Psyching the Market: The Leading Diagonal Pattern

Stock market patterns reveal market psychology. Wouldn't it be better for market psychology to predict market patterns? We are living through a great example right now with the potential Leading Diagonal pattern.

The market is a nonlinear chaotic system which at times follows order (impulses) or (more often) lives at the edge of chaos as it seeks order (corrections). Impulses typically stretch as the psychology is one of piling on. We saw this in 1987 and again recently with the Flash Crash; and to the upside in the 1984-6 and 1995-7 bull runs. The impulse patterns require one of their segments to stretch or extend, reflecting this piling-on psychology. 

At times impulses instead compress and form what are called Diagonals or (at the end of a wave) Terminal patterns. This compression comes from a market psychology of anticipating a major event or policy change. In Mar08 we saw an Ending Diagonal (ED) as the market anticipated a bailout of Bear Stearns and slowed the piling on. Another recent ED happened right before the GM bailout in Nov08. I discussed ED's at some length a few months ago.

A leading diagonal (LD) is more rare and indicates hesitation in the kick-off to a strong move. The chart from EWI shows a bullish LD. They give trader tips on diagonals as well. 

In a diagonal, unlike normal impulses, wave 4 overlaps wave 1. In addition, the wave ends converge in a wedge. (I explored the expanding ED, and concluded it was not a proper structure; it doesn't fit the psychology of compression.)  Also, wave 1 is longer than 3, and 3 is longer than 5. It compresses. 

The LD starts a wave like a nested 1-2 structure while the ED ends a wave like a triangle. The LD pattern breaks as a 53535 structure, while the ED is 33333. This avoids confusion as to where one is in a larger wave structure. (The site I cited in the prior post argues an LD can be 33333, which I think is unsound.)  

When one sees nested 1-2s, as now, the antennae should perk up for an LD. When technical analysts call out a Diamond Formation, the antennae should perk up for an LD. Whether it is nested 1-2s or an LD pattern cannot be confirmed until the fifth wave:

• if it gaps down and is shocking in its intensity, we have had nested 1-2s 
• if it is anemic with overlapping waves, it is the fifth leg of an LD

We had smaller degree nested 1-2s off Apr26 and then a stunning drop - confirmation. 

We have larger degree nested 1-2s into Friday and then overlapping waves - caution flags. Today is more of the same. 

How can market psychology inform us as to which it is early enough to place bets in the market? In contrast with the prior ED examples where we fell hard and were momentarily saved by government bailouts, this time we were rising until belief in bailouts began to fade. The fall off April 26 coincides with the Greek Tragedy in Europe and a whole series of ever-increasing bailouts. This weekend the G20 met to discuss continued global stimulus, and the Europeans are backing off. This does not end the matter, as a major G20 meeting is upcoming in Toronto in two weeks. 

My conjecture is the current overlapping waves down reflect the fifth leg of an LD. Today the market is so far in a trading range as well. The tell from market psychology: we are in a wait-and-see period for the next and possibly final bailout attempt. 

if we are in an LD, it should drift down but no farther than Sp970-1000, shorter than the third leg from Sp1174 to Sp1041. After that the retrace should head back at least 50% into the 1095-1107 area. The 1106 and 1115 gaps may remain unfilled. Then we start the next Big Down. This could all look like a June Swoon followed by a Summer Rally and then yet another August Peak before an October Crash. 

Comments

[Mamma Boom Boom]

As of about 2:15 P.M., I see nothing holding this rally back.

[Michael]

The Wednesday of June 16th heading into "Triple Witch" will surely show some fireworks!

[DG]

According to Neely, "Leading Diagonals" don't even exist.

[Steven_737]

It appears that both ES and NQ have formed a Leading Diagonal i of minor wave 3 of w5 on the 5 min chart;
currently at support levels 1057.5 ES and 1808.5 NQ

A small ii wave to prepare for iii of minor wave 3 of w5 of 3 is expected here.

Lets see how this evolves.

[Wave Rust]

Close the 1025 gap and maybe the 980 one.
then the dow gap at 11,150 by mid-summer, then back down for the 907 gap for thanksgiving
then d & e of C
e of C can get to the spx 768 gap, otherwise known as a 78.6% retracement

That should clean out the last of the weak bulls.

wave rust

[Hank Wernicki]

This Week :

Trap Door all Week !

[Steven_737]

"According to Neely, "Leading Diagonals" don't even exist"

hi DG; that's OK !
because my eyes understand the price action when it forms such a pattern!!

