Waves and Cycles

Hello BBTL readership,

Short Term Equity Outlook

Although many market participants including gurus (Tom De Mark and several more) have expected a correction for many days now, the market continues to advance in baby steps and thus continues to defy the bears.

Besides the usual observation that financial markets often climb a wall of worry (surely this is one of them), ask yourself, what I had stated a while ago (January) about the FED?

Is this not the exact market that Ben Bernanke mandated with his recent announcement that FED rates would be exceptionally low - for at least three more years?

More realistically, today, to start the week off, the technical side truth again showed early selling was eventually met - by yet another successful late in the day comeback.

Frankly, in my own view I believe Wall Street will continue to advance slowly this week on bullish Bernanke talk about the economy, but further, there is a whole tranche of month-end economic news due out as well as the typical Bernanke Fed-speak in his semi-annual address to Congress.

In essence, I expect the planned media spins will focus on the positive news this week, as important month-end economic indicators such as durable goods, Case-Shiller (homes), confidence, jobs, auto sales and more hit the street. Perhaps more important will be how well money-man Bernanke reassures the street. If the news is bad, the men in suits will still attempt to spin it as positive, by saying "it could have been worse".

As a general rule recently, when Bernanke usually speaks to Congress or after a FED meeting, the pawns and friends of bankers (banksters  - smile) on Wall Street buy to show their support.

This is therefore most likely a preplanned up week.

At the same time however, we would be wrong not to point out that the market is now advancing in mere baby steps.

Momentum is waning (typically a certain warning since momentum precedes price) and most typical of what can happen days or even weeks before the eventual correction onset.

Most important, we are now nearing the month of March.

As I have been stating all along in 2012 (since early January), March will be a vastly different month. It is a robust cycle hotspot in the first half of 2012 that is far too complex to explain in full detail on a blog.

If you are an Astro W. D. Gann cycle student, or perhaps enjoy Arch Crawford (never use Astro in isolation even if you are an expert), the planetary aspects become far more difficult.

From a more conventional static cycle perspective, we will soon celebrate the third anniversary of the bull market from the panic sub-prime low. Seasonally, we then enter Spring time when liquidity slowly falls off and the seasonal cycles become far more important.

I cannot talk at length herein about cycle details in March, other than to again reiterate and say that I informed everyone regarding the cyclical nature month of March at the beginning of this year (or even earlier in some cases).

Without any doubt, I do not expect March to pass without some type of more serious correction.

Given our close proximity now to that highly cyclical monthly hot-spot in March, the correction which I have labelled and forecast for some time in March as a Wave 4 down, could be over relatively fast.

I also expect some stocks and perhaps certain commodities will make their yearly peak here, whereas others will rotate to take-up new or strengthening leadership, so you will have to be an alert stock picker either way after March 2012.

In the short term therefore, I still remain bullish on the SP500 Index, (and thus equities in general) but strongly suggest tightening stops now.

As a final important cyclical note, the first all-out or highly significant cycle day in March 2012, for the SP500 Index is about March 9th, 2012.

The most important cycle day of the March month however for the SP500 Index is about March 22- 23, 2012.

Size Matters

Way back in 2009, British Research proposed that size matters. In this case, even though it was reported on major news portals, it really turned out to be more of a laughing matter. For that non- newsworthy and laughable story click here.

However, before you laugh too hard about size and some of the absurd chatter on Wall or Bay Street, some research about size is actually very important.

The size of financial institutions and what they do is extremely important. The market participants can be sorted and ranked by size, and watching them closely (PS the largest size players are at the top of my watch list), is almost as important as watching the FED.

By example, we all should know and acknowledge that if largest financial institutions (the commercials or hedgers as opposed to the major institutions, mid-size funds, and large speculators ) started robust selling their equities tomorrow, and especially if they start simultaneously selling, they could indeed initiate a new trend down.

Can this be observed? Yes

Yet even the most established trends can indeed be upset, or by external events. So this is one reason, we always need to keep an open mind and have a plan B - or what if  plan.

Assuming the trends are stable (without upsets), the social mood will shift in accordance with Natural Law, and cycles - just as the great W. D. Gann and R. N. Elliott observed by the repetition of patterns and cycles. Anyone who denies that patterns and cycles exist is simply a non-observer of Natural Law at work.

Recently, the commercials as they are often called, or the largest Wall Street equity holders have slowly started hedging their portfolios (using futures, options or derivatives). I first commented at KRTT about this factor a couple of weeks ago. This is simply another red flag that suggest the higher the market goes without any correction, the more unstable it gets until we hit a breaking point.

