|Figure 1 shows the weekly price chart of the Financial Select Sector SPDR (XLF). In this chart see that XLF made a major bull market top in May 2007. Since then, XLF has been trading in the downward direction and has formed an impulse wave made up of waves (1), (2), (3), (4), and (5), completing the larger wave 1 down. R.N. Elliott, who discovered the wave principle, stated more than 70 years ago that impulse waves define the major trend in the market. With the completion of the first impulse wave from the major bull market top, XLF is now defined as being in a bear market trend. Further, since May 2007, XLF has now completed waves 1 and 2 of a much larger impulse wave to be made up of waves 1, 2, 3, 4, and 5. Wave 1 always travels in the direction of the major trend and is made up of five smaller waves. Wave 2 is always a corrective wave made up of three waves, waves a, b, and c, and moves against the direction of wave 1, correcting the price movement of wave 1. Elliott wave convention labels impulse waves with numbers and corrective waves with letters. Wave 3 is another wave that travels in the direction of the major trend and is made up of five smaller waves. Wave 4, like wave 2, is always a corrective wave made up of three waves, waves a, b, and c, and moves against the direction of wave 3 correcting the price movement of wave 3. And finally, wave 5 is also made up of five smaller waves and moves in the direction of the major trend. As we can see from Figure 1, wave 2 is now complete, and wave 3 down, which will be made up of five smaller waves, is now under way.|
|FIGURE 1: XLF, WEEKLY. Simply stated, the Elliott wave principle defines the direction of a major trend to be in the same direction as five nonoverlapping waves.|
|Graphic provided by: StockCharts.com.|
|Two characteristics of wave 3 is that they are never the shortest wave and is most often the longest of waves 1, 3, and 5. Another characteristic of wave 3 is that they normally move quickly with the greatest amount of momentum of any other wave. Therefore, we can expect wave 3 to spiral downward quickly during the weeks ahead.|
|One way that we can tell that wave 3 down is now under way is by going to a smaller time frame, such as the daily price chart, to see if we can find smaller impulse waves that have subdivided into five smaller waves in the downward direction. This will then define the current trend from the early May price peak as being in the downward direction.|
|Looking at Figure 2, note that wave 2 ended in early May 2008. Since that time, XLF has been moving lower and has formed subwaves (1), (2), and wave (3) of a five-wave impulse wave in the downward direction (it is not yet clear if wave (3) is complete yet). However, note that the impulse wave is not complete and so we cannot count five waves down. But since we can count three of the five waves, we have a pretty good idea that XLF is now moving lower and will eventually complete the five subwaves necessary to verify that the market is trading lower and that wave 3 down on the weekly chart is under way. |
There is another way of verifying that XLF is now trending in the downward direction and that the selloff from early May is not part of the market correction that started in March. Look at subwave (3) down. Note that it is also made up of five subwaves — waves (i), (ii), (iii), (iv), and (v). These five waves also form a small impulse wave, and as we know, impulse waves move in the direction of the larger trend, which in the case of XLF is down. Therefore, these five small subwaves tell us that the larger trend made up of waves (1), (2), and (3) are moving in the downward direction. This then helps to verify that waves (1), (2), and (3) are part of a larger impulse wave, to be made up of waves (1), (2), (3), (4), and (5), that then define that the major trend of XLF is in the downward direction. This then helps to verify that wave 3 down on the weekly chart is under way and that XLF is starting its downward spiral to much lower prices.
|FIGURE 2: XLF, DAILY. This chart, which shows the Elliott wave count, also shows that wave (3), part of a larger five-wave impulse wave, is also made up of five nonoverlapping waves defining the direction of the trend as being in the downward direction.|
|Graphic provided by: StockCharts.com.|
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