Topics for Remainder of Course

• In our remaining time, we will hope to cover:

– Options trading and Black Scholes (Partial, Introduction)
– Fundamental and Technical Analysis (Partial, Introduction)
– Machine Learning and AI (Partial, Introduction)
– Cryptocurrencies and Fintech (Partial, Introduction)
– Kelly Criterion

• We will not have time to cover:

– Minimal spanning trees
– Market stability
– Portfolio construction: Efficient Market Hypothesis, Sharpe ratio,
Pricing theory, Factor analysis, Principal Component Analysis, Utility,
Efficient frontier, Capital allocation
See the lectures on these topics if you have interest
 Lecture 15

Technical Analysis and Trading

John Rundle Econophysics PHYS 255
Fundamental and Technical Analysis
https://en.wikipedia.org/wiki/Technical_analysis
• Fundamental analysis considers free cash flow, employment trends,
profit and loss, interest rates and other business factors that affect
valuation of future stock price
• Technical analysis is a security analysis methodology for forecasting
the direction of prices through the study of past market data,
primarily price and volume.
• Behavioral economics and quantitative analysis use many of the
same tools of technical analysis, which, being an aspect of active
management, stands in contradiction to much of modern portfolio
theory.
• The efficacy of both technical and fundamental analysis is disputed
by the efficient-market hypothesis which states that stock market
prices are essentially unpredictable.
 Technical Analysis
https://en.wikipedia.org/wiki/Technical_analysis
• The principles of technical analysis are derived from hundreds of years of
financial market data.
• In the 1920s and 1930s Richard W. Schabacker published several books
which continued the work of Charles Dow and William Peter Hamilton in
their books Stock Market Theory and Practice and Technical Market
Analysis.
• In 1948 Robert D. Edwards and John Magee published Technical Analysis
of Stock Trends which is widely considered to be one of the seminal works
of the discipline.
• It is exclusively concerned with trend analysis and chart patterns and
remains in use to the present.
• Early technical analysis was almost exclusively the analysis of charts,
because the processing power of computers was not available for the
modern degree of statistical analysis.
Fundamental vs. Technical Analysis
https://en.wikipedia.org/wiki/Technical_analysis
• Fundamental analysts examine earnings, dividends, assets, quality, ratio,
new products, research and the like.
• Technicians employ many methods, tools and techniques as well, one of
which is the use of charts.
• Using charts, technical analysts seek to identify price patterns and market
trends in financial markets and attempt to exploit those patterns.
• Technicians using charts search for archetypal price chart patterns, such as
the well-known head and shoulders or double top/bottom reversal
patterns, study technical indicators, moving averages, and look for forms
such as lines of support, resistance, channels, and more obscure
formations such as flags, pennants, balance days and cup and handle
patterns.
Fundamental vs. Technical Analysis
https://en.wikipedia.org/wiki/Technical_analysis
• Technical analysts also widely use market indicators of many sorts, some
of which are mathematical transformations of price, often including up
and down volume, advance/decline data and other inputs.
• These indicators are used to help assess whether an asset is trending, and
if it is, the probability of its direction and of continuation.
• Technicians also look for relationships between price/volume indices and
market indicators. Examples include the moving average, relative strength
index, and MACD (Moving Average Convergence-Divergence).
• Other avenues of study include correlations between changes in Options
(implied volatility=VIX for SP500) and put/call ratios with price.
• Also important are sentiment indicators such as Put/Call ratios, bull/bear
ratios, short interest, Implied Volatility, etc.
Fundamental vs. Technical Analysis
https://en.wikipedia.org/wiki/Technical_analysis
• There are many techniques in technical analysis.
• Adherents of different techniques (for example, candlestick
charting, Dow theory, and Elliott wave theory) may ignore the
other approaches, yet many traders combine elements from
more than one technique.
• Some technical analysts use subjective judgment to decide
which pattern(s) a particular instrument reflects at a given
time and what the interpretation of that pattern should be.
• Others employ a strictly mechanical or systematic approach to
pattern identification and interpretation.
 Examples of Chart Patterns
http://stockcharts.com/school/doku.php?
id=chart_school:chart_analysis:introduction_to_chart_patterns

