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Enrique Santos MONOGRAPH Corrective patterns Electronic edition Acknowledgements To my friend Clare Hartland for her indefatigable proof reading. Copyright © Enrique Santos 2014 ISBN: 978-84-606-5520-6 Translated by : Rudolf Krzos Corver desing: Juliana Serri All rights reserved. The contents of thi...

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Corrective patterns Enrique Santos

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Enrique Santos MONOGRAPH

Corrective patterns Electronic edition

Acknowledgements To my friend Clare Hartland for her indefatigable proof reading.

Copyright © Enrique Santos 2014 ISBN: 978-84-606-5520-6 Translated by : Rudolf Krzos Corver desing: Juliana Serri All rights reserved. The contents of this publication may not be reproduced, in any form or part, or transmitted, or registered by any system of data recovery, in any form or any means, without previous permission in writing from the author.

Corrective Patterns

Enrique Santos

CONTENTS Introduction

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 5

Chapter I: Flat Patterns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 6 I.1. Deinition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 7 I.2. Typology

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 8

I.3. A lat and a trend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 11 I.4. Wave B and a trend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 13 I.5. Conirmation of the pattern: line O-B . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 20 I.6. Flats and indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 34 I.6.1. RSI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 34 I.6.1.1. Divergences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 36 I.6.2. MACD . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 37 I.6.3. An ideal igure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 40

Chapter II: Triangles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 48 II.1. A triangle and the direction of a price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 50 II.2. Price structure, requirements and objectives . . . . . . . . . . . . . . . . . . . . . . . . p. 53 II.3. The irst wave . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 55 II.4. Wave four . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 57 II.5. A continuation pattern or an exhaustion pattern . . . . . . . . . . . . . . . . . . . . . . p. 62 II.5.1. The feeling . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 69 II.6. The three bars . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 70 II.7. The triangle of gold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 73 II.8. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 76 3

Corrective Patterns

Enrique Santos

Chapter III: Zigzags . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 78 III.1. Price development of wave C . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 83 III.2. Conirmation of the pattern . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 84 III.3. A bullish trend and correction in a zigzags . . . . . . . . . . . . . . . . . . . . . . . . . . p. 86

Appendix: Corrective patterns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 91

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Corrective Patterns

Enrique Santos

1. Introduction The term “corrective pattern” includes all patterns that are not impulse patterns. This deinition is so general that it leaves an immense number of patterns among which we can distinguish three groups: lat patterns, triangles and zigzags. The principal objective of this book is the same as that of the irst monograph in the series, namely to help you identify the patterns at a glance, as we know that this constitutes the main dificulty that someone with theoretical knowledge of these techniques will have, when faced with a real chart. For this reason we have selected a series of igures which will help you exercise this recognition and then pinpoint the moment when the correction ends. In the irst monograph we studied impulse patterns and observed that it was necessary for the structure of the pattern under analysis to comply with a series of rules. Once we had made that analysis we were able to know we were dealing with one of them and consequently had a good chance of accurately predicting the price movement subsequent to the exhaustion of the pattern. In many cases the technique made it possible for us to establish the objectives of the price movement in the development of the pattern. In summary, we were within a framework where the price movements were relatively controlled. This will not occur with the study of corrective patterns. There are very few rules which can deine a lat pattern. For this reason the framework within which the price will move in its development is much more open than in the case of impulse patterns and in consequence is much less foreseeable. We will identify the common typical features of a large number of patterns in order to identify them more easily, although I must emphasise, that the task will be much more complicated than in the case of impulse patterns, for the reasons just presented. When we were analyzing impulse patterns we tried to predict when the trend was going to reach exhaustion. What we will try to interpret now is when the trend comes back. As always, it is indispensable that the analysis based on patterns should be accompanied by the analysis of the current indicators to be able to complete a system that can permit us to follow the market with a certain guarantee of success.

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Corrective Patterns

Enrique Santos

Chapter I Flat Patterns I.1. Deinition I.2. Typology I.3. A lat and a trend I.4. Wave B and a trend I.5. Conirmation of the pattern: line O-B I.6. Flats and indicators I.6.1. RSI I.6.1.1. Divergences I.6.2. MACD I.6.3. An ideal igure

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Corrective Patterns

Enrique Santos

I.1. Deinition The Elliot Wave Theory deines a lat pattern as that formed by three waves (a, b and c), of which the irst two have a corrective structure and the third has an impulse structure. Apart from that, the retracement of the second wave over the irst has to be of at least 61.8% and the price development of the third wave must be more than 38.2% of the price development of the irst. PB >PAx0.618 AND PC>PAx0.382 Flat patterns are continuation patterns, that is to say once a lat pattern is completed, the trend previous to the beginning of the pattern will manifest itself again. In the irst chart we can see the irst of the twenty lat patterns that we are going to analyze in this Monograph. a

5

c

3 4

1

2

O

b Fig. 1. A lat pattern

In this case, the price developments of the three waves are equal. The previous trend (downtrend) stops when it gets to point o, the origin of wave a. As a continuation, wave b retraces by 100% the price movement of wave a and then it bounces up unfolding the third wave which, as we can see in the chart, has an impulse structure. Therefore, with the line 2-4 crossover we get the conirmation of the exhaustion of wave c, the irst sign of the ending of the lat and the return of the trend. 7

Corrective Patterns

Enrique Santos

We obtain a graphic conirmation of the ending of the pattern when the price drops below the support deined by line o-b. Please note that the structure of wave b is more complex than that of wave a which is formed by three segments, while wave b is formed by ive. We can also see that wave b takes more time to form than wave a and wave c. This observation is important because although it is not considered a compulsory rule, in practice the second wave of the lat will have a more complex structure than the other two and will also take more time to form.

