Chapter 4
Wave Analysis
Shortly after being introduced to the Elliott wave concept in the early 1970s, I sought out experts to educate me regarding this approach. Unfortunately, the only practitioners of whom I was aware were Joe Collins from St. Louis and Jack Frost from Canada. I contacted both, and they, in turn, referred me to a number of investors who had experimented with Elliott wave analysis and with Fibonacci numbers. Two individuals, both from Florida and both physicians, were recommended to me as possible resources. The experience and information they provided—more precisely, the lack thereof—were instrumental in the creation of my own approach to wave analysis.
By recounting two unrelated incidents, I might better communicate the effort in futility that I expended. I invited one doctor to Wisconsin to deliver to my business associates a speech about his interpretation of wave research. When I had arrived at the airport gate to greet him and all the passengers had deplaned and he was nowhere to be found, I called his office to determine whether he had missed the plane. His nurse/receptionist reassured me that he had made the plane; she had seen him depart. She said he would find me. I continued to wait, and eventually an individual approached and asked if I was “Tom” and I said yes. He said he recognized me because I had been walking in Fibonacci angles. I realized that I had my hands full and that my expectations were for the worst. He did not let me down—the meeting was totally unproductive and a complete disaster. Rather than give up entirely, I proceeded to interview the other wave specialist over the telephone before extending an invitation to visit. It proved to be a wise decision. My concerns were justified. I learned that the doctor was an Elliott wave and a Fibonacci enthusiast and that his life's routine had been guided by both. For example, he informed me that he had been married three times, had five children, made it a practice to work for eight consecutive days without a break, and then would take 13-day vacations. I had heard enough. I was determined to conduct my own research and draw my own conclusions regarding the subject matter. I was convinced that something of value existed but I had to uncover it myself. From the construction of the Egyptian pyramids to the conversion of kilometers to miles, the pervasiveness of Fibonacci numbers and relationships was obvious, but it was a struggle to decode and to define the role of Fibonacci and of wave behavior in the markets. My conclusions regarding Fibonacci retracements were discussed in Chapter 2. In this chapter, I discuss my wave techniques.
The elevation of wave analysis from total obscurity in the early 1970s to today's widespread acceptance is impressive to say the least. Approximately 20 years ago, I literally exhausted myself attempting to integrate the facets of both wave identification and application. Retrospectively, nothing worked better, but to apply it prospectively was next to impossible. There existed no hard and fast rules to accurately define the completion, let alone the inception of the wave pattern as it was unfolding. It was as if one were trying to catch smoke—it was visible but elusive.
Some proclaimed practitioners have applied the theory successfully, but, when asked, their explanations regarding specifics will lack consistency and will be riddled with exceptions. What has always disturbed me is, given the widespread usage of the “theory,” why are the interpretations so diverse? Jokingly, I have often remarked that were one to give ten Elliott “experts” the identical chart to analyze separately, there would be ten totally different interpretations. Given all the derivation applications, such as retracements, if the core is lacking substance, how can its by-products be relied on? To address these seemingly legitimate concerns and, at the same time, capitalize on the wave principle, I developed my own approach to wave identification. It is distinguished from the conventional version in the sense that it is definitive, concise, and logical.
Elements of the Fibonacci number series are interwoven throughout the Elliott wave principle. The thread stretches from the number of waves to the extent of retracements and of price projections. Unfortunately, prior to my development of a totally mechanical wave method, no one had produced the fabric necessary for an objective approach to wave analysis. Simply, my approach—D-Wave analysis—incorporates patterns that are defined by a series of highs and lows. The number of days selected for each series is Fibonacci-derived. Although the specific Fibonacci numbers used may vary, the same requirements apply. In each instance, however, sufficient data must be accumulated to construct a workable template. Specifically, I identify a 13-day high close—a close greater than all previous 13 days' highs. Next, I locate the first close, subsequent to the 13-day high close, that is an 8-day lowest close—a close less than all previous 8 days' closes. Once those points are identified, the first wave is complete. The second wave is not begun until a 21-day highest close is recorded—a close greater than all previous 21 days' closes. The second wave is considered complete once a 13-day lowest close is formed—a close less than all previous 13 days' closes. Finally, the third wave begins once a 34-day high is realized—a high greater than all previous 34 days' highs. The third wave is considered complete when a 21-day low is made—a low less than all previous 21 days' lows (see Figure 4.1). As with most other illustrations presented throughout this book, the examples and references demonstrating various concepts are replete with daily charts. This in no way implies that their application is limited to just that time frame. These principles apply equally to all periods, whether hourly or monthly.
