Wave Rules and Why I think We are Still Headed for a lower Wave 3 Support ….

I received the following comment on my bog site yesterday …

Basically, Taylor is asking whether there is a possibility that we have made our final move lower into support with the late December move. I started to write a reply to this question on the blog and I realized that it would be better answered with a detailed blog post that showed exactly why I thought the way that I did – this way any interested reader of my posts can actually learn something and apply it to their own chart analysis going forward.

Back to Taylor’s question … my short answer is that anything is possible, especially when you consider all of the market manipulations by central banks and governments around the world. Beyond that general comment, my answer would be “No” … and I say that because I fall back to the rules I learned about the structure of price waves in the financial markets.

I have a older 2-part PDF in my Education section that details wave measurement rules (Trading Wave-to-Wave) and I would encourage all readers to take a look at those documents.

I think it makes sense for me to try and apply those wave structure rules to the current corrective move being made in the NASDQ 100 futures contract. Ok, let’s get started …

Through-out this blog post I will talk about impulsive and corrective wave structures … when I speak about impulsive wave structures, I am referring generally to price moves that do not have overlapping candle structures and in wave speak, looks like an expansion phase move. Corrective wave structures generally have price candles that overlap each other to a great extent.

For impulse waves, the first basic rule that traders should be looking at when analyzing price waves is …

  1. When price is in a possible impulsive wave structure, the impulsive wave will be either a 2-wave or 3-wave structure. You will know you are completing a 2-wave structure when the second leg/wave terminates at the 1.272x extension target area (using the start to the first wave as the anchor for measuring the second wave).

So let’s look at the NQ futures contract and begin back at the October 1st high …

NASDQ 100 Futures Contract (NQ) – 240 Minute Chart #1

So to begin with, traders don’t know for certain whether or not a wave structure has ended/ begun until well after the official end/start to the move. No trader would have known that October 1st was an important high in the NQ futures contract until well after the fact … if you were analyzing the price wave structure into that high you may have had reason to believe that a high was being made, but you would not have known for certain until price began moving away from that price high.

I like to use ATR resistance and supports drawn on my charts as a type of “first/early warning” of a possible change in trend, but even with that type of trading system, you have to understand bigger time frames and how price will make pull-backs of varying degree all the time during a trend move. I don’t want to get lost in how/when traders could or should have been able to call the October 1st top in the NASDQ … what I want to focus on is the price structure after it became obvious that a top had been made and we were making a larger time frame corrective move lower.

So let’s just say that you were on holidays in early October and you arrived back to work sometime during that first week. If you were looking at the NQ chart anytime after October 4th, you should have realized that price was “impulsing” lower and began looking at smaller time frame charts to see if you could ascertain where price was in terms of wave structure rules.

NASDQ 100 Futures Contract (NQ) – 60 Minute Chart #1

One simple price movement rule that traders should have ingrained in their brains is that price will often have three pushes into pivot points … on the above 60-min chart, On October 8th traders should have been quick to see 3 pushes into that day’s low. Over the next day and a bit, price made an overlapping abc corrective wave structure, and if you undestood how price waves work, you would have realized that you had probably just completed 2 waves of a probable 3-wave structure.

So where should you anticipate Wave 3 terminating? Generally, Wave 3’s will terminate around that 1.272x price extension target drawn using Wave 2 and the beginning of Wave 2 as the anchor.

You will see on the above 60min chart that price moved well through the normal 1.272x extension target and actually waterfalled lower to take out the 1.618x level. That is not the norm, but entirely possible – that is why I wait for price to tell me it has finished moving before I become convinced a wave is done.

I do that by watching smaller time frames, and by using a series of chart indicators … to keep things simple, I do not show those chart indicators but I do have my colored candle system on this blog post’s charts. You can see that at the end of wave 3 price began overlapping and the candles were painted dark blue with pink divergence dots … dark blue candles visually warn me about the trend strength of the move in price being at a level that historically have been very difficult to maintain (i.e., the trend should be near exhaustion). The pink divergence dots are painted when the trend strength is > than 100 on my indicator but declining from the prior candle’s reading.

There are some nuances in understanding trend strength and various time frame comparisons, but suffice to say, when you see dark blue candles with pink divergence dots, price is often near or almost at the end of that expansion phase.

So no, price did not stop exactly at the 1.272x as I would normally expect it to … it did not even stop exactly at the 1.618x level. I use those extension targets as an “AREA” that I expect to see price to find support/resistance.

Obviously price was making an emotional move lower here as indicated by the large range waterfall candles. More importantly to traders is that you understand that price had found support and now was going to move higher out of support.