• A Head and Shoulders (Top) reversal

pattern forms after an uptrend, and its
completion marks a trend reversal.
• The pattern contains three successive
peaks with the middle peak (head) being
the highest and the two outside peaks
(shoulders) being low and roughly equal.
• The reaction lows of each peak can be
connected to form support, or a neckline.
• As its name implies, the Head and
Shoulders reversal pattern is made up of a
left shoulder, a head, a right shoulder, and
a neckline.
• Other parts playing a role in the pattern
are volume, the breakout, price target and
support turned resistance.
 Examples of Chart Patterns
http://stockcharts.com/school/doku.php?id=chart_school:chart_analysis:introduction_to_chart_patterns

• The Head and Shoulders (Bottom),

sometimes referred to as an Inverse Head
and Shoulders, is a pattern that shares many
common characteristics with its comparable
partner, but relies more heavily on volume
patterns for confirmation.
• As a major reversal pattern, the Head and
Shoulders Bottom forms after a downtrend,
and its completion marks a change in trend.
• The pattern contains three successive
troughs with the middle trough (head) being
the deepest and the two outside troughs
(shoulders) being shallower.
• Ideally, the two shoulders would be equal in
height and width.
• The reaction highs in the middle of the
pattern can be connected to form
resistance, or a neckline.
 “Candlesticks”
http://wikifinancepedia.com/wikifinance/investing/trading/technical-analysis
 Fundamental Analysis
https://en.wikipedia.org/wiki/Technical_analysis
• Contrasting with Technical Analysis is Fundamental Analysis,
the study of economic factors that influence the way investors
price financial markets.
• Technical analysis holds that prices already reflect all the
underlying fundamental factors.
• Uncovering the trends is what technical indicators are
designed to do, although neither technical nor fundamental
indicators are perfect.
• Some traders use technical or fundamental analysis
exclusively, while others use both types to make trading
decisions.
 Fundamental Analysis
http://wikifinancepedia.com/wikifinance/investing/trading/technical-analysis
 Fundamental Analysis
https://www.google.com/finance?q=NYSEARCA%3ASPY&ei=hCrUUfjdJ5qAlgPtOw
 Fundamental Analysis
https://en.wikipedia.org/wiki/Technical_analysis
• Fundamental analysts focus on the equation M = P/E, where M is the
stock multiple.
• Stock multiples involve psychology, i.e. the extent of willingness to
buy/sell.
• Also in M is the ability to pay as, for instance, a spent-out bull can't make
the market go higher and a well-heeled bear won't.
• Technical analysis analyzes price, volume, psychology, money flow and
other market information, whereas fundamental analysis looks at the facts
of the company, market, currency or commodity.
• Most large brokerage, trading group, or financial institutions will typically
have both a technical analysis and fundamental analysis team.
 Technical Analysis
https://en.wikipedia.org/wiki/Technical_analysis
• Technical analysis is widely used among traders and financial professionals and is
very often used by active day traders, market makers and pit traders.
• In the 1960s and 1970s it was widely dismissed by academics.
• In a recent review, Irwin and Park reported that 56 of 95 modern studies found
that it produces positive results but noted that many of the positive results were
rendered dubious by issues such as data snooping*, so that the evidence in
support of technical analysis was inconclusive
• It is still considered by many academics to be pseudoscience.
• Academics such as Eugene Fama say the evidence for technical analysis is sparse
and is inconsistent with the weak form of the efficient-market hypothesis.
• Users hold that even if technical analysis cannot predict the future, it helps to
identify trends, tendencies, and trading opportunities.

*Data snooping refers to statistical inference that the researcher decides to perform after looking at the
data (as contrasted with pre-planned inference, which the researcher plans before looking at the data).
 Components of Technical Analysis
https://en.wikipedia.org/wiki/Technical_analysis
• John Murphy states that the principal sources of information available to
technicians are price, volume and open interest.
• However, many technical analysts reach outside pure technical analysis, combining
other market forecast methods with their technical work.
• One advocate for this approach is John Bollinger, who coined the term rational
analysis in the middle 1980s for the intersection of technical analysis and
fundamental analysis.
• Another such approach, fusion analysis, overlays fundamental analysis with
technical, in an attempt to improve portfolio manager performance.
• Technical analysis is also often combined with quantitative analysis and economics.
• For example, neural networks may be used to help identify intermarket
relationships.
• Investor and newsletter polls, and magazine cover sentiment indicators, are also
used by technical analysts.
 Support and Resistance
http://wikifinancepedia.com/wikifinance/investing/trading/technical-analysis