I can call this price action segment, or wave swing, with a term of my own then.

If so, then nobody can tell me it does not exist, because it is my own construct (fractal).

And the name is:

"testing the water 3 times and having second thoughts - or meeting opposing forces that don't let the traders on my side overcome them"

I guess it is too verbose.
I am certain Neely would not approve.

The question is: does it make my understanding of price action better or not.

If Neely does not use them (those "testing the water 3 times and having second thoughts - or meeting opposing forces that don't let the traders on my side overcome them" fractals ) he may have good reasons. That's OK by me.

It should also be OK by him (or anyone else counting waves).

My response does not mean that I do not value your contributions on this blog.

It is just that mankind has one never-making-mistakes-and-know-the-real-truth-Pope too many.

cheers :) :)

[Steven_737]

If my count is correct iii is in progress and should accelerate NOW.

Lets see how this evolves

cheers :)

[Wave Rust]

Hank
thursday may change your mind :)

wave rust

rhetorically musing ,,,, if one changes their mind, fractically speaking, is that really a change? or, is it just an unanticipated variation of the original mind set?

[Min]

I see your LD.

Unfortunately, NDX doesn't sport one. What does one make of this?

[Roger D.]

Youn know what I think of everybodys LD, complete bullsh*t. The real fireworks will start tomorrow, should move down to 950,then bounce.next target after that 840 and then a crash into the 600's. Then your first tradeable low the week of June 21st.

Parabolics always end badly. Just like the pools that drove the market higher in 1929. This FED backed pool drove stocks up for 14 months straight. Most market leaders doubling and tripling or more. Now they are selling and selling big!

[Pup]

You need to head back into the Elephant grass Roger. Folks are having an intelligent conversation here —you don't fit in.

[DG]

The question is: does it make my understanding of price action better or not.

Indeed.

It is just that mankind has one never-making-mistakes-and-know-the-real-truth-Pope too many.

The question of which set of rules is "canonical" in Elliott Wave is definitely open. It's ultimately an empirical question, though. I provide details of Neely's trading track record all the time and those who disagree with Neely's "rules" don't do the same for their own trading. It's hard to compare something with nothing, so I haven't even been bothering anymore lately. If people are profitable on 60%+ of their trades and their profit to loss ratios are higher than, e.g. 1.25 to 1, they should be KILLING the market if they have any sense of how to position-size against minimizing the "risk of ruin", i.e. the Kelly Criterion. Heck, I can show you a sequence of trades made with the rules I use at my new blog that would have turned $25K into $34 million since last April just trading in the money options according to those rules. Did I do that? No, because unfortunately I only figured out the rules in January 2010. Am I now working on doing that? Yes. Will it work? I don't know. I can also show you how shifting between Neely's Weekly trades and my rules at "the right time" could have turned that number into ~$70 million since September 2008.

But, point being that the winning percentage for those rules is 61% and the winner to loser size ratio is 1.6 to 1.

Yet, to read people's postings here, they never have losing trades, so why aren't those gains compounding into millions and hundreds of millions in the same amount of time, if my rules get a "pedestrian" 61% winning trades and my winners are "merely" 1.6 times the size of my losers?

Anyway, clearly I am not telling anyone they should do x,y,z with their capital, but traders should take a hard look at their results and ask if they are really all that fantastic for the amount of risk they are taking.

So much of what people discuss here is about "the next trade", but rarely does anyone bring up their systematic edge and quantify it based on past results. Of course, I'm solely talking percentages and ratios or even hypotheticals based on specific starting values. The last thing I care about is someone's capitalization. If you're good, you'll be well-capitalized soon enough. If you're bad, no amount of capital will work for you.

Anyway, just my thoughts on how the adjudication of different Elliott Wave "schools of thought" should be ranked.

[Steven_737]

DG;
your points are understood.

By the way, I should clarify that
the comment
"It is just that mankind has one never-making-mistakes-and-know-the-real-truth-Pope too many."

refers to Neely.

[Roger D.]

The reason I don't think the LD has any credence is most stocks are just breaking major support. The measuring implications of these tops are well below 970 to 1000 level. This Federal Realty chart is at the cusp and should break lower,eventually faller to the base of it's wedge.

The mistake most are making is a 5 minute flash crash doesn't technically do damage. Now this last impulse down has put stocks at their necklines.

This broadening top formation is textbook and will break lower, this is a classic crash pattern. I just trade what I see.

I just say that most continue not to see the danger in this market.