As a trader, you have to be thinking ahead … you would normally have two thoughts to weigh when you see price finding support. You have to decide whether price was likely to have finished moving lower and was likely to make another attempt at making a new high on the next move higher, or you would have to think that price was likely making a multi-leg correction lower and that this first move lower was therefore likely part of a 2 or 3 legged move lower.

If you have read many of my blog posts, I show in multiple examples why I think that the early October highs in the market are in fact a very important high pivot, and therefore, my thought in early October was that we were going to find resistance in the SLOT coming out of the October 10th low.

Again, I have been wrong often in analyzing charts, but on the bigger wave structures, I have a pretty good feel for what is going on, and I would argue that I have made more right calls than wrong ones. But I do misread what is happening, so I always keep in mind that the market is going to do what it is going to do. So in mid-October I was playing a bounce higher in the NQ and I was expecting resistance to work, but I wanted price to show me that it was respecting resistance, and was in fact going to head lower in a 2nd or 3rd leg price structure.

NASDQ 100 Futures Contract (NQ) – 60 Minute Chart #2

So the first minor point to make on the above chart is that the dark blue candles with pink divergence dots in early October were actually exceeded with a push to a new minor low – again, that happens often when price is making a move into support or resistance … not every time, but it is something I have learned to watch for.

Take a look at the price action from October 12th-15th … totally overlapping and therefore confirmation that what we were likely making was a corrective bounce higher – more evidence that SLOT resistance should hold this bounce higher. On smaller time frames, price makes many wiggles, but I have labelled the corrective wave higher – abc in the first or bigger A-wave and while not labelled, the bigger B wave had multiple 2-legged waves into support.

Please note that price did not make it all the way back into minor SLOT support (50% – 78.6%), and only made it down past the 38.2% Fibonacci level. You will often see smaller time frame corrective waves only make it to the 38.2% level and not all the way back into the SLOT … that is another subtlety that traders must except. Take all of the evidence that you can garner from your chart’s indicators to determine whether or not a pull-back is complete and be open to your “general rules” to be on occasion not met.

The bigger wave I was trading in October was for a move up into resistance and then lower from there … and out of those two moves, I was more concerned about the bigger move coming out of upper SLOT resistance. You can see that price did make it into resistance and did in fact paint dark blue “extreme warning” candles with pink divergence dots.

Can you gear down to a smaller time frame to see if it makes sense that resistance would hold there?

NASDQ 100 Futures Contract (NQ) – 30 Minute Chart #1

So looking at the above 30-min chart, I can see price making three pushes higher into the SLOT and dark “extreme warning” blue candles with pink divergence dots being painted. To me that is what I want to see and in this case what I would expect to see.

However it wasn’t until October 17th/18th that you really had “evidence” that price was very likely finished moving higher – again, no guarantees in trading, but all evidence to me tell me that a corrective bounce had completed 2 legs higher (i.e., an ABC) and the C-wave had completed its normally expected 3-wave move into the SLOT. The dark blue candles, and the price action out of that interim high was plenty proof that price was likely headed lower in the next move.

So what do we “know” here? You should know that price was headed lower into the next level of support. You don’t know whether or not the move is going to be two waves or three yet but at a minimum, it will be a 2-legged move.

Simple corrective patterns are typically 2-legged, and more important (i.e., higher time frame price patterns) are typically more complex and therefore 3-legged or 3-wave in structure. But again, you don’t “know” ahead of time what this correction is going to be … you can have your thoughts, and I clearly have stated a number of times I think the October all-time high is an important pivot and therefore I am expecting a complex correction off of the top (i.e., a 3-legged correction)

But traders should not let the wagon get ahead of the horse … draw your extension targets and try and trade price as it makes its way down into potential support.

NASDQ 100 Futures Contract (NQ) – 60 Minute Chart #3

So again, traders should have been expecting price to make it down to at least the 1.272x extension target (dark blue) … price is going to make many smaller waves on its way down into possible support, and in real time, many traders are likely going to be convinced that support was made. However, I like to ask two simple questions when waiting for support to be made/hit … is price at a point where support makes sense (i.e., at a 1.272x – 1.618x extension target), and can I see a smaller time frame price structure complete a move into that level? If I can’t see a possible smaller time frame wave complete into support, then I am wary of the move being complete.

