THE
ROLLERCOASTER, PART 3
by Anthony M.
Cherniawski
The Practical
Investor
May 28, 2004
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As a follow-up to the May 3, 2004 and May 14, 2004 articles entitled “Ready to Ride the Rollercoaster?” and “The ‘Rollercoaster,’ Part 2,” it’s time to bring a progress report to evaluate whether the expanding triangle formation or broadening formation has a legitimate place in stock market analysis. The reason I am bringing this pattern to be examined is that it seems to have no coverage at all by technical analysts who are reporting on the current state of the markets. If this is a legitimate pattern, then a record of its existence needs to be made and a catalogue of occurrences kept. The first comment that I wish to make is, until now, occurrences of the expanding triangle formation in the broader stock indexes are practically nonexistent. This formation has no mention by R. N. Elliott in any of his works. The closest he comes to this formation is the ending diagonal formation composed of 3-wave sub-fractals within a 5-wave pattern. It is the only catalogued 5-wave pattern consisting of 3-3-3-3-3, until very recently. The expanding triangle formation is also a set of 3-3-3-3-3 waves. That explains why the vast majority of Elliotticians have mistakenly labeled this pattern as a 4th wave correction. They believe that we are currently in the 5th wave (up) to new highs. The expanding triangle formation calls for a failure at the 50% retracement of the prior wave down in the majority of instances. On Wednesday, May 26th, the markets closed within ticks of the 50% retracement level on all the indexes advancing to point 7. This is very significant, since it anticipates a reversal day today, May 28th. It also supports a significant decline starting either this week or next. Let’s revisit the essential pattern and the indexes:
The pattern in both the red and the blue expanding triangle formations are following the main model remarkably closely. In both Edwards & Magee’s Technical Analysis of Stock Trends, 8th Edition and John J. Murphy’s Technical Analysis of the Futures Markets, the basic outline is given (see figure 1), without a lot of embellishment. For example, both sets of authors claim that point 5 generally terminates at or above point 3, but occurrences where point 5 “falls short of point 3” do not invalidate the pattern. Rather, according to Murphy, “the analyst is given some additional warning of market failure, and the pattern actually begins to resemble a head and shoulders top with a declining neckline. I have included examples with “failed 5s,” such as the SPX. The structure of the expanding triangle formation is visually evident without point 5 completing to its natural target. There is more to follow. Can there be an Elliott wave where both 3 and 5 truncate? Consider Figure 1. In that idealized count, only wave 5 (point 7) is truncated. Now consider points 3, 5 and 7 to be the same as terminus of waves 1, 3 and 5 in the SPX. Is the blue “failed 5” a truncated wave 3? If so, it implies that research on the Elliott wave is incomplete and a potential market failure of a massive size is straight ahead. Another observation made by Murphy is that “The pattern is completed and the major bear signal given (at point 6) when the reaction from the third peak (point 5) violates the bottom of the second trough (point 4) Because the pattern has three peaks and two troughs, it is sometimes referred to as a five point reversal.” Elliotticians, please note, every move from point 1 to point 6 consists of a-b-c waves! One of the implications may be that the infamous Elliott wave 3 may not start until the formation is complete to point 7. Can this be the completion of Elliott wave 5 of C? It sure appears to break a lot of rules, but the expanding triangle formation is an ending formation! Also consider the green circled “throw-over” in the SPX chart. That is 5th wave behavior on a “double a-b-c” correction. I rest my case. A Rogue Wave Fibonacci appears to rule “in reverse” in the expanding triangle formation. Elliott wave 5 is only .618 times wave 4. Elliott wave 3 is only .786 times wave 2! When it comes to Elliott wave analysis, this pattern really is an outlaw. That may be why it defies traditional analysis. That may also be why it may be so dangerous, as well. Folks, we have seen an important market top and so few analysts recognize it. Let’s consider other indexes. The results may astonish you.
Consider the NYSE Composite Index. It may be considered “complete” to point 7.
The Russell 2000 takes on a more “traditional” look. Point 7 stops at the 50% retracement of the decline from point 5 to point 6. Here, too, we have arrived at the point-of-no-return.
The Brits do seem a bit slower than us. Next is needed an Elliott wave C to bring us to point 6.
The rest of the world seems to be on the same page, however. Could it be that there is a financial crisis already brewing in Asia? Large cracks are already appearing in the markets there.
The chart of the Nikkei index also shows another double expanding triangle formation. The magnitude of decline in the red formation is enough to give one pause. This morning’s close on the Nikkei was 11,309. You will notice that the target for blue point 7 naturally occurs at 11,357. Now consider this…the Nikkei will have had two complete trading sessions before the Tuesday opening bell in the U.S. Could the selling of U.S. financial assets have already started before Tuesday’s open? If so, will we have an orderly market on Tuesday?
Could oil be ready for a plunge? Think about this…China is the fastest growing economy in the world and is second only to the U.S. in oil consumption. Could it be that a meltdown in the Chinese economy causes their oil consumption to plummet?
Then again, it could happen here too. Conclusion On the technical side, there seem to be more questions than answers at this time. What appears here is some old-fashioned technical analysis that has been discarded or ignored and needs to be re-examined, if only for this time in history. The only published charts that bear this formation are of individual stocks that occurred in the 1929-1930 era. I have yet to find the expanding triangle formation occurring in the major indexes prior to today. On the practical side, these charts give us a powerful warning. A quote from John J. Murphy, “…the broadening formation (expanding triangle pattern) is a relatively rare pattern. When it does appear, it’s usually at an important market top. So the question in the title, “Is the Rollercoaster cresting or derailed?” will be answered very soon. I hope you have the right answer, too.
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