Roger D.

http://www.screencast.com/users/parisgnome/folders/Default/media/b9986eb6-cccc-4bf0-9d82-7ce1fdaf3020

[DG]

refers to Neely.

Sure. Hey, if Neely considers himself the Pope, then I am definitely a rebel against his authority. I disagree with his short-term work nearly all the time these days. He's probably sick of me e-mailing him my opinions! But, bigger picture, I'd definitely need to see some data on someone else's track record before I put that person's wave theory knowledge and application of that knowledge ahead of Neely's.

The closest I can tell, Neely views "traditional" Elliott Wave as a "too-subjective subset" of NeoWave. I agree with that characterization.

[yelnick]

Roger, the LD and the Big One down tomorrow would both start about the same. The place to watch is around Sp970-1000 for a surprise bounce

[Steven_737]

"I just say that most continue not to see the danger in this market."

I see the danger and try to quantify it.

Analysis of wave 1 of whatever wave the market is in:

http://steven737.typepad.com/blog/2010/06/esspx-analysis-and-projections-06072010.html

http://steven737.typepad.com/blog/2010/06/nqndx-analysis-and-projections-06072010.html

cheers :) :)

[yelnick]

Min, the LD is not my prime view, but an alternative that has been elevated for discussion. Today's action lowers it a bit but it is still there. Whether we drop hard, have the surprise bounce (see my next post) or meander down, both the LD and the nested 1-2 indicate at least a fall to around Sp970-1000.

[Roger D.]

Yelnick,

I apoligise for being so blunt. EWI talks about the posibility of losing 1000 pts real fast from here, I agree. It would surprise me if we only declined to 1000 /970 here and then bounced for several days. I could see a intraday bounce under a beginning panic. The market leaders are just starting to break down. It should be exciing to watch how it unfolds.

Roger D.

[Steven_737]

DG;

Have you established (or read about) any pattern or bellwether so as to expect that a wave 3 will expand?

cheers :)

[yelnick]

Roger, not sure what you mean by a wave 3 "expanding".  Yes, the STU thinks we drop 700-1100 Dow pts either right away or after one final bounce. 

I will post tomorrow am a third view coming from the TRIN spike Friday:
LD says we drop to 970-1000STU says we drop to below 970, although we might have a bounce to 1070-1090 firstTRIN suggests bearish exhaustion and a bigger bounce to Sp1150 first

[DG]

Steven_737,

The first sign would probably be the amount of wave-1 that is retraced by wave-2, right? If wave-1 will be the "Extended" wave, then wave-2 should not retrace much more than 38.2% of it, before the start of wave-3. If wave-2 retraces more of wave-1 than that, odds are that wave-3 will be the extended wave and waves 1 and 5 will either be equal, related by .618 or by .382, in descending order of likelihood.

[Roger D.]

"not sure what you mean by a wave 3 "expanding". "

Yelnick, I never mentioned a expanding wave 3.

My analysis is all about the wedge pattern and the parabolic moves off the march'09 low.

Could the market bounce off the 970 -1000 area? Sure but it will be a one day wonder that proceeds a crash wave down. Typically in this pattern, there is only a one very sharp rally lasting a day before the panic phase begins.

We should move down 4 days bounce and then waterfall for 6 bottoming around the 21st or 22nd of this month. Very weak and very powerful decline.

[yelnick]

Roger, my apologies re expanding 3rd, that was Steven who asked.

[KRG]

Y : Is the concept of LD there in original Elliott? If a overlapping 53535 is acceptable then this would add further confusion to any wave counting.. Would the LD be corrective or impulsive ; If impulsive why the overlap...The whole action may be easier to count as running correction rather than as LD, if at all the subsequent action turns out to be impulsive

[usdollar]

I have ABC X (irregular flat)Then abc A formed, B on its way (shoulder)10700ish dow. Then a five wave C down low, possibly 2000 djia area bottoming dec 2010. First wave down of C done in the end of July, followed by sideways move. After this huge crash towards the end of this year we will see a sharp X wave up. Corresponds well with the USDs sharp drop in its wave 5. If LD wave1, then I believe we will see a much deeper wave 3 testing march 2009 lowes in the end of July. Nov crash I believe will relate to the oil spill somehow maybe getting oil on the shores of Washington DC, or they will nuke the well etc.

[trendlines]

Hi yelnick & folks,

here's my latest view on the S&P500. Looking for a move up towards 1140-1150.

http://trendlines618.blogspot.com/2010/06/s-short-term-upwards-towards-1140-1150.html