New high = “resistance level” New low = “support level”

 Technical Analysis: Criticisms
https://en.wikipedia.org/wiki/Technical_analysis
• Whether technical analysis actually works is a matter of controversy.
• Methods vary greatly, and different technical analysts can sometimes make
contradictory predictions from the same data.
• Many investors claim that they experience positive returns, but academic
appraisals often find that it has little predictive power.
• Of 95 modern studies, 56 concluded that technical analysis had positive results,
although data-snooping bias and other problems make the analysis difficult.
• Nonlinear prediction using neural networks occasionally produces statistically
significant prediction results.
• A Federal Reserve working paper regarding support and resistance levels in short-
term foreign exchange rates "offers strong evidence that the levels help to predict
intraday trend interruptions," although the "predictive power" of those levels was
"found to vary across the exchange rates and firms examined".
 Burton Malkiel

My Econ 101 Professor at Princeton in 1972

Burton Malkiel on Technical Analysis
https://en.wikipedia.org/wiki/Technical_analysis
• The random walk hypothesis may be derived from the weak-form efficient
markets hypothesis, which is based on the assumption that market
participants take full account of any information contained in past price
movements (but not necessarily other public information).
• In his book A Random Walk Down Wall Street, Princeton economist
Burton Malkiel said that technical forecasting tools such as pattern
analysis must ultimately be self-defeating:
• "The problem is that once such a regularity is known to market
participants, people will act in such a way that prevents it from happening
in the future.”
• Malkiel has stated that while momentum may explain some stock price
movements, there is not enough momentum to make excess profits.
• Malkiel has compared technical analysis to "astrology”.
 Andrew Lo on Technical Analysis
https://en.wikipedia.org/wiki/Technical_analysis
• In the late 1980s, Andrew Lo and Craig McKinlay published a paper which
cast doubt on the random walk hypothesis.
• In a 1999 response to Malkiel, Lo and McKinlay collected empirical papers
that questioned the hypothesis' applicability that suggested a non-random
and possibly predictive component to stock price movement, though they
were careful to point out that rejecting random walk does not necessarily
invalidate EMH, which is an entirely separate concept from RWH.
• In a 2000 paper, Andrew Lo back-analyzed data from U.S. from 1962 to
1996 and found that "several technical indicators do provide incremental
information and may have some practical value”.
• Burton Malkiel dismissed the irregularities mentioned by Lo and McKinlay
as being too small to profit from
• The success of Jim Simons’ Renaissance Technologies Medallion Fund may
lend some support to Lo and McKinlay’s conclusions
 Andrew Lo on Technical Analysis
https://en.wikipedia.org/wiki/Technical_analysis
From a paper published in the Journal of Finance by Dr. Andrew W. Lo, director MIT Laboratory
for Financial Engineering, working with Harry Mamaysky and Jiang Wang found that:

• “Technical analysis, also known as "charting", has been a part of financial practice for many decades, but
this discipline has not received the same level of academic scrutiny and acceptance as more traditional
approaches such as fundamental analysis.
• One of the main obstacles is the highly subjective nature of technical analysis – the presence of geometric
shapes in historical price charts is often in the eyes of the beholder.
• In this paper, we propose a systematic and automatic approach to technical pattern recognition using
nonparametric kernel regression, and apply this method to a large number of U.S. stocks from 1962 to
1996 to evaluate the effectiveness of technical analysis.
• By comparing the unconditional empirical distribution of daily stock returns to the conditional
distribution – conditioned on specific technical indicators such as head-and-shoulders or double-bottoms –
we find that over the 31-year sample period, several technical indicators do provide incremental
information and may have some practical value1.”

