Rawwwwwr... went the bear last night as the S&P 500 encouragingly broke the first support level that needs to be broken to indicate that the market has topped. I continue to monitor the situation. Earlier on in the week the market chugged up but its movements were laboured and insignificant. Then at the end of the week a nice, big red day.
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| Behold my fangs |
Portfolio wise, I sustained small drawdowns as the markets chugged higher early in the week, before ending the week positive with a gain of US$1k+ thanks to the movements on Friday (as you know, I have cautiously gone net short since last week). If the markets continue to fall, I will gradually be adding to my positions as the bear market grows in probability. As I mentioned last week, I am hardly using leverage for now and hence the returns I have (even though I may be correct in my directional call) may be somewhat muted.
2. The 5 Waves in Elliot Wave
Perhaps it is time to talk a bit about Elliot Wave. In Elliot Wave theory, putting it extremely simply, waves in the trending direction (can be up or down) move in 5 waves.
The first wave is the "first mover wave", where for instance, after a long bear market between 2007 to 2009, nobody really believed the bulls anymore when the market bottomed in March 2009 and we saw the markets start to rally initially. People were still so fearful to re-enter the markets back then that the rally was heavily doubted and there was no widespread participation.
Then comes the second wave. It is the "wave of doubt" because the second wave actually retraces the movement of the first wave. This means it wipes out most of the first wave and creates doubt in the markets about the viability of the first wave. This is the role the second wave is meant to play. In a bull market, it would get people thinking "cheh, the rally in the markets last week (i.e. the first wave up) was just a smokescreen. Better don't enter the markets first!!"
Then we come to the famous third wave of Elliot Wave theory. It is the "wave of recognition". It is the wave that finally reveals to the mass markets (and leaves no doubt in everyone's minds) as to what the true trend in the markets is. Third waves are usually forceful and ferocious and in bear markets they can be very sudden, leaving investors with little or no chances to exit. Remember the days in 2008 when AIG and Citi ran into problems and the markets were tanking 3% on some days? That's the heart of a bear market wave 3 for you. In a bull market wave 3s tend to be more serene events. In a bull market wave 3 you tend to see the markets going up steadily by 0.5% for many, many days in a row. Then a correction once in a while to keep the bears hopeful, before more up days. Nice and steady.
Wave 4 is the wave of consolidation. It is the period where the mass market have, seduced or awed by the force of the wave 3, are thoroughly convinced about the market trend and have entered the market because they want their share of the pie now (but sadly they are usually too late)! But in Wave 4s, the markets keep ding-donging without any net movement, and can frustrate many investors. Wave 4 is usually seen as the worst period to be in the markets. Even traders can get blue-black from all the whipsaws that wave 4s can throw at them and there are quite plenty who choose to sit wave 4s out.
Wave 5 is the final wave where all the "stupid money" comes in. This is where you see your shoeshine boys and "ah-gong ah mah" investors come out to play in the markets because they have very belatedly heard about the market movements and want to make some money. Sometime in the wave 5 the smart money would have exited with profits in the bag, leaving most of the retail market to hold the fort. And while there are returns to be had, wave 5s are usually for suckers. While wave 5s are typically never as forceful as wave 3s and are usually of the same scale as wave 1s, there is still money that can be made out of them (getting long during the 2000 NASDAQ rally where the markets went parabolic would have bagged you a ton of money, provided you exited in time) but one must tread cautiously because at the end of a wave 5 is a trend change.
The classic application of Elliot Wave is to wait for a wave 1 to clearly pan out in order to confirm the beginning of a trend. Then enter at the end of wave 2, and ride wave 3 for maximum profits at minimal risk. Sit out wave 4, and ride wave 5 cautiously with a tight stop.
Also, the beauty of Elliot Wave is that it is fractal in nature. Which means for instance, within a wave 1, there are actually 5 mini-waves within that wave 1. And within each of the 5 mini-waves, there are actually 5 micro-waves inside. You get the idea. It's something like SIM cards, you have mini, micro and nano. Just that in Elliot Wave we call them Cycle waves, Primary waves, Major waves, Minor waves, and so on. In addition, if you look at the insides of every wave 2 and wave 4, they very generally tend to correct in 3 waves, i.e. a wave A, wave B and wave C. And to complicate things, wave As and Cs themselves consist of 5 smaller waves, while wave B consists of 3 smaller waves.
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| An illustration of the fractal nature of the waves. You see how a wave [1] is actually made up of 5 smaller waves? And how there are ABCs within waves 2 and 5 of the smaller waves, and for wave [2] as well? |
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