There are a few different methods of watching the institutions closely, but if you are going to watch, you may as well include study of the largest group or the commercials, which tend to be more right at major turning points or significant CITs, than the medium and smaller institutions which tend to more often be trend followers.

Predicting Upsets

Although many wonder what might bring this bull market to conclusion to a final peak, more than anything, if such an event was to occur by surprise - it will most likely impact and influence confidence.

This is an important topic because when upsets occur at an inopportune time - financial markets can move quickly or in a watershed-like event, that sometimes becomes an all out financial crash.

At this point, everything ahead in 2012 is pure speculation. That is not my topic, other than for education purposes.

However as I say and teach over and over, without upsets, it is really Natural Law and cycles that bring about CITs (changes in trend) and even market conclusions.

However due to ego and our lesser human traits, man feels desperate and needy to be logical and to explain the financial events daily. The men at the top, or decision makers and media with even more ego, and combined with our common bad human traits,  - feel they simply must do something or to intervene.

When man intervenes without the knowledge of financial cycles and natural law, it can become a rapid catalyst for abundant or abrupt change.

However, it is really important to emphasize that very few real upset mechanisms will occur. Upsets too, must therefore be quantified by size and impact. Again, it seems a statement of fact, that in certain cases - size does matter.

As I mentioned, a recent smaller bullish financial upset was back in the January announcement by the FED (by Bernanke) of three more years of ultra-low rates had smaller than normal impact.

This could have been an even bigger upset event, but realistically we already had ultra-low rates.

At this point the FED is really pushing on an economic rope (low efficacy) with more of the same old monetary moral suasion. Ben did not get the moniker Helicopter Ben (throwing free money out of a helicopter) for no reason. What is below zero Ben?  Free?  Does Bernanke not even see the monetary forest for the trees?  Is virtually free FED cash for financial institutions at the FED credit window becoming a Ponzi scheme?


It was the central bank ultra-low rate policy that created the recent sub-prime speculative bubble and yet central bankers want to do more of this. As I wrote recently, they have a vested self-interest and frankly are now being fully transparent, honest or fair, in that taxpayers are now paying for bank and policy mistakes by the FED.

Click here to view the video on the same central bank scheme as it happens in the Euro zone.       

Bernanke's low rates therefore, could one day again backfire and become a much more important upset. Here are some examples for teaching points.

Another name for a true upset mechanism is a significant surprise event (i.e. the disaster in Japan last year - but it also can be a man-made event).

Here are some examples of potential real surprise events, and relatively large upset mechanisms that could indeed happen this year. Yes, let me repeat 2012.

1. A Greece Default (leaving the Euro zone) - I have talked about this one a lot. Again, here is yet another excellent video (more were given on our latest blogs) that everyone with money in the markets should watch, especially if you think this cannot happen (click here).  

2. A Bond Vigilante Revolt (potential bond market crash) - Whereby, the largest group of global investors (think size matters again) decide to simultaneously cash out of their ultra-low yielding and thus ultra-risky bonds, that are now being exposed to multiple massive financial risks including currency risk, sovereign debt risk, inflation risks (especially after massive and repeated monetary stimulus by central banks) as well as the overall loss potential when bond prices falls as yields must certainly rise (we all know this is now only a matter of time). A revolt of any significant size and done in tandem will overwhelm any central bank buyback program, including those called QE. Moreover the USA FED balance sheet is already drastically bloated from past QE's and rescue programs.

3. More Global Derivative Losses. Derivatives are really another name for leverage. The leveraged real estate and housing markets were a recent past example, but there are trillions of dollars of derivatives in a largely unregulated market.

4. A USA Sovereign Debt Crisis on the eve of the USA election

In summary once again, we see that size does matters, especially when major upsets occur. So, do you know what you are going to do if a major significant event occurs tomorrow?

Think about it.

Elliott Wave Answers

Background

Recently in our blog comments, a good question came up regarding Elliott Wave (herein EW) counts and the answer relates to understanding the overall EW theory.

So, in response I felt I would include this more lengthy commentary and a few teaching points for our general blog readership.

Normally, this is not one of the topics that I intend to cover in detail on a free blog, but frankly, due to the importance of my upcoming financial events that I forecast over the next few months, I felt compelled to set the record straight.  Consider this a blog special or bonus EW feature.

My comments below assume the reader is already familiar with at least the basic tenets of the EW principle.