In the above 60-min chart, I labelled a possible 30-wave move into the bigger 1.272x extension target level … I even drew extension targets for that smaller 2nd and 3rd waves. I did this to in part show how waves never hit my levels exactly, especially in smaller time frame moves. Minor wave 2 did not quite make it down to 1.618x, but we were not close to the bigger 1.272x minimum target I was watching so in real time, I would have to say that this point was the end of the 2nd minor wave.

The third minor wave made 3 smaller waves inside itself, but again, price exceeded my “rules” and pushed well beyond the 1.272x-1.618x target zone (drawn in brown and green). Traders need to be flexible and think about the bigger structure and not caught up in every small wave being according to the rules.

The more important point for traders would have been the move into the bigger 1.272x target and the price action around that support level. I wrote a blog post on October 27th where I went over the move into support for all of the major indexes that I follow (click here) … here is the NQ chart.

NASDQ 100 Futures Contract (NQ) – 195 Minute Chart #5 (October 27, 2018)

So again, I don’t “know” for certain that price is going to act the way I have drawn it on the above chart … all I know is that according to the price wave structures that I have learned and have proven to myself they add value to my trading, I was expecting price to unfold at a minimum like the chart above.

I could have been wrong and the price correction could have been over with just one ABC off of the October high … I go into great detail in that October 27th blog post why I thought the move down in October was just the first leg of at least an ABC corrective pattern – I won’t repeat those thoughts here, but suffice to say that I was open to resistance not holding as I was forecasting in early November. I was expecting resistance to hold but price was going to have to prove me right or wrong before I became committed one way or the other.

My favored scenario had price holding support at the 1.272x at around my October 31st time target/window … I then expected to see price find resistance at the 50% level (symmetry with the prior bounce into resistance) on November 8th (assuming that my support would be found on October 31st).

I could have been wrong and price could have blown down through the 1.272x target into the 1.618x level. My thought at the time, however, was that for price to go much lower during this corrective move, it would first need to bounce and suck in some more bulltards to fuel an eventual push to lower levels.

So my thought on October 27th was the 1.272x zone was going to hold, but the bounce from support would respect SLOT resistance and then push at a minimum down to where an ABC/2-legged corrective pattern would find support (i.e., at the 1.272x target zone). It was possible for price to push below that 1.272x here at the end of October and signal to me that the corrective pattern was going to be 3-waves right out of the gate, but that was yet to be proven/shown to me. My first rule is to look for the possibility of support at the first 1.272x target.

Sure enough, support came in around that 1.272x level on October 29th, and then price pushed higher into SLOT resistance

NASDQ 100 Futures Contract (NQ) – 60 Minute Chart #4

The first wave higher in the corrective bounce can be labelled as a minor 3-wave structure. It terminated right at below the 50% level (7154.75) at 7143.25. So why did I not expect that to be the top of the corrective bounce? Are you paying attention? I have said a number of times, I want to see a 2-legged corrective bounce that terminates in the 1.272x – 1.618x extension target zone inside the SLOT. The first and most basic requirement of having 2-legs was not even seen here yet.

Several years ago, a follower of my blog posts wrote to me about a time when he shorted the SPY in an example just like this one … the SPY had made it just short of the SLOT and looked like it was finished bouncing. I wrote a blog piece about that example and called it my “Patrick-Rule” after that particular blog follower. I wasn’t trying to pick on this reader, I was just trying to make a point that would stick with him going forward.

What happened in the Patrick Rule example, was that he was correct in that the move higher looked like it had terminated … what he didn’t wait for however, was a 2-legged price structure that made its way into the SLOT. A corrective move can fail to get into the SLOT, but it has to at least show two obvious separate legs before I will count my chickens and assume it is complete.

The NQ chart above showed that price moved down to a level just barely short of the SLOT, but note here that price had carved out an obvious 2-legged correction into what turned out to be the B-corrective wave inside the bounce higher.

Price then made a 3-wave move in the last C-wave of a corrective bounce which is text book what I would expect in my wave structure rules.

The price move into the SLOT made 3 minor waves in that final C-wave, and terminated at the 1.272x extension target for that 3rd minor wave and my software painted dark blue “extreme warning” candles with pink divergence dots. This happened on November 7th which was more or less where I would have expected it to happen if I had drawn my forecast using the actual October 29th low vs the Oct 31st date I was assuming when I drew my October 27th road map.