Source: Logical Information Machines, Inc. (LIM), Chicago, IL.
Figure 4.1 Identified on the chart is a map of the D-Wave concept. At point A, a 21-day low is identified—a low less than all previous 21 days' lows. Upside movement labeled 1 actually was identified 4 days before the peak—once price closed greater than all previous 13 days' highs. D-Wave 1 was officially completed once a subsequent close was recorded that was less than all previous 8 closes. The next wave up began on the first day price closed greater than all previous 21 days' closes. This upleg was completed once price closed less than all previous 13 days' closes. The final wave up began once a 34-day high was recorded—a high greater than all previous 34 days' highs. This wave was completed once a subsequent 21-day low was made. Time is not a critical factor other than in establishing the number of days to complete waves. Price movement is important, however.
As is apparent by examining the sequence of numbers defining the three waves, the number of days required to establish the lows is .618 of the number of days necessary to qualify the highs. A critical consideration is the point of inception. It is essential that at least a 21-day low close be recorded before the first D-Wave count commences (see Figure 4.2). Once the D-Wave technique has been mastered, the retracement method described in Chapter 2, including the identification of the critical price and the use of the TD Retracement Qualifiers, can be applied similarly.
Source: Logical Information Machines, Inc. (LIM), Chicago, IL.
Figure 4.2 Point A identifies a 21-day low close—a close less than all previous 21 days' closes—and thereby initializes D-Wave 1. Once a 13-day high close is recorded and subsequently an B-day low close is made, D-Wave 1 is completed. Note point A, which is the 21-day low close.
The Fibonacci numbers selected to identify the waves do not have to conform with those selected above. To establish a longer-term perspective, the series can begin with a greater number of days than 13. For example, 21, 34, 55, and so on, days can be used, but once the initial number is determined, all subsequent ones follow in sequence and each wave must experience a .618 number of days' low to record wave completion (see Figure 4.3).
Source: Logical Information Machines, Inc. (LIM), Chicago, IL.
Figure 4.3 D-Wave 1 was properly initialized and the move to point 5 conformed well. Had this been an hourly chart instead of a daily one, the same requirements and relationships would have been adhered to.
Once the D-Wave is understood and installed, it is possible to estimate price objectives by multiplying the first wave by various Fibonacci numbers, such as 1.618, 2.618, and 3.618 (see Figures 4.4 and 4.5).
I have always believed that the holding period for trades can be categorized as short-, intermediate-, and long-term. I am certain that this terminology is acceptable to most traders. I am confident, however, that these same traders do not consider their definitions for these words to be identical to mine. Whereas they may relate these words to specific time intervals, I choose to consider them in terms of price movement.
Source: Logical Information Machines, Inc. (LIM), Chicago, IL.
Figure 4.4 By multiplying the first price leg from A-B by 1.618, 2.618, 3.618, and 4.618, the subsequent price objectives identified by points C, D, and E are projected.
In the past, volatility was not as pronounced as in recent years. Consequently, it was not unusual for a price move of 10 percent to consume a period of at least 1 to 2 months, a move of 10 to 20 percent to require 2 to 6 months, and a move of 20 to 30 percent to unfold over 6 months. As a result of large pools of funds deciding to buy or to sell at the same time because they have similar trend-following techniques or share simultaneous reception of information, prices move in vacuums quickly. What took weeks to accomplish in the past, conceivably could occur now in minutes. This is one of the major reasons why cycles are so unpredictable. In fact, this is why I feel that concentrating on time rather than price movement is outdated. D-Wave analysis acknowledges the importance of price movement, and I believe this recognition is one of the most important elements of this theory.
Source: Logical Information Machines, Inc. (LIM), Chicago, IL.
Figure 4.5 Observe how, by multiplying O-Wave 1 (points A-B) by 1.618, 2.618, and 3.618, price objectives C, D, and E are identified.
This has been a superficial description of D-Wave analysis, but it sends a distinct message: If the analyst subscribes to the belief that market advances and declines unfold in waves, it is not difficult to translate these movements into patterns that are objectively identifiable. Such a procedure facilitates the process of price projections and retracements. In addition, it ensures consistency and uniformity in wave identification and selection.