BTW - If you have no interest in Elliott Wave theory, simply skip to the final section for the technical truth (the chart).

A good question that came forward from a blog participant was; “Should I get out at the peak of wave 3, and perhaps buy back (trade) the waves when wave 5 appears?  The second question (about what comes after wave 5) is somewhat answered herein, but I feel is less important and will be addressed in time as our blog updates in the future.

After all, we all know that an eventual five wave should exceed the peak price of wave three – right? 

Wrong, on many counts. My answer is that one should sell a wave three top - especially if it is clearly identified. Here is why.

If you have been around financial markets for a couple of decades or more as I have been, you have probably seen some amazingly accurate EW calls. There are also a lot of really bad calls, so the scorecard depends on whom you talk to. 

Clearly, without any doubt, Ralph Nelson Elliott contributed a great deal to the financial world, via his astute and keen sense of observation and attention to detail.  Perhaps without realizing the forces at work, Elliott was essentially observing science and natural law, while nature created patterns that repeated in our fractal and harmonic universe.

Therefore, like the great Gann (W. D. Gann's discoveries were even more profound), Elliott too had observed the work of financial cycles, a fractal universe, and the patterns of repetition in dissimilar financial securities. Both men had discovered science and nature’s law at work. They were exceedingly brave considering the time they lived in, to go public with their observations.  

However as Elliott put forth in his 1940's final theory, which has been advanced by many EW theorists, most notably Prechter and Frost, some very important details and concepts have been badly overlooked, or at least not properly taught and emphasized in my view.

The first important facet to embrace and stay aware of was characterized in Ralph Elliott’s Basic Principles. Elliott clearly implied that “the waves after they fully had unfolded – were indeed perfect”.

This is indeed mainly true, as similar to the Natural Laws of all sciences – once fully understood.

However, in the exact same breath, Elliott also equally declared and admitted, that his human and flawed interpretation and classification of the waves, (or essentially the rules that humans impose on such waves) were far from perfect.

So, this latter statement must not be overlooked and is still vastly true yet unknown to this day. The wave theory still has a long way to go. Elliott was admitting this fact and advising us of EW's limitations.

One reason the Elliott Wave theory gets a really bad reputation even today (when the theory has been intensely studied and evolved), is that frankly you can put five EW theorists in the same room with the same chart, and often get seven different answers.

The surplus responses come from the alternate wave counts. What good is seven answers, when you seek and need only one?  This greatly reduces the value of any financial hypothesis. 

Although, perhaps exaggerated somewhat, I hope you get my main teaching point that although the waves are indeed a science and perfect (after the fact - and for the most part), our analytical human rule-set and interpretation of EW Theory is still an evolving art and very flawed or prone to error.

Perhaps another hypothetical example of a past art, - that eventually became a science, was when the laws of planetary motion were thought to be perfect circles, – yet turned out to be ellipses.

The point of similarity is that a small mistake in one's calculations or prediction, can lead to a vast mistake or error. In the case of EW theory, mistakes translate into losses.

 

Elliott Wave Theory as it turns out, although brilliant and highly useful, indeed admits to built in  imperfect rule sets for the waves. Moreover, these rules need expert interpretation akin to a trained doctor reading an MRI or an X-ray. So before you use EW analysis, ask yourself who your specialists is, that is interpreting your EW count?

You would not seek advice from an amateur health care practitioner, yet many follow the exact same practice relying on all of the free advice from so-called wave experts on the internet, yet most fail badly but profess otherwise.       

Elliott himself called out and admitted the anomalies that failed to fit into his derived rule set, with names such as extensions or truncations, and double or even triple zig-zags when only one was predicted.

Labels that did not fit the standard three or five wave classical pattern, so dominant in wave theory and our fractal universe, were sometimes forced to be labelled outside the classical rule theory as x-waves and so on.

Most of all, remember that the key objective, or goal in EW Theory is really to identify (preferably in advance if art equals science) the exact pivot point, or swing high, or swing low on a chart, whereby a change in trend – must occur. 

     

That stated, for many years (in some cases decades) EW theorists, some of whom are highly respected have been mistakenly calling for a bear trend and while missing the overall point that their observations were wrong.

Worse, when not combined with a broad research outlook, and sometimes due to human ego, these failed theorists seem to forget everything else taught to them in technical analysis and market structure.

The real moral of my missive is that Elliott Wave Theory is still not yet a science because it requires interpretation that is imperfect. Although the waves are perfect, we have ways to go yet in determining and correcting the rule set which is flawed.

