Indicator Explanation © ™

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WAVE COUNTS

  • My wave counts are not Elliott Wave Theory.
  • This is a simple wave count system that I developed through years of observation and is a direct result of KISS. “Keep It Simple, Stupid.”  I believe the Elliott Wave Theory has too many exceptions and variations.  My method is not perfect but the variations are fewer and are more easily recognized at an early point by the experienced eye.
  • I count peaks and troughs and believe there are 3 peaks (or troughs) to a completed wave count. A reversal takes place after a completed wave count of 3 steps. Often times it’s as simple as counting 3 bumps on a chart . . . Other times, not so easy.
  • Each step must stay within a channel and the 3 steps that make up a completed wave count will also be confined to a relatively larger channel.  Laying a pen or pencil on the suspected channel will help you visualize the channel. When the market breaks a channel, the wave (or step) has terminated and you have temporarily begun a counter-trend correction. Breaking outside of a channel also marks the beginning of another step.
  • It’s common for one of the peaks (or troughs) to sub-divide into another 3 waves and the total count becomes a 5 instead of a 3. This is easy to visualize as the subdivided step will stay confined to a channel.
  • Here is an example of a subdivided wave with a total count of 5, plus you can see how it stayed within a channel during the rally.

06-17-11, SP 500, DAILY BARS

LINES

  • Any line whether it is a trend line, fan line or retracement line is a possible support or resistance area. Keep that in mind when viewing the charts.

TREND LINES

  • A trend line is a straight line that connects two or more price points and extends into the future to act as a line of support or resistance. It identifies the primary direction or trend. A parallel trend line drawn from other peaks or troughs can identify other support or resistance points. Many of the principles applicable to support and resistance levels can be applied to trend lines as well. In other words, look for possible support or resistance on any of the trend lines.

FIBONACCI FANS

  • Fibonacci Fan lines are trend lines based on Fibonacci percentages. Draw the primary rising Fibonacci fan line from a trough to a peak. The opposite is true for a falling Fibonacci fan line, drawing from a peak to trough. These fan lines estimate support levels or potential reversal areas. The first fan line is the primary line drawn from peak to trough, or trough to peak, and is the 100% line (rising or falling at full speed, 100%). The other lines are 38.2%, 50%, 61.8% and 76.4%, which rise or fall as a percentage of the primary line (100%). Edson Gould referred to these lines as “Speedlines” and used them in his advisory publication, “Findings and Forecasts”. He illustrated how lines based on important market turning points could influence the market for years.

VOLATILITY CHANNELS

  • Volatility channels can identify over-bought or over-sold price levels.
  • The volatility mid-line (yellow dashes) is a support/resistance level where price action may waver around this mid-line before penetration. Sometimes the market can rebound back over the line within the first 3 days of penetration.  Penetrations become an established trend when the market stays on the other side of the line for a week or more.
  • The upper (solid red) and lower (solid green) lines are extreme levels and the market has risk continuing in its primary direction after contact on these lines. When contacting these lines the market is ready for an opposite move.
  • The channels lines, which are red dashes or green dashes and lay mid-way between the yellow mid-line and the upper (sold red) or lower (solid green) boundaries are minor support/resistance.

CONFIDENCE INDEX

  • The confidence index is the ratio of high-grade bonds (AAA) to low-grade bonds (junk bonds). As this indicator rises, it shows confidence that junk bonds will not default and investors are buying junk for the higher yield. The opposite is true as this indicator falls. Normally a rising line takes place as the economy is improving. A falling line takes place as the economy weakens.

UP DOWN VOLUME LINE

  • This is a running total of the daily net volume (up volume minus down volume). As it rises it indicates investors are net buyers of stocks on a volume basis. When it falls it shows investors are net sellers of stocks (volume basis).

ADVANCE DECLINE LINE

  • This is a running total of the daily net advancing stocks (total advancing stocks minus total declining stocks). As it rises it indicates that there are more advancing stocks than declining stocks. The opposite is true when the line falls.

SP 500 FUTURES

  • Occasionally I will refer to the SP 500 futures, which is exactly like the SP 500 index only it trades 24 hours per day.  Because it trades constantly there are no large gaps up or down.  The regular SP index often has large gaps with the opening trades of the day.  The futures have a smoother looking chart and usually have more accurate wave counts.

THE ECONOMY

  • The ECRI Weekly Leading Index has a moderate lead time over the U.S. business cycle. It usually is a very perceptive indicator of the economy’s strength.
  • We also have a real-time indicator of the business cycle, which also has treasury bond yields on the chart. Treasury bonds are also a good indicator of the health of the economy. Rising interest rates take place with a strengthening economy and falling rates show a weakening economy.

BOTTOMS

  • Market bottoms occur with a bang or a whimper.   Ending with a bang, the market loses a large number of points in just a few hours. This is characterized as climactic because of the high volume and high volatility.  Ending a decline with a whimper, the market will be “sold out” and trading in a dull manner. The decline will have exhausted most of the seller’s supply of stock and the buyers will be moving in a tepid manner. This is a classic “dull” market, which usually lasts a couple days. It is characterized by low volume and low volatility. From this type of market rose the Wall Street axiom, “Never short a dull market”.

TOPS

  • Tops are harder to identify than bottoms as they occur over an extended period of time. As a top unfolds stock is distributed (sold) from “strong” hands to “weak” hands.  This “strong” hands selling process is disguised in order that other market participates are kept in the “dark” to their true intentions.  This is necessary so that the “strong” hands can get the best possible price.
  • The wave count can be a helpful tool pinpointing a top and could be considered a “finesse” tool.  It identified the May 2, 2011 peak as a completed 5 count.  Most topping indicators are non-specific as to the date of the actual peak.  Long term peaks will normally have several non-confirmations that indicate we are in an area of a top.

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