[1] Foundations of Technical Analysis: Computational Algorithms, Statistical Inference, and

Empirical Implementation, Andrew Lo, Harry Mamaysky and Jiang Wang, Journal of Finance
55(2000), 1705-1765.
 On the Other Hand…
https://en.wikipedia.org/wiki/Technical_analysis
• Technicians claim that the EMH and random walk theories both ignore the
realities of markets, in that participants are not completely rational and
that current price moves are not independent of previous moves.
• Other signal processing researchers dispute the random walk hypothesis,
that stock market prices resemble Wiener processes, because the
statistical moments of such processes and real stock data vary significantly
with respect to window size and similarity measure.
• They argue that feature transformations used for the description of audio
and biosignals can also be used to predict stock market prices successfully
which would contradict the random walk hypothesis.

Ended 2/12/2023
 On the Other Hand…
https://en.wikipedia.org/wiki/Technical_analysis
• Caginalp and Balenovich in 19941 used their asset-flow differential equations
model to show that the major patterns of technical analysis could be generated
with some basic assumptions.
• Some of the patterns such as a triangle continuation or reversal pattern can be
generated with the assumption of two distinct groups of investors with different
assessments of valuation.
• The major assumptions of the models are that the finiteness of assets and the use
of trend as well as valuation in decision making.
• Many of the patterns follow as mathematically logical consequences of these
assumptions.
• One of the problems with conventional technical analysis has been the difficulty
of specifying the patterns in a manner that permits objective testing.
• It is possible that this situation may change with better pattern recognition
classifiers

[1] Gunduz Caginalp & Donald Balenovich (2003), A theoretical foundation for
technical analysis, Journal of Technical Analysis. 59: 5–22.
Nassim Nicholas Taleb
 Charting Terms and Indicators
https://en.wikipedia.org/wiki/Technical_analysis
• Average true range – averaged daily trading range, adjusted for price gaps.
• Breakout – the concept whereby prices forcefully penetrate an area of prior support or resistance, usually,
but not always, accompanied by an increase in volume.
• Chart pattern – distinctive pattern created by the movement of security prices on a chart
• Cycles – time targets for potential change in price action (price only moves up, down, or sideways)
• Dead cat bounce – the phenomenon whereby a spectacular decline in the price of a stock is immediately
followed by a moderate and temporary rise before resuming its downward movement
• Elliott wave principle and the golden ratio to calculate successive price movements and retracements
• Fibonacci ratios – used as a guide to determine support and resistance (see below)
• Momentum – the rate of price change
• Point and figure analysis – A priced-based analytical approach employing numerical filters which may
incorporate time references, though ignores time entirely in its construction
• Resistance – a price level that may prompt a net increase of selling activity
• Support – a price level that may prompt a net increase of buying activity
• Trending – the phenomenon by which price movement tends to persist in one direction for an extended
period of time
 Indicators
http://wikifinancepedia.com/wikifinance/investing/trading/technical-analysis

• The MACD indicator (or "oscillator") is a collection of three time series calculated from historical price data, most
often the closing price.
• These three series are: the MACD series proper, the "signal" or "average" series, and the "divergence" series which
is the difference between the two.
• The MACD series is the difference between a "fast" (short period) exponential moving average (EMA), and a "slow"
(longer period) EMA of the price series.
• The average series is an EMA of the MACD series itself.
MACD: Moving Average Convergence-Divergence
 Types of Charts
https://en.wikipedia.org/wiki/Technical_analysis
• Candlestick chart – Of Japanese origin and similar to OHLC, candlesticks widen and
fill the interval between the open and close prices to emphasize the open/close
relationship.
• In the West, often black or red candle bodies represent a close lower than the
open, while white, green or blue candles represent a close higher than the open
price.
• Line chart – Connects the closing price values with line segments.
• Open-high-low-close chart – OHLC charts, also known as bar charts, plot the span
between the high and low prices of a trading period as a vertical line segment at
the trading time, and the open and close prices with horizontal tick marks on the
range line, usually a tick to the left for the open price and a tick to the right for the
closing price.
• Point and figure chart – a chart type employing numerical filters with only passing
references to time, and which ignores time entirely in its construction.
 Overlays
https://en.wikipedia.org/wiki/Technical_analysis
Overlays are generally superimposed over the main price chart:
• Bollinger bands – a range of price volatility based on standard deviations
• Channel – a pair of parallel trend lines
• Ichimoku kinko hyo – a moving average-based system that factors in time
and the average point between a candle's high and low
• Moving average – an average over a window of time before and after a
given time point that is repeated at each time point in the given chart. A
moving average can be thought of as a kind of dynamic trend-line.
• Parabolic SAR – Wilder's trailing stop based on prices tending to stay
within a parabolic curve during a strong trend
• Pivot point – derived by calculating the numerical average of a particular
currency's or stock's high, low and closing prices
• Trend line – a sloping line described by at least two peaks or two troughs
 Breadth Indicators
https://en.wikipedia.org/wiki/Technical_analysis
• These indicators are based on statistics derived from the
broad market.
• Advance–decline line – a popular indicator of market breadth.
• McClellan Oscillator - a popular closed-form indicator of breadth.
• McClellan Summation Index - a popular open-form indicator of breadth.