The only time a law or rule is strong and hardened and withstands the test of time (as it eventually evolves into a proven science) is when all analysts can agree fully - without reservation. 

For now at least, as far as I have determined, there is seldom a single financial situation when EW practitioners will agree.    

So, if one was to risk real money on the current art of wave theory alone, no matter how logical or how good it looked, they better have deep pockets and know how to stop out fast – especially if things do not work out as planned and the wave count forecast fails.

Further in my view, the greater value of Elliott Theory is being cognizant about knowing when a proposed swing high or pivot point might terminate, which can be later confirmed via several other technical ways.

Although, I show a more classical text book approach in wave counts here on the BBTL blog, in actual practice I actually use two completely different EW systems, neither of them being shown here on this blog. 

For Prechter and classical or text book theorists, the new and still evolving methodologies I chose to use outside of classical interpretation, would likely be deemed or seen as unorthodox in that they violate the old rules. Yet these rules were erroneous at the outset in my view.

Further, I have witnessed too many occasions when my alternative EW systems work, and do so in a far simpler and superior fashion for expedience in day to day analysis and EW calls. 

BTW - These are are just one of the modules in KRTT training classes. For more details about these or other KRTT products and services simply write to me.

Moreover besides the EW wave theory, for assistance in forecasting tops or market bottoms and the important financial pivot points (CIT), I personally never endorse a single system - no matter how good. 

To be professional analyst one must use a complete assortment of additional financial tools for confirmation. Not the least of these - are cycles, which Gann too first discovered and wrote about in his plethora of teachings around the same era.

By example, regarding technical confirmation, if you have not already seen the video, go back and review the video that I posted here on this blog just last August (Follow the Money Flow and Natural Law) when the markets where extremely pessimistic.

In that special blog video done last August of 2011 (click here), which BTW - now in hindsight has turned out to be 100% correct (in that another whole leg of the bull market did materialize), I demonstrated how it was not just EW theory, but rather, a whole assortment and varied toolbox of math, cycle and technical tools that ultimately led to the correct forecast of another wave or bullish leg up at the time.

So I guess my major missive of what I trying hard to say, is that no financial analyst should ever use one method (no matter how good) in isolation.

The principle of technical or financial analysis or technical confirmation is extremely important. As I also teach and point out, inter-market financial analysis (think John Murphy's book) is also valid and valuable.                 

Ultimately, the answer to the question; "should I get out at the end of wave three or wait for the end of wave five", in my viewpoint is that you must get out if you truly believe it is the end of a wave three.

Although trading the wave four down and ensuing wave five up is generally for more advanced traders, novices too have other compelling EW reasons to abandon ship at the end of wave five.

As I pointed out with an imprecise rule set, the Elliott Wave count you thought was a three wave top, might actually become  wave five top.

We have all surely experienced too many blown or mistaken EW calls in our trading and investment experience, assuming you have been around the block. Furthermore, commissions out and back in are a very minor in today's era of discount brokers. 

   

If Ralph Elliott was man enough to admit or state that the Waves were perfect, but his rules and interpretation were still fully lacking and far from perfect, we need to plan for such events and failures. Wave counts change - after the fact, when we decide our past label was wrong. 

Further and secondly, Elliott allows in his own theory for considerable leeway, in that even if wave five does materialize, it still may truncate or fail.

In conclusion, perhaps the biggest mistake in EW theory (and one not to overlook) is that EW theorists have failed to point out and explain the inherent difficulties in the wave theory.

As such their interpretation, even at key market junctions has been left open to multiple outcomes, possible failures, extensions, X Waves, truncations and more. These are all in addition to the greatest or most common mistake - human error in interpreting the wave count.

I have also acknowledged that I have to deal with and explain upset mechanisms, as we teach and learned about Gann Theory, Cycles and Natural Law.

The world is indeed dynamic, and man does his best to impact and change nature and our planet all the time. Just look at the enormous FED intervention.

Sometimes, as it turns out, man does the exact wrong thing, even when nature pointed him/her in the other direction.

As new information comes into the financial markets daily, it is important for the savvy and successful EW analyst to keep an open mind, to review the wave count on a regular basis, and to do their amended financial analysis in a proactive way.

If in doubt get out. If not, follow the trend and go with it. It is very costly to do otherwise.

Financial Chart Truth

James Kelly Sr.,
Editor in Chief, BBTL Blog
www.KRTT.com
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