ABC. Trend-Wave Trading Harnessing the Power of the Elliott Wave Principle with the Discipline of Trend Following.

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1 Technical Analysis Trend-Wave Trading Harnessing the Power of the Elliott Wave Principle with the Discipline of Trend Following June 0 Murray Gunn CFTe Head of Technical Analysis HSBC Bank plc murray.gunn@hsbcib.com View HSBC Global Research at: Issuer of report: HSBC Bank plc Disclosures and Disclaimer This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it ABC Global Research

2 The Elliott Wave Principle A Basic Guide Elliott Wave Principle A Fractal Design () Ralph Nelson Elliott Price action occurs in regular patterns () (B) moves (or waves) in the direction of the primary trend moves (or waves) when the price action is correcting against the primary trend Repeat at every time frame or fractal Mass human psychology is patterned Ratio analysis/natural mathematics (Phi, the golden ratio,.68, Leonardo Fibonacci) Elliott heavily influenced by Charles Dow Wave Principle is the purest form of TA Long Term Medium Term Short Term The Full Cycle () () B A C () B A C () () B A C () B A C () () (A) A B C A (A) (B) B Putting it all together C (C) (C)

3 Waves Are Self Similar in FORM but they do NOT have to be self similar in TIME or depth (AMPLITUDE) Much more like REALITY () () B D () E () C B A A C ()

4 Elliott s Wave Principle is technical analysis Elliott heavily influenced by Charles Dow Empirical observations confirmed Dow s Theory Refined Dow s work into more detail Price and volume = pure technical analysis Edwards & Magee pattern recognition a derivative of Dow and Elliott

5 Dow Theory Charles Dow s editorials in his Wall Street Journal around 900 Analysis of price action of the market averages (Dow Industrials, Transports, Utilities) Markets have movements (value, primary and secondary movement). Concept of stock market value was important to Dow s analysis. Trends have phases (accumulation, public participation, distribution) Distribution phase Source: istockphoto Participation phase Increasing volume Confirmed end of bull trend. Previous low point broken. No more higher lows. Accumulation phase The stock market discounts all news Stock market averages must confirm each other. If it s a Primary bull market the Industrials must be making higher highs along with the Transports etc and vice versa. Trends are confirmed by volume (an uptrend on declining volume is an unconfirmed uptrend) Trends exist until definitive proof that they have ended (defined by a lower high and a lower low after an uptrend)

6 Cycles Of Psychology Reference: Frost & Prechter Elliott Wave Principle, 978 Fundamentals / news flow still negative Strongest, broadest move, fundamentals / news flow turn positive Bubble, speculation, narrow breadth best fundamentals / news flow Consternation, impatience Distribution from strong hands to weak hands Mania, euphoria, complacency A Shock, denial, buy the dips mentality Relief, hope, denial, lack of breadth B Broad, destructive decline, fundamentals / news flow turn negative C Despair, fear Despair, fear Denial, comfort that bear is back Accumulation by strong hands from weak hands 6

7 Elliott s Wave Principle is technical analysis Head & Shoulders = Elliott A B C correction or truncated fifth Flags = Elliott flats Pennant = Elliott triangle Double tops / bottoms = Elliott flat or truncated fifth Rising / Falling Wedge = Elliott ending diagonal 7

8 The Elliott Wave Principle A Basic Guide Rules & Guidelines Elliott s empirical observations led to his conclusion that there were various rules and guidelines that wave formation held to. It is the existence of these rules that makes the Wave Principle relatively objective compared with other forms of market analysis. The rules must be respected. Guidelines point to tendencies. Three (of many) cardinal rules of Elliott s Wave Principle are: Wave Can Never Retrace More Than 00% Wave Is Never The Shortest Wave Of Wave. Wave Can Never End In The Price Territory Of Wave. Incorrect Correct Incorrect Correct Incorrect Correct nd waves of a motive wave can be very deep but they cannot move beyond the start of wave. Three (of many) guidelines of Elliott s Wave Principle are: Alternation: Wave Will Usually Be A Different Corrective Pattern From Wave When Wave Is Extended, Waves And Will Tend To Equality Or A Fibonacci Ratio 00% Zig Zag then Triangle Flat then Zig Zag nd waves tend to be zig zags and th waves tend to be triangles or flats. 00% rd waves are usually the most powerful. They can be shorter than or but they must never be the shortest of, and. 00% When wave is extended, wave will tend to end when it equals the size of wave or a ratio such as.68 times the size of wave. 6.8% The end of the th wave must never overlap the end of wave. Note that if wave is a flat or a triangle the first corrective waves could overlap wave so long as the ending wave does not. Wave Usually Terminates Near The Previous Wave Of Lesser Degree () () () () A th wave will tend to finish in the price zone of wave of the just ended wave. 8