Basic market breadth is difference between number of

advancing shares and declining shares
 Price-Based Indicators
https://en.wikipedia.org/wiki/Technical_analysis
• These indicators are generally shown below or above the main price chart.
• %C – denotes current markets environment as range expansion or a range
contraction, it also forecast when extremes in trend or choppiness are being
reached, so the trader can expect change.
• Average directional index – a widely used indicator of trend strength.
• Commodity Channel Index – identifies cyclical trends.
• MACD – moving average convergence/divergence.
• Momentum – the rate of price change.
• Relative strength index (RSI) – oscillator showing price strength.
• Relative Vigor Index (RVI) – oscillator measures the conviction of a recent price
action and the likelihood that it will continue.
• Stochastic oscillator – close position within recent trading range.
• Trix – an oscillator showing the slope of a triple-smoothed exponential moving
average.
 Examples of Chart Patterns
http://stockcharts.com/school/doku.php?
id=chart_school:chart_analysis:introduction_to_chart_patterns

• The ascending triangle is a bullish

formation that usually forms during an
uptrend as a continuation pattern.
• There are instances when ascending
triangles form as reversal patterns at the
end of a downtrend, but they are typically
continuation patterns.
• Regardless of where they form, ascending
triangles are bullish patterns that indicate
accumulation.
• Two or more equal highs form a horizontal
line at the top.
• Two or more rising troughs form an
ascending trend line that converges on the
horizontal line as it rises. If both lines
were extended right, the ascending trend
line could act as the hypotenuse of a right
triangle.
 Examples of Chart Patterns
http://stockcharts.com/school/doku.php?
id=chart_school:chart_analysis:introduction_to_chart_patterns

• A price channel is a continuation

pattern that slopes up or down
and is bound by an upper and
lower trend line.
• The upper trend line marks
resistance and the lower trend
line marks support.
• Price channels with negative
slopes (down) are considered
bearish and those with positive
slopes (up) bullish.
”The trend is your friend”
 Examples of Chart Patterns
http://stockcharts.com/school/doku.php?
id=chart_school:chart_analysis:introduction_to_chart_patterns

• The symmetrical triangle, which can also

be referred to as a coil, usually forms
during a trend as a continuation pattern.
• The pattern contains at least two lower
highs and two higher lows.
• When these points are connected, the
lines converge as they are extended, and
the symmetrical triangle takes shape.
• You could also think of it as a contracting
wedge, wide at the beginning and
narrowing over time.
• While there are instances when
symmetrical triangles mark important
trend reversals, they more often mark a
continuation of the current trend.
• Regardless of the nature of the pattern,
continuation or reversal, the direction of
the next major move can only be
determined after a valid breakout.
 Examples of Chart Patterns
http://stockcharts.com/school/doku.php?
id=chart_school:chart_analysis:introduction_to_chart_patterns

• Flags and Pennants are short-term

continuation patterns that mark a small
consolidation before the previous move
resumes.
• These patterns are usually preceded by a
sharp advance or decline with heavy
volume, and mark a mid-point of the
move.
 My Favorite
http://jeffhirsch.tumblr.com/post/123059521013/three-peaks-and-a-domed-house-top
 Fibonacci Retracement
https://en.wikipedia.org/wiki/Fibonacci_retracement

