|How can we profit from the pain of other participants as
stocks fall? Where should short sales be entered to capitalize
on their fear? And how can we shift trading strategies as the
new uptrend takes over? Answers to these questions can often be
found by watching the countertrend rallies between
dynamic falls. Hidden rules of proportion guide Five
tendency expects the first corrective wave to drop about
38% of the next larger up trend, while the second falls
to 50% and the final thrust all the way down to 62%.
However, 5WDs will sometimes correct 100% (or more) of
the first wave, creating a classic double top.
Selling short during 5WDs is more difficult than you might
expect. The down trendline consists of only two points unless
the first Top lines up with the subsequent two impulses.
|So you may
not know a trendline exists until several entry points pass.
Fortunately this barrier also marks the highest level the first
post-bottom (Drop) rally should reach. This pinpoints a good
trade setup when price gets close enough to the line. However,
the reward potential is smaller than during other declines and
selling short is now a countertrend entry.
The best short sales in the 5WD pattern arise from natural
breakdown points, as impulses violate prior support. Frequently
this requires foregoing entry on the very first impulse since
this wave can complete with little or no selling pressure. This
changes dramatically during the 2nd and 3rd falls when the crowd
becomes highly emotional.
The 5WD trendline becomes a signpost for long trades that follow
the first breakout through it. Immediately buying the break
works exceptionally well on clean gap moves. Pullback entries
routinely appear after breakouts as price returns to test the
trendline from above. But watch out for very weak breakouts.
Stocks may use this side of the trendline to initiate a new
downward impulse, with price gently sliding along the line until
the prior low is retested.
Downtrends do not easily give way to new uptrends. While a break
of the 1-2 trendline marks the completion of the Five Wave
Decline, subsequent price movement may not generate much
momentum. Long entries initiated at the trend break can be very
successful but a defensive posture is warranted. At these times,
remember the old traders wisdom: the bigger the move, the
broader the base. Bottoms can take time to form.
|Reading The Breakdown: The
2nd downward impulse (1) of 5WDs often begin close to
the same level as the 1st decline (Top). This sketches
the classic double top breakdown pattern. Short sales
can be initiated at the first violation of the prior up
trend. But the danger of a short squeeze remains high
during this early stage. Subsequent breakdowns are not
as deadly to short positions as a new bear mentality
weakens rally attempts.