Notes On Gold's 3-3-5 Flat

03/29/04 09:47:06 AM

by David Penn

Higher prices sooner, lower prices later ... if the Elliott wave flat proves an accurate description of the recent moves in gold.

Security: GCJ4
Position: N/A

One month ago, I suggested that higher gold prices were likely ("Gold's 3-3-5 Flat," Traders.com Advantage, February 27, 2004). At the time, April gold was trading at $395 an ounce. My chief rationale for this observation was the form of correction gold futures appeared to enter in the wake of their early January peak just north of $432 an ounce. This correction began with a slide down to an early March low just north of $388 an ounce, a decline of some 10% in about two months.

This slide saw gold futures (basis April) slip beneath their 50-day exponential moving average. But it also saw the development of a positive divergence between the price and the stochastic, as well as price and the daily MACD histogram. This pair of positive divergences helped signal a rally upward back above the 50-day EMA and up over the February 2004 highs at $418 an ounce.

A flat in gold would suggest a near-term challenge of the January 2004 highs.

Graphic provided by: eSignal.

The "form" I mentioned above was a correction called a flat. The idea of a flat is derived from Elliott wave methodology, and represents one of the three major corrective patterns (the others being the zigzag and the triangle). While triangles are relatively easy to spot -- not the least because triangles are a part of mainstream technical analysis pattern recognition, while flats and zigzags are not -- there are a few rules which can make it easier for observers to tell the difference between a correction that is a flat and a correction that is a zigzag. The current price action in gold futures appears to give us an excellent chance to learn more about the former.

What chiefly distinguishes flats from zigzags is that while zigzags have a wave structure that is 5-3-5, flats have a wave structure that is 3-3-5. A more apparent difference however is that the middle, three-segment "B" wave in a flat will correct at least 61.8% of the preceding "A" wave, often moving as far as the beginning of the "A" wave or even slightly beyond it. The middle, "B" wave in a zigzag, by contrast, will generally correct no more than 61.8% of the preceding "A" wave. Given that the rally in gold since the end of the "A" wave decline in early March has retraced more than 75% of that preceding "A" wave, it is more likely that the current correction in gold futures represents a flat (as opposed to a zigzag). Further, this suggests a strong possibility for the current advance in gold to challenge the highs set in early January.

There is further news that is potentially good for gold bulls. Unlike zigzags, the third and final "C" wave in the flat correction tends to end near the level of the "A" wave low. In fact, flats often have "C" waves that are equivalent in size to their "A" waves. Zigzags, by contrast, tend to have particularly destructive "C" waves that conclude beyond the low of the "A" wave. The 1929-1932 Great Stock Market Crash, for example, is considered to be a zigzag. So, if the correction that began in the first few days of the year in gold futures is in fact a flat, a challenge of the January 2004 highs is likely to be followed by a challenge to the February 2004 lows near $388.

While a decline to the $388 area should represent the end of the correction in gold futures for the time being, it should also herald the beginning of disproportionately negative sentiment toward the yellow metal. This should be expected largely because of the psychology that tends to accompany "C" waves, a psychology that is notable particularly by its extremes (see my Working-Money.com article "Elliott Waves in C" for more on this theme). When the "C" wave is upward, sentiment is extremely positive ("C" waves are, at root, "third" waves and have all of the fundamental psychological characteristics of third waves). When the "C" wave is downward, sentiment is extremely negative. Those able to bear the impending bearishness in gold may find themselves scaling a wall of worry in the event of a resumption of the bull market in gold.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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ELLIOTT WAVE

Notes On Gold's 3-3-5 Flat

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