9 Motive Waves Motive (or impulse) waves are the trending part of the cycle. These waves are relatively straightforward to identify due to their dynamic, thrusting nature and volume normally increases during wave three indicating a market where the participants are motivated to participate. These examples show bull market motive waves. Bear market motive waves are simply the reverse. () Leading Diagonal () () () Added to Ellliott s original work after observations by Frost & Prechter, a diagonal can also occur in the wave position and subdivides into five waves of three moves. () () The Elliott Wave Principle A Basic Guide () () () () () () () Extensions Extension (Nine Wave) Ending Diagonal Extensions occur when one of the motive waves is prolonged and subdivides into amplified waves. Frequently occurring in the wave position, normally only one wave within a motive wave will be extended. () () () Leading Diagonal Expanding Diagonal Truncated Fifth The leading diagonal can also subdivide into five overlapping waves of the normal motive corrective waves. Divergence between price and oscillators are normal characteristics of diagonals. () () () () () () () () (6) () (7) (8) Quite rarely an extension will occur where each subdivided wave is of roughly equal amplitude. This results in the entire motive wave looking like a nine wave move. (9) A th wave that subdivides into fives waves of three. The expanding nature of the price action points to increasing volatility that can signal the end of a trend. () () () () () () () () () Also known as a rising or falling wedge, the ending diagonal is a th wave that can subdivide into five overlapping waves of waves each (zigzags). It is a sign of an exhausted trend. 9 () Sometimes the trend is so exhausted by the time the th wave comes that the wave does not even move past the wave top or bottom. It is a sign of a very tired market trend.

10 Corrective Waves Elliott observed a number of ways that prices consolidate. Zig Zags and Flats have three wave movements with the final wave C being an impulse or motive. The powerful nature of this C wave is a result of a crowd psychology panicking in either closing shorts or bailing out of longs. It clears the weak hands out of the market out so that the trend can continue. Triangles on the other hand exhibit five wave movements. The Elliott Wave Principle A Basic Guide (B) C B A B A A B A B B A C C (A) (A) (A) (C) (C) ZigZag (--) (C) Flat (Regular) (--) Flat (Expanded) (--) A sharp correction consisting of two motive waves (A) and (C) separated by a corrective wave (B). (B) C A sideways correction where wave (B) retraces close to 00% of wave (A) followed by a motive wave (C) sharp move. (B) C Also known as an Irregular Flat, this is a sideways correction where wave (B) retraces more than 00% of wave (A) followed by a motive wave (C) sharp move. Triangles (----) A B C (A) A (B) C B A B A C (C) B (D) C A B C (E) (A) (B) (C) (D) (E) Triangle (Symmetrical) Triangle (Reverse Symmetrical) Triangle (Ascending) Triangle (Descending) Triangles usually occur in the th wave position of a motive wave and represent periods of equilibrium between bulls and bears. They consist of five waves A-B-C-D- E each subdividing into three waves. The reverse symmetrical or expanding triangle is relatively rare. (A) (B) (C) (D) (E) This pattern reflects a situation where there is equilibrium in the price but the bulls are increasingly gaining the upper hand resulting in an upward break in price. (A) (B) (C) (D) This pattern reflects a situation where there is equilibrium in the price but the bears are increasingly gaining the upper hand resulting in a downward break in price. 0 (E)

11 Alternative Wave Counts Two or more valid wave counts at any one time Job of the analyst is to find the most probable Not 00% sure what the wave is until it is over But ALL analysis is EX-POST Also gives us Plan A, B and C etc Analysis is one skill Trading is another skill Charts Source: Bloomberg, Updata, HSBC

12 Trend-Wave Trading

13 The Get It Moment Newcomers to Elliott initially like it Then realise the existence of alternative wave counts Most leave The ones who stay struggle with how to actually use (trade) it Then the light bulb moment ELLIOTT IS NOT A TRADING SYSTEM ELLIOTT DESCRIBES THE EVOLUTION OF MARKET PRICE IT IS AN EXERCISE IN PROBABILITY ELLIOTT SETS THE CONTEXT FOR THE PROBABLE NEXT MOVE Source: istockphoto

