Welcome to the continuation of Module 2 of the Elliott Wave Vertical.

This is on
Impulsive Patterns.

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In the previous learning object, we learned about:
Mathematical Applications, and
Projections and Targets.

In this learning object, we will learn about:

Determining the End of a Trend, and
Reversal Patterns

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Donald Trump said, “I try to learn from the past, but I plan for the future by focusing
exclusively on the present. That’s where the fun is.”
The key to doing well in the market is by using the tools available to know when the
trend is over and when the next trend is starting. How would you like to be able to
target the end of a 5-wave sequence so that you know when the next trend is
beginning? Do you think that would be useful to you? Let’s have some fun and plan
for the future, by focusing on what price is telling us in the present, just like Donald
Trump does.

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There are several methods of determining the end of a trend. They include:
1. Channeling to target wave 5
2. Projected price in the target zone for 5-wave sequence and internal sub-wave 5
3. Divergence between waves 3 and 5 and a change in direction of the current
momentum
4. Reversal chart patterns, such as
rising or falling wedges
broken trendlines
double or triple tops and bottoms, and
1-2-3 tops and bottoms
5. The 8, 13, 21, and 34-day Fibonacci EMA filter, and finally
6. Candlestick reversal patterns

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The Channeling Technique is another useful tool for wave projection. Elliott noted
that 5-wave sequences are usually contained within parallel lines or a channel.

This channeling methodology is often used to delineate the exhaustion zones, such
as the end of a 5-wave sequence. Once the wave 5 target is achieved, one would
expect to see a trend reversal as long as the other confirmation signals are also
present. It serves as an optimal timing guide, giving the trader a competitive edge.
The first step is to connect the bottoms of waves 2 and 4. The next step is to draw a
parallel line off the top of wave 3 to project wave 5. If however, wave 3 is extended,
draw the parallel line off the top of wave 1. Using both channels actually gives a
price zone targeting the end of wave 5.

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There are some variations to this technique which have gathered attention. The first
point to make is that three reference points are required before drawing a channel.

An initial channel can be drawn once waves 1, 2 and 3 are complete. The first step
is to connect the tops of waves 1 and 3. Then step 2 is to draw a parallel line off the
bottom of wave 2 to project wave 4. This provides the initial wave 4 boundary. As
you can see, the wave 4 moves outside of the initial channel boundaries. At this
point for step 3, wait until wave 4 is complete, and redraw the channel, starting by
connecting the bottoms of waves 2 and 4. Step 4 is to draw a parallel line off the
tops of each of the waves 3 and 1, as before. Finally, step 5 is to draw the parallel
line halfway between the lines off waves 1 and 3. The wave 5 target should fall
within this range. Sound complicated? It isn’t really. It just takes practice.

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In this EUR/USD example, the downtrend channel is formed by first connecting the
bottoms of waves (1) and (3) with a parallel line off the top of wave (2).
As you can see, this initially provides a good approximation for the end of wave (4).
Once wave (4) is complete, redraw the lines connecting the tops of waves (2) and
(4).
Then, the final step is to draw parallel lines off the bottoms of wave (1), wave (3)
and 50% between them. As you can see, wave (5) of this move falls short of the
channel since wave (3) is extended. However, it is also worthwhile to note that wave
(5) ends at the 61.8% trendline, which also happens to be the bottom of sub-wave 1
of (3). You are probably asking yourself, “How would I know that wave 5 is not going
to reach the channel target?” The answer is, you don’t but at this point you can
target the sub-wave 5 of the 5-wave move. Let’s look at that example.

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The EUR/USD internal target for wave 5 can be calculated using the same
channeling technique, but for the sub-wave 5 of the 5-wave sequence. Start by
connecting waves 2 and 4 tops. By drawing a parallel line off the bottom of wave 3,
you can see that sub-wave 5 falls exactly at the base of the channel. Hence,
channeling the internal sub-wave 5 told us that the entire 5-wave sequence was
nearing an end at that stage. In fact, when we are projecting the end of wave 5 by
using our Fibonacci ratios, we do exactly the same thing. First we target the end of
the 5-wave sequence. Then we target the internal sub-wave 5 count on its own. By
projecting the internal wave 5 sequence, we are narrowing in on the end of the
entire 5-wave move.

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How do we project price in the target zone for a 5-wave sequence and the internal
sub-wave 5?
Impulse wave 5 is a multiple of wave 1 or the start of wave 1 to the end of wave 3.
When wave 3 is extended, meaning that it has traveled further than 1.618 times the
length of wave 1, it means that wave 5 will not likely be extended. The probable
targets for wave 5 when wave 3 is extended are:
1 times wave 1, or equality with wave 1, where the length of wave 5 equals the
length of wave 1,
.618 times the length of wave 1,
1.618 times the length of wave 1, and
.618 times the length of the start of wave 1 to the end of wave 3.