Fibonacci sequence:
[Xn] = 1, 1, 2, 3, 5, 8, 13, 21, 34,
55, …

Retracement points:
1st: Xn/Xn+1 -> 0.618
2nd: Xn/Xn+2 -> 0.382
Sequence is generated by taking the integers: 1,2,3,4,5,6,… and begin with
1, then add each number in the Fib sequence to the number previous
 Fibonacci Retracement
https://en.wikipedia.org/wiki/Fibonacci_retracement
• In finance, Fibonacci retracement
is a method of technical analysis
for determining support and
resistance levels.
• They are named after their use of
the Fibonacci sequence.
• Fibonacci retracement is based
on the idea that markets will
retrace a predictable portion of a
move, after which they will
continue to move in the original
direction.
 Fibonacci Retracement
https://en.wikipedia.org/wiki/Fibonacci_retracement
• The appearance of retracement
can be ascribed to ordinary price
volatility as described by Burton
Malkiel, a Princeton economist in
his book A Random Walk Down
Wall Street, who found no
reliable predictions in technical
analysis methods taken as a
whole.
• Malkiel argues that asset prices
typically exhibit signs of random
walk and that one cannot
consistently outperform market
averages.
 Fibonacci Retracement
https://en.wikipedia.org/wiki/Fibona
cci_retracement
• Fibonacci retracement is created by taking
two extreme points on a chart and dividing
the vertical distance by the key Fibonacci
ratios.
• 0.0% is considered to be the start of the
retracement, while 100.0% is a complete
reversal to the original part of the move.
• Once these levels are identified, horizontal
lines are drawn and used to identify possible
support and resistance levels.
• The significance of such levels, however,
could not have been statistically confirmed.[
• Arthur Merrill, CMT (Chartered Market
Technician) determined there is no reliable
standard retracement; not 50%, 33%,
38.2,61.8%,or any other.
• The 0.618 Fibonacci retracement that is often
used by stock analysts approximates to the
"golden ratio”.
 Golden Ratio
https://en.wikipedia.org/wiki/Golden_ratiohttps://en.wikipedia.org/wiki/Golden_ratio
 Elliott Waves
https://www.investopedia.com/terms/e/elliottwavetheory.asp

• The Elliott Wave theory is a theory in technical analysis used to describe

price movements in the financial market.
• The theory was developed by Ralph Nelson Elliott after he observed and
identified recurring, fractal wave patterns.
• Waves can be identified in stock price movements and in consumer
behavior.
• Investors trying to profit from a market trend could be described as riding a
wave.
 The Elliott Wave theory is a form of technical analysis that looks for recurrent long-
term price patterns related to persistent changes in investor sentiment and
psychology.
 The theory identifies impulse waves that set up a pattern and corrective waves
that oppose the larger trend.
 Each set of waves is nested within a larger set of waves that adhere to the same
impulse or corrective pattern, which is described as a fractal approach to investing.
 Elliott Waves
https://www.investopedia.com/terms/e/elliottwavetheory.asp

• The Elliott Wave theory was developed by Ralph Nelson Elliott in the 1930s.
• After being forced into retirement due to an illness, Elliott needed something to
occupy his time and began studying 75 years worth of yearly, monthly, weekly, daily,
and self-made hourly and 30-minute charts across various indexes.1
• The theory gained notoriety in 1935 when Elliott made an uncanny prediction of a
stock market bottom.
• It has since become a staple for thousands of portfolio managers, traders, and private
investors.1
• Elliott described specific rules governing how to identify, predict, and capitalize on
these wave patterns.
• These books, articles, and letters are covered in R.N. Elliott's Masterworks, which was
published in 1994.
• Elliott Wave International is the largest independent financial analysis and market
forecasting firm in the world whose market analysis and forecasting are based on
Elliott’s model.
 Elliott Waves
https://www.investopedia.com/terms/e/elliottwavetheory.asp

• Some technical analysts try to profit from wave patterns in the stock market
using the Elliott Wave Theory.
• This hypothesis says that stock price movements can be predicted because they
move in repeating up-and-down patterns called waves that are created by
investor psychology or sentiment.
• The theory identifies two different types of waves: motive waves (also known as
impulse waves) and corrective waves.
• It is subjective, meaning not all traders interpret the theory the same way or
agree that it is a successful trading strategy.
• Unlike most other price formations, the whole idea of wave analysis itself does
not equate to a regular blueprint formation where you simply follow the
instructions.
• Wave analysis offers insights into trend dynamics and helps you understand
price movements in a much deeper way.
 Impulse Waves
https://www.investopedia.com/terms/e/elliottwavetheory.asp

