One of the terrific benefits of using the Elliott wave model is that when you believe you have identified the correct wave count and latched on to the start of a third wave, the market must give you immediate confirmation. In other words, the market must move sharply without delay in the direction you have forecast.
Third waves are usually the longest and strongest wave in a motive five-wave sequence where counter-trend moves are brief and shallow. As the market progresses along a third wave, it is increasingly obvious you have caught a big one – to your delight!
I began my latest coverage of the FTSE on 2 November (“The FTSE decline has finally begun”). This was the chart I showed:
The market had hit the major multi-year line of resistance in a new high which I suspected was the final thrust of the rally off the August 24 plunge low and there was a small momentum divergence at that 6,490 high made on October 23 to add to my evidence.
That was the evidence I needed to claim that I had found the top and a decline was in store.
And on Wednesday, I outlined how my first attempt at a short trade went bad with a loss of 25 pips. But as I wrote, I was determined to try to find another low-risk entry and had my chance when the market broke through my tramline.
This was the chart I captured on Tuesday:
I had my waves 1 and 2 marked and if we really were in a wave 3 down, I needed to see a sharp break to at least my T3 target at the 6,200 area. And if it hit that, wave 3 would be confirmed by a rapid decline to the Fibonacci 62% support level around 6,100.
So this was my set-up on Wednesday:
That break set my near-term target at T3 in the 6,200 region. But first, it had to negotiate the various Fibonacci support levels on the way down. Each of these levels had the potential to turn the market back up and go on to make new highs. In fact, because my third wave thesis had hardly developed, the potential existed that the move off the high was really a corrective A-B-C three down affair.
But if the market had really embarked on a third wave down, any bounce off a Fibonacci level, such as that on Wednesday would have to be shallow and brief.
And that was my litmus test. A shallow bounce at the Fibonacci 38% support would indicate the main trend was firmly down.
And later on Wednesday and yesterday, the market broke hard down to confirm my third wave idea.
This is the hourly chart this morning:
Indeed, the market fell hard yesterday in an impulsive move to break the Fibonacci 50% support and appears to be heading for my Fibonacci 62% target which lies only around 40 points away.
But will the wave 3 low be put in there and lead to a decent wave 4 up?
In Elliott wave theory, we have a guideline whereby the five waves should look ‘in proportion’, especially the motive waves 1,3, and 5. Basically, that means we cannot have a huge wave 1, a moderate wave 3 and a tiny wave 5.
My wave 1 spans around 200 points and so far, wave 3 is spanning around 300 points for a 3:2 ratio. That is very small by the usual standards, and so I expect wave 3 will terminate at much lower levels.
This is going to be an exciting ride.