation SECTION 5
The rule of alternation ♦ This rule is relatively simple as it states that no two corrective phases are similar
♦ If Wave 2 is a Zig-Zag then Wave 4 will probably be a flat or a triangle – typical scenario
♦ The rule also states that only one of the impulse waves will extend (and can itself extend)
♦ If two corrective phases are similar then one will differ in magnitude or length
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Alternation 5
5
2
3
3
2
4
1
4
1
1
4 4
1 2
2
3
5
3
5
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The rule of alternation 5
3
b
a FLAT
1
TRIANGLE b
4
d
c a
c
e
2 0101092L.ppt
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The depth of corrective waves SECTION 6
The depth of corrective waves No market approach other than the Elliott Wave Theory gives a satisfactory answer to this question. The primary guideline is that corrections , especially when they themselves are fourth waves tend to register their maximum retracement within the span of travel of the previous fourth wave of one lesser degree which would also represent support (or resistance for a rising market). 5 3
4 1
2
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The Fibonacci sequence and its application SECTION 7
Ratio analysis ♦ Ratio analysis has revealed a number of precise price
relationships that occur often among waves. There are two categories of relationships: retracements and multiples
Retracements
♦ Fairly often, a correction retraces a Fibonacci percentage of the preceding wave
♦ Sharp corrections tend more often to retrace 61.8% or 50%
of the previous wave, particularly when they occur as Wave 2 of an impulse wave, Wave B of a larger Zig-Zag, or Wave X in a multiple Zig-Zag
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Retracements Typical retracement levels
100
24.6 38.2 50.0 61.8 76.4
0
Typical of Wave 2
100
Typical of Wave 4
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Impulse wave multiples When Wave 3 has extended, waves 1–5 will tend towards equality (1.00) or a 0.618% relationship. All three impulse waves tend to be related by Fibonacci mathematics whether by equality, 1.618 or 2.618 whose inverses are 0.618 and 0.382
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Impulse wave multiples (continued) 3rd wave extension
5th wave extension 5
5 3
1st wave extension 5
1.00
3 .618
4
4
1
.382
2 3 .618
1
.382 1 2
4
1.00 2
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Corrective wave multiples Double Zig-Zag
b x b
a
c
a
1.00/.618/2.618
1.00
1.00/6.18/1.618
1.00
Zig-Zag
c
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Corrective wave multiples (continued) Flat
Irregular flat b b 1.00
a
c
1.00 .618 a
1.618 c 3070446AL.ppt
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3?
i
1 ii
2 Wave 3 = 1.00/1.618/2.618 of Wave 1
3
4
1
2 Wave 5 can be equal to wave 1 0.618 of 3 0r .382 of waves 1 and 3
Calculating targets
5?
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Fibonacci relationships Wave 2 retraces just above the 61.8% level of wave-1
2 ii
i
1
Wave 4 retraces just above the 38.2% level of wave-3
4 iv
Failed
iii
v 5th
3
5 0101092L.ppt
85
Fibonacci relationships (continued) 1.9000
(V)
Wave (V) is 1.00 multiplied by the length of wave (I)
1.8904
1.8500 1.8000
(III)
Wave III is 2.62 multiplied from the length of wave I
1.7500
1.7207
1.7000
Wave (III)and III retraces Wave (IV) and IV by 24%
1.6500
(I)
1.6000
1.5000 II
1.4500
IV
1.6618
(IV)
I
1.5489
1.5500
V
III
Wave II retraces Wave I by 62%
(II) Wave (II) retraces Wave (I) by 50%
1.4000
1.3811
(0)
1.3500 May-95
Nov-95
May-96
Nov-96
May-96
Nov-96
May-97
Nov-97
tmta3 © DEM-USD Weekly Bar 06-Mar-95—28-Nov-97 [Zoomed] 1.8904 1.3455 1.7635 0.3685 0.0000 V 2.980014 Copyright 1994-1997 Tradermade International Ltd. 3070446AL.ppt
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A word on momentum 2
♦ Divergence between price and momentum warns of technical weakness in a trend
1
♦ Divergence between price and momentum is typical during the 5th and final wave.
4
3
5
♦ One would also expect such a set-up to develop during wave-C
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Fibonacci Relationships - S&P Cash
1.00 of wave 1 (1246) 0.618 of wave 1 (1175)
3
4? 1
2 Potential for bearish divergence in momentum
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Fibonacci Relationships - S&P Cash
iii
3 i
4
5 v
iv ii
1
2
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Analyse
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Analyse
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Analyse
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Analyse
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