• Impulse waves consist of five sub-waves that

make net movement in the same direction as
the trend of the next-largest degree.
• This pattern is the most common motive wave
and the easiest to spot in a market.
• Like all motive waves, it consists of five sub-
waves—three of them are also motive waves,
and two are corrective waves.
• It has three unbreakable rules that define its
formation:
• Wave two cannot retrace more than
100% of the first wave
• The third wave can never be the shortest of If one of these rules is violated, the
structure is not an impulse wave.
waves one, three, and five
The trader would need to re-label
• Wave four can't go beyond the third wave
the suspected impulse wave.
at any time
 Corrective Waves
https://www.investopedia.com/terms/e/elliottwavetheory.asp

• Corrective waves, which are sometimes called

diagonal waves, consist of three—or a
combination of three—sub-waves that make
net movement in the direction opposite to the
trend of the next-largest degree.
• Like all motive waves, its goal is to move the
market in the direction of the trend.
• Recall the corrective wave consists of five sub-
waves.
• The difference is that the diagonal looks like
either an expanding or contracting wedge.
• The sub-waves of the diagonal may not have a
count of five, depending on what type of
diagonal is being observed.
 Corrective Waves
https://www.investopedia.com/terms/e/elliottwavetheory.asp

• As with the motive wave, each sub-wave of the

diagonal never fully retraces the previous sub-
wave, and sub-wave three of the diagonal may
not be the shortest wave.
• These impulse and corrective waves are nested
in a self-similar fractal to create larger patterns.
• For example, a one-year chart may be in the
midst of a corrective wave, but a 30-day chart
may show a developing impulse wave.
• A trader with this Elliott wave interpretation
may thus have a long-term bearish outlook
with a short-term bullish outlook.
 Elliott Waves: Special
Considerations
https://www.investopedia.com/terms/e/elliott
wavetheory.asp

• Elliott recognized that the Fibonacci sequence

denotes the number of waves in impulses and
corrections.
• Wave relationships in price and time also
commonly exhibit Fibonacci ratios, such as 38%
and 62%.
• For example, a corrective wave may have a retrace
of 38% of the preceding impulse
• Other analysts have developed indicators inspired
by the Elliott Wave principle, including the Elliott
Wave Oscillator, which is pictured in the image at
right.
• The oscillator provides a computerized method of
predicting future price direction based on the
difference between a five-period and 34-period
moving average.
Example of a pattern
that didn’t pan out:

SPY “Bull Trap”

(Investopedia)
 The Case for a “Bull Trap” (2/2/2019)
Analysis of Data
• New market highs tagging the upper monthly Bollinger band on
a monthly negative RSI (relative strength index) divergence —
check.
• A steep correction off the highs that breaks a multi-year trend
line — check.
• A turning of the monthly MACD (Moving Average Convergence
Divergence) toward south and the histogram to negative —
check.
• A correction that transverses all the way from the upper
monthly Bollinger band to the lower monthly Bollinger band
before bouncing — check.
• A counter rally that moves all the way from the lower Bollinger
band to the middle Bollinger band, the 20MA — check.
• A counter rally that produces a bump in the RSI around the
middle zone, alleviating oversold conditions — check.
• All these events occurring following an extended trend of lower
unemployment, signaling the coming end of a business cycle —
check.
• All these events coinciding with a reversal in yields — check.
• All these events coinciding with a Federal Reserve suddenly
halting its rate hike cycle — check.
 The Case for a “Bull Trap” (2/2/2019)
https://www.marketwatch.com/story/the-evidence-is-in-stocks-are-in-a-bull-trap-2019-02-02

Relative Strength Index

2/1995
Closing Price with Bollinger Bands
(1 around 1 Year Exponential Moving Average)

Moving Average Convergence Divergence)

Unemployment Rate

TNX 10 Year Bond Yield

 Investopedia
https://www.investopedia.com
 Investopedia
https://www.investopedia.com
 Charting Web Site
StockTA.com

Example of chart analysis

https://www.investopedia.com
https://www.investopedia.com
https://www.investopedia.com