Guest Post by DV 34
As world markets nervously consider the implications of the Italian election result, DV 34’s post on the potential for big picture reversal patterns may be a timely read.
DV has also generously shared some of his recent experiences trading FX pairs and the lessons he has taken from this.
The Dow Jones – Monthly Ending Diagonal??
Looking at the larger timeframe there appears to be what could be the makings of a large ending diagonal pattern, interestingly there are numerous patterns occurring within this larger structure.
– Elliot wave ending diagonal pattern – picture sourced ex thepatternsite.com, noting Thomas Bulkowski’s work
– Harmonic butterfly pattern
– Three drives pattern
Of the three patterns the one that interests me the most is the ending diagonal pattern after personally getting some good (costly) lessons on it recently in the FX market
I am not an Elliottician and only have a basic understanding of Elliot wave theory read in books, so it is quite likely I will get my count wrong or see this incorrectly…
And for those who are unfamiliar, the text book patterns look like this:
Monthly Chart – Ending Diagonal Pattern
Weekly Chart 01 – ABCD Patterns
Weekly Chart 02 – Ending Diagonal. Waves 1-5.
Weekly Chart 03 – Internal Butterfly Patterns
Weekly Chart 04 – 3 Drives Pattern
On the monthly chart above there appears to be what I think is an ending diagonal pattern, the price action has moved up in 4 distinct moves then been moving up within an ascending wedge formation.
This is also closing in quickly on the all time pivot high, which with no major fundamental news right now threatening this uptrend looks likely to be tested if not broken.
On the weekly chart 01, I have shown some very long term AB=CD projections, interestingly there is a cluster at around the 14400 which is above the all time high.
On the weekly chart 2, I have marked out what I think are 5 internal swings within the wedge formation, which suggests it is near complete.
On the weekly chart 3, I noticed that the majority of the internal swings are in three waves, which also formed bearish butterfly patterns that did not follow through, and right now we have a 3rd bearish butterfly setting up at the 127.2% extension that has yet to confirm.
On the weekly chart 4, there is currently a text book three drives pattern noted with equal 127% extensions
At present we have a weekly three drives pattern combined with a bearish butterfly right at the same time; however in the larger picture we are also near the top of a large ending diagonal pattern.
Although we may get a reaction down from here, my preference would be to see another rally through the top of the wedge to new highs which sounds counter intuitive, however I think this would stop out any bears with stops above the highs and also fuel optimism… (More complacency/ low vix etc)
Early days right now but if we do see a rally, the levels that would interest me mainly focus around 14400ish,
At that stage I would be looking for weakness that could signal a major shift, and if this coincides with rumours of major fundamental problems (withdrawal of fed intervention/ US debt sequester/ debt ceiling limits etc) in the US it would look even better on confirmation with price action at one of the two key levels.
Recent trading experience
The main reason I chose this pattern is because of a good lesson I learnt recently, which was knowing when to stay out…! And when not to fight the tape
I will demonstrate this on some FX pairs that have similar patterns that have either played out or currently in progress…
EUR: NZD – Monthly
USD: JPY – Monthly
Trading reversals does not mean trading anywhere on a chart and recklessly fighting a trend, It is only at very specific zones and circumstances that reversals are worth acting on and knowing when not to act is even more important…
My most recent lesson was not to trade reversal patterns when we have a major longer term reversal with a confluence of reversal patterns within it. These two patterns above in the FX market took 4-6 years to develop, so not surprisingly – when they triggered even the weekly charts were having extreme indicator readings not seen in around 5+ years and very extreme buying with no/ very shallow pullbacks… the shorts were being covered quickly as the longs piled in at the same time… i.e. the proverbial freight train
This is where indicators can be misleading and shorter term reversal patterns fail – mainly in extreme markets because the trader fails to see it in the correct context of the larger picture
The context (and reminding lesson in my case) was not recognising when a longer term consolidation was over (usually 5 waves within a triangular pattern) and underestimating the strength of a breakout from a long term consolidation zone.
Looking back to the Dow we have seen multiple reversal patterns forming within the ending diagonal, When the eventual breakdown happens we must be mindful of the fact that many people are already long and been making money buying dips and usually have stops under swing lows that have to be suddenly unwound with fewer buyers and competing sellers.
This is where the scales can be tipped very one sided, and at the start of a major shift it is very dangerous to trade against it – unless we are at longer term key levels of support or resistance
Hope this helps!