So what comes next? Again, I fall back to my price structure rules … if you go back to the 195min chart from my October 27th blog piece you will see that I was expecting price to next come down to atleast the 1.272x target to complete a possible bigger ABC corrective pattern. I could be wrong and price could be making an even bigger 3-wave corrective pattern to the downside, but I would be shown that by price over time going forward. My first rule is to look for a possible ABC …

NASDQ 100 Futures Contract (NQ) – 240 Minute Chart #2

But what happened? Price looked like it made a two-legged wave lower and found support prior to the 1.272x level. If the move lower was indeed a C-Wave it should have formed a smaller 3-wave structure and terminated around the 1.272x target. Once price showed me that it had completed a probable 2-legged move lower and was bouncing, I had to assume that the move lower had made the first leg only of a bigger multi-legged move into support.

What does a trader do next? Look to the expect SLOT resistance level and monitor/trade price as it bounces higher.

NASDQ 100 Futures Contract (NQ) – 240 Minute Chart #3

So what happened on the bounce higher? Well, price made what looks like a nice little 3-wave structure move into the SLOT … it wasn’t text book, but it seldom is. What actually happened was price gapped open higher on Dec 2nd and actually pushed price through the upper boundry of the SLOT. I don’t usually like to see that happen, but because price gapped higher and then reversed lower back into the SLOT during normal cash trading hours, I was ok with that move – I still expected the SLOT to hold and for price to push lower.

I didn’t obviously know for sure, but everything up until this point made me think that price still needed to go down, at a minimum, to the 1.272x target level to complete the ABC. Also still possible was a move down to the 1.618x level which would then tell me that price was actually making an even bigger 3-wave price structure, and that price would only have been finished the 2nd of 3 waves when it found support around the 1.618x level.

I highlight the two area on the above chart … if the pattern was going to be an ABC, then price should make a final 3-wave move into that 6268.25 area. If it was going to signal that we were making a bigger 3-wave pattern, then it needed to blow through that 1.272x target level and make it down to the 1.618x extension target.

So what happened?

NASDQ 100 Futures Contract (NQ) – 240 Minute Chart #4

This is where it gets interesting and where Taylor asked me his original question about it being possible that the corrective move lower is complete.

Hopefully Taylor and other readers can more completely understand it when I say that “the move lower could be complete, but based on all of my price structure rules, it can’t be”!

The move lower through the 1.272x target of 6268.25 down to the 1.618x target level of 5871.00 means that we are “likely” making a bigger 3-wave corrective pattern, and that the low trying to be made now is only the end of wave 2.

The above is what I can say with confidence based on all of my experience as a trader and as someone that understands price structure. The interesting thing facing traders right now however, is the question of whether or not Wave 2 is complete since we hit that 1.618x extension level.

Remember what I tried to impress on you … firstly, those targets are only a target and a zone. Price can often exceed those exact levels by some margin. What is often more important than an extension target level, is wanting to see the completion of the actual smaller price structure.

In the above chart I show what looks to me a 3-wave structure that has only competed 2 waves lower and is bouncing into resistance. I draw the 1.272x and 1.618x extension target using brown and green to differentiate it from the bigger pattern’s blue and purple.

I also drew the extension targets using the “alternative method” that I more fully explain in the education pieces mentioned earlier – I won’t go any further into that explanation here in this blog.

One other of my price structure rules is that the bigger price targets are more important than any smaller extension target – that is why I think the final move lower in this 3-wave structure into the bigger Wave 2 support is likely to be a minuscule break below the low of December 24th. That would complete the smaller 3-wave price structure and keep the final level around the 1.618x target for the bigger 2nd wave at 5871.00.

Is that clear enough?? LOL

To make it even more interesting, is that we have pushed into the SLOT with an obvious 2-legged pattern and just short of the 1.272x – 1.618x target for the final push of that last bounce.

Here is a bigger view of how I see it unfolding …

NASDQ 100 Futures Contract (NQ) – 240 Minute Chart #5

So there you have it … I think we are almost finished bouncing into resistance in the SLOT (the Point of Control for the Volume Profile for the minor 2nd wave lower is 6516.5 vs the Friday close of 6431.75).

From there, I am only expecting price to complete the wave 3 move to just below the Dec 24th low to make the wave complete, and stay around the 1.618x extension target for bigger Wave 2 support at 5871.00. The Dec 24th low was 5820.50.

From there price should bounce into SLOT resistance at around 6880ish and then make one more price structure move lower into the typical Wave 3 target at the 1.272x extension target using wave 2 for your calculation – I used 5800 as my wave 2 termination value.

Again, all of this could be wrong and we could be complete as Taylor is suggesting/questioning … however, all I know is that I am going to trade whatever happens to be the case, but as an experienced trader, I am going to anticipate what “should” be the case going forward, and by that I mean what price structure rules imply will be the support and resistance levels.

Cheers … Leaf_West

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