I.2. Typology The deinition of lat patterns provided by Elliot gives space to an ample variety of forms. This variety is, in turn, a result of the diversity of the structures of the second of the three waves, namely wave b. When studying impulse patterns, we said that the complication lay in knowing where wave four ended and the decisive factor was the exhaustion of wave ive. In the case of lat patterns, it is dificult to know when wave b has ended and our decisive factor is knowing when wave c has inished. The irst wave will not give us problems as generally it will have a simple structure, formed, on many occasions, by only one segment. The third wave, wave c, has to be an impulse pattern, so whether complex or simple, its structure will be deined by the rules we already know. However, wave b will cause us many a headache as we will not be able to determine what structure it has. At times wave b will be another lat. Other times, wave b will be a triangle, but in a great number of igures, it will not be of any identiiable pattern. This can sometimes make it dificult to ind the end of the correction, until we realize we have come across a very advanced wave c. Let us look at some examples. In Fig. 2 we can see a wave -b-, which is a lat. The retracement of -b- over -a- is more than 61.8% but less than100%. The previous trend is bullish and if we compare the structure of -a- with that of -b-, we can see that -b- is more complex and takes longer to form than

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Corrective Patterns

Enrique Santos

-a- but not as long as -c- 1. -o-bc a

2

1

b

-a4

3 5

-c-

Fig. 2. Dax-Xetra. Continuous Future. 15- min chart.

In Fig. 3 the lat pattern is wave 4 of an upward impulse pattern. On the left part of the igure we observe the last wave of -3- unfold. The price stops to unfold a corrective pattern in three waves which form major degree wave -4-. Waves a and c are very fast and almost equal in price movement and wave b is a triangle. Wave b retraces wave a by more than 61.8% , and wave c retraces wave b by more than 38.2% and has an impulse structure2.

1 Ta=88, Tb=79 and Tc=66 periods. 2 The level of retracement is measured from the end of a wave.

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Corrective Patterns

Enrique Santos

-35

3

b 2

4 1 4 1

a 2 3

c

5

-4-

Fig. 3. USD-YEN. 5- min. chart.

To inish, let us have a look at a typical example of the second wave of a lat: neither a triangle, nor a lat: simply a corrective pattern.

B

A

C

Fig. 4. IBEX-3 Index. 15- min. chart.

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Corrective Patterns

Enrique Santos

I.3. A lat and a trend As we have already said, lat patterns are considered to be continuation patterns of a trend. We will often ind lat patterns in waves two and four of impulse patterns. As we can see in Fig. 5 once a pattern ends, the trend continues and the price returns to the direction it followed before the beginning of the correction. We know that in impulse patterns, waves two and four are corrective patterns and therefore it will be in them that we will be able to ind lat patterns.

b

a c

Fig. 5. NIKKEI 221 Index. Daily chart.

The irst objective of technical analysis is to identify which trend underlies the movement of the price. Sometimes it will be easier to identify that trend than other times, but there will be situations when it will be impossible, because there will be no trend at all. Our interest will concentrate on those situations where an identiiable trend stops momentarily to unfold a corrective movement. If this corrective movement is a lat pattern, we will look for its end before we see the trend continue. In other words, we will look for the exhaustion of the third wave (wave c), which will always be, as we have already said, an impulse pattern, and when we conirm its 11

Corrective Patterns

Enrique Santos

exhaustion we will have a signal to enter the trend. In the following chart you can see another example of how a bearish trend continues once a lat has ended. You can see this in more detail in Fig. 7.

b

-a-

-c-

a c -b-

Fig. 6. USD-YEN. 15- min. chart.

Thanks to the impulse structure of waves c and to what we have already learnt about them, we can detect the exhaustion of the minor and major degree lats, namely waves c and -c-, respectively.

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Corrective Patterns

Enrique Santos

b

-c5

-ax3 2

4

1

a 1 4

2 x3 c 5

-b-

Fig. 7.- USD-YEN. 10- min. chart.

It is obviously major degree (-c-) which interests us in this case because it ends the correction and we can adopt positions again in the direction of the trend; bearish in this case.

I.4. Wave B and a trend As we have said, there is a very diverse typology of the lats from the point of view of their structure. This diversity is caused by the second wave. Wave b is very useful for one particular reason: it give us a sample of the state of the trend. In fact wave b of a lat moves in the same direction as the trend previous to the beginning of the pattern. Starting with this fact, the price development of wave b in relation to that of wave a will give us a graphic estimation of the state of the trend previous to the beginning of the lat and a possible development after wave c. The table that follows sums up the most common relations between the waves of a lat 13

Corrective Patterns

Enrique Santos

pattern, depending on the retracement of wave b over wave a. When the trend is strong, wave b will be strong and will have to surpass the origin of wave a. That is to say, the retracement of wave b over wave a will be more than 100% and when this happens wave c will retrace wave b by less than 100%. WAVE B

RETRACEMENT OF B OVER A

RETRACEMENT OF C OVER B

WEAK

61.8% - 80%

> 100%

NORMAL

81%-100%

100% - 138.2%

STRONG

100%-123.6%

100%

STRONG +

>123.6%...