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Minyan Mailbag: Fibonacci & Phi


Thx for the clarification!


Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next discussion with that very intent.

Dear Prof. Reamer,

I have put some effort into studying the EW methodology ( I have read Elliott Wave Principle, and Conquer the Crash), and was wondering whether you could clear up a few questions I had:

a) Why is it necessary for impulsive waves to propagate in 5's, and corrective waves to come in 3's? Robert Prechter claims that simple mathematics says that this must be so (for net advancement vs. stagnation), but I am not clear on this point. See also point B below.

b) There's a common saying on Wall Street - the most vicious rallies happen in bear markets. To me, this contradicts the EW dictum that "implusive" waves are one that are part of the trend. Presumably, if the trend is bearish, the impulsive and most vicious waves should be down, not "vicious" "corrective" rallies.

Would appreciate your thoughts.

Minyan AA

Minyan AA,

Great questions: let me see if I can answer them for you.

A) It is not strictly necessary for impulsive waves top to be "5"s and for corrective waves to be "3"s, what is more important is that the ratio between the impulsive and corrective waves approach phi, or 0.6180339887.... Prechter's point (I believe) was that "5" wave impulsive moves and 3 wave corrective moves are the bare minimum number of waves within each wave in order to achieve the net progress/egress rules that Fibonacci analysis deems. Which is a long way of saying that the next lower numbers, 4 waves up and 2 waves back produces a ratio of 2.0 (4/2), which is, as Prechter suggests, untenable in terms of the way natural systems evolve and grow (for a more detailed discussion of Fibonacci in nature please see any number of books on Phi and the Fibonacci sequence). The same holds true as we decrease the number of needed waves by one more digit: 3 wave impulse moves and 1 wave correction would produce a (3/1) ratio of 3.0. Again, natural systems do not progress and egress on either of these two ratios. So 5 waves in an impulse and 3 waves in a correction are the MINIMUM number of waves within a standard Elliott wave sequence. That is not to say of course that one cannot have more than "5" waves in an impulse: indeed, impulse waves where one of the waves 'extends' (say, where the 3rd wave itself traces out "5" waves before completing and leading to a 4th wave and 5th wave sequence) are common. Such patterns produce a net 9 waves in the entire impulse wave. And even more complex impulse waves can also trace out where the number of waves within the entire impulse wave continues even higher. The most important point however is that the ratio of impulsive to corrective waves asymptotically approaches 1.618 or Phi. That is what makes Elliott waves "work", only because they adhere to the mathematical concept that natural systems are governed by the golden ratio of Phi.

B) Vicious is a qualitative term that means something different to everyone. But don't confuse the terms impulsive and corrective with anything more than the number of waves within the pattern itself. I have seen in the last several years - at many different degrees of scale - 'corrective waves that are weak and shallow and corrective waves that are strong and steep. The same is true of impulsive waves: some have high momentum and some little if any. The only hard and fast rule about determining if a wave is impulsive or corrective is the number of waves within each pattern: 3 (or a combination of '3's) means corrective and against the larger degree trend. 5 (or any combination of '5's) mean it is impulsive and with the larger degree trend. All other factors - momentum, breath, ticks, new highs/new lows, etc. are contextual and not definitive. Which means that the presence of high momentum, great breadth, and solid ticks makes it more likely that a move is impulsive. But if it still breaks down as a "3" wave move, it cannot be considered impulsive. The same is true in reverse. This is one reason I have chosen to develop a combination approach to my use of Fibonacci tools: Elliott waves AND DeMark indicators along with some of the contextual indicators that I mentioned above; it helps me to gain or lose confidence in my assessment of the internal wave count, making me confident or circumspect about the number of waves I "see" in a pattern.

Hope that helps AA. And good for you for doing the reading. There is a huge percentage of investors out there that do not appreciate the reality that markets are complex, non-linear systems governed by Phi. You are fast on the road to understanding that reality and, as a result, appreciating the markets for what they really are and not what they merely seem to be. Bravo.

No positions in stocks mentioned.

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