|As uptrends end, the same crowd that lifts price
provides fuel for the ensuing decline. Longs get lulled
into a false sense of confidence as rally momentum fades
and a topping pattern forms. As smart money quietly
exits, the uptrend hits a critical trigger point: the
bulls suddenly realize they're trapped. Seeking to
protect profits, they start dumping the stock. Price
fails and selling spirals downward through wave after
||Common features appear through most price declines.
Several false bottoms print and fail. Volume repeatedly
surges as losers unload positions and price carries well
past downside target after target. Then just as hope
collapses, the stock makes a final, multiple bottom.
|Pattern Cycles offer a superb way for the short-term
trader to understand and capitalize upon this repeating
market behavior. Look no further than R. N. Elliott's
work in the 1930s and you'll find the Five Wave Decline.
This structure for price correction is as powerful today
as it was 60 years ago. And as a parable for crowd
behavior, traders can use it without understanding the
broader Elliott Wave Theory.
|The 1st, 3rd and
5th wave impulses in EWT become Top-1-2 in the
Decline's count. Connect the 3rd (1) and 5th (2)
waves with a trendline. Ignore the 1st (Top)
wave, which the trendline can violate in any way
it wants. The first bounce after the (Drop) may
come close to that trendline but will rarely
5WDs consist of three downward impulses and two
corrections. The first impulse (Top) corrects the
uptrend that carries an issue to a new high. This Top
begins the price failure that completes through the
second impulse (1): the technical breakdown of the
stock. As with rising markets, this impulse can be very
dynamic. But in most declines, the worst is usually
reserved for last. As this 2nd impulse completes, a
false bottom paints a comforting picture that slows the
selling and brings in weak longs. The selling then
suddenly resumes and accelerates into a final 3rd
impulse (2) that is so emotional that prices violate set
targets and reasonable support zones.
The emotion of this last wave extinguishes selling
pressure, bouncing the stock. Rapid upward motion
ignites the first impulse of a significant countertrend.
This strong rally then fails suddenly. As the longs
brace for more pain, the prior low unexpectedly holds. A
new crowd then steps in and price returns to the 1-2
trendline as a double bottom forms. The balance of power
shifts and the stock breaks through that line into a new
The skilled eye can see 5WDs in all time frames, from
5-min to monthly bars. And the unconscious crowd
behavior represented by this fascinating pattern goes
well beyond declining markets. These volatile movements
fit perfectly into the larger structure of herd
mentality that drives Pattern Cycles through their
orderly and predictable process.