14 Trend-Wave Trading () or (A) () or (C) High probability Elliott set ups B waves followed by waves Next wave is highly probable Significant Low Significant High A C () or (B) () or (B) A C () or (A) B () or (C)

15 Trend Following A life philosophy Run winners. Cut losers. Disciplined It works (John Henry) Live in the moment psychology Source: istockphoto

16 Keep It Simple A trend is a trend Moving Averages Optimisation Shmoptimisation No magic, just discipline, 0 and 00 Source: istockphoto 6

17 Tee It Up, Get In The Zone & Let It Happen Psychology Golf & The Markets Pre shot routine Automatic Make the swing Source: istockphoto 7

18 Tee It Up, Get In The Zone & Let It Happen Step : Identify an Elliott Wave Principle set up Step : Switch on your automatic Trend Following routine Step : Take the shot Step : Trail stop and take profit Pros: Cons: Simple Defined risk management process Mitigates cognitive dissonance Applicable over all time scales Not for top or bottom pickers Source: istockphoto 8

19 Trend-Wave Trading (Day Traders) Source: Bloomberg, Updata, HSBC 9

20 Trend-Wave Trading (Swing Traders) Source: Bloomberg, Updata, HSBC 0

21 Trend-Wave Trading (Swing Traders) Source: Bloomberg, Updata, HSBC

22 Trend-Wave Trading (Portfolio Managers) Source: Bloomberg, Updata, HSBC

23 Trend-Wave Trading (Asset Allocators) Source: Bloomberg, Updata, HSBC

24 Trend-Wave Trading Counting s and s is not as objective as some like Why not use moving averages as an objective proxy for waves Short, Medium and Long (,0,00) A Trend-Wave positive signal is given when crosses above 0 and price is above 00 A Trend-Wave negative signal is given when crosses below 0 and price is below 00 Trading / investing in the direction of the bigger trend Buying / selling pullbacks in a bigger trend (just like s and s)

25 Trend-Wave Trading Source: Bloomberg, Updata, HSBC

26 Trend-Wave Trading Continuous Return (0% Position Size) % Winners (Trades) Win / Loss Ratio (Return) Trend-Wave Trading Return (0% Position Size) Trend-Wave Trading Return (0% Position Size) % Winners (Trades) Win / Loss Ratio (Return) Continuous Return (Variable Position Size, % and 0%) US Dollar Index.9% % of 8.0.9% 6.86% 9% of.8 7.6% S&P % % of 9.7.% 6.88% 6% of 6..0% Results from using daily charts / moving averages Trend-Wave Trading produces higher Win / Loss Ratio than a Continuous system Results show a small but significant edge 6

27 Current Market Outlook 7

28 Defender of the Dean Source: HSBC, Bloomberg 8

29 The most important chart in the world Source: Bloomberg, Updata, HSBC 9

30 Breadth and sector rotation negative Source: Bloomberg, Updata, HSBC 0

31 Topping out Source: Bloomberg, Updata, HSBC

32 OBV worries Source: Bloomberg, Updata, HSBC

33 A very BULLISH chart Source: Bloomberg, Updata, HSBC

34 Korea also very bullish Source: Bloomberg, Updata, HSBC

35 Chance of a big shake out in Gold Source: Bloomberg, Updata, HSBC

36 The bell is rung Source: Bloomberg, Updata, HSBC 6

37 As it was here Source: Bloomberg, Updata, HSBC 7

38 And here Source: Bloomberg, Updata, HSBC 8

39 Oil near a top Source: Bloomberg, Updata, HSBC 9

40 Dollar bull market Source: Bloomberg, Updata, HSBC 0

41 A stirring in long end Gilts Source: Bloomberg, Updata, HSBC

42 Suggesting big changes to come Source: Bloomberg, Updata, HSBC

43 Summary Elliott Wave Principle is purest form of technical analysis Price and volume create patterns of psychology Natural proportionality to mass human behaviour Elliott Wave is NOT a trading system Running winners and cutting losers makes money Combining Elliott with Trend Following makes sense Zones in on high probability set ups Live in the moment Zen psychology Source: istockphoto

44 HSBC Technical Analysis Day Traders Support & Resistance Levels (Daily) Short Cycle Report (Twice per Week) Wave Principle Letter (Weekly) Trend-Wave Trading Signals (Ad-hoc trade ideas / portfolio) coming soon. Long Wave & Socionomic Journal (Semi-Annual)

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