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Just as we target the wave 5 move, we can target the internal sub-wave 5 move, or the sub-
wave 5 of wave 5 move. We do that in the same way as described in the previous slide.
Again the impulse sub-wave 5 of wave 5 is a multiple of sub-wave 1 or sub-wave 1 to sub-
wave 3.
When sub-wave 3 is extended, meaning that it has traveled further than 1.618 times the
length of sub-wave 1, it means that sub-wave 5 will not likely be extended.
The probable targets for sub-wave 5 when sub-wave 3 is extended are:
1 times sub-wave 1, or equality with sub-wave 1, where the length of sub-wave 5 equals
the length of sub-wave 1,
0.618 times the length of sub-wave 1,
1.618 times the length of sub-wave 1, and
0.618 times the length of the start of sub-wave 1 to the end of sub-wave 3.

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To summarize, we have 3 ways that we have learned to target the wave 5 move.
1. Project wave 5 of the 5-wave sequence using Fibonacci ratios
2. Project internal sub-wave 5 of wave 5 using Fibonacci ratios
3. Use channeling techniques and begin to narrow in on the end of the 5-wave
sequence

When we complete all three ways of targeting the end of the 5-wave sequence, we
have a pretty good idea as to where the move will end.

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We have already seen this slide – the wave 5 target is in equality with, meaning the
same length as, wave 1 which takes us to within 12 pips of the actual wave 5 price.
In the next slide we will come up with the internal sub-wave 5 price target by looking
exclusively at sub-wave 5 of the 5-wave sequence, just like we did in the channeling
example.

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This chart of the EUR/USD takes wave 5 of the 5-wave sequence and magnifies it
so that we can count the waves and measure the targets for wave 5. By taking the
price difference between the start of wave 1 and the end of wave 3 and taking .618
times that difference we get one target of 1.1778. The second target of 1 times the
length of waves 1-3 measures 688 pips. Subtracting it from the top of wave 4 at
1.2203 we get 1.1515. The actual wave 5 price is 1.1640 which is exactly half way
between both targets!

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Another way to identify the end of a 5-wave sequence, is to look for divergence between waves 3 and 5. We do
that by using Bill William’s Awesome Oscillator.
The awesome oscillator is a 5/34/5 MACD, a momentum indicator that takes a 5-bar and 34-bar simple moving
average, plotted in a histogram of 100 bars and a maximum of 140 bars on the screen.
This indicator is always measuring an Elliott wave of some degree. If the wave under consideration occupies
fewer than 100 bars, the MACD will be measuring the Elliott wave of a larger degree. If the wave sequence
occupies more than 140 bars, the MACD will be measuring an Elliott wave of a smaller degree. You can
also use a MACD with the standard setting or change the settings to a 5/34/5 to conform to the awesome
oscillator.

Some of its uses are as follows:

1. The awesome oscillator identifies the top or bottom of wave 3. Because all oscillators are lagging indicators,
the top or bottom of wave 3 will be the highest or lowest price that occurs between 1 and 5 bars on the
oscillator prior to the top or bottom in the oscillator.
2. The oscillator determines the end of wave 4, or when its minimum requirements have been met. This is
evident when the histogram comes all the way back to the zero line. Assuming a downtrend, immediately
after the bottom of wave 3, we notice the histogram moving above the signal line. The signal line is the 5-
bar average of the oscillator itself. When this happens, be careful about placing any short positions: the
momentum is running out of steam and we are due for a 4 th wave correction. If short, you may choose to
hold on through wave 4 or you may decide to take profits and wait until the histogram comes all the way
back to the zero line, which indicates that the minimum requirements for the wave 4 have been met.
3. It indicates the end of the trend and the top or bottom of wave 5 with oscillator divergence.
In looking for the end of a downtrend and the bottom of wave 5, we tend to see divergence in the oscillator
which tells us when we are in a wave 5 versus a wave 3. We will have a price divergence where the wave
5 price makes a new low below the wave 3 price, but the oscillator does not. It actually lags and runs out of
steam which tells us that the entire 5 wave sequence is running out of steam.
4. It signals a change in direction of the current momentum.
The awesome oscillator signals the immediate direction of the current momentum by looking at the relative
position between the 5/34 histogram of the oscillator and the signal line which is a 5-bar simple moving
average of the 5/34 oscillator. Then, take trades only in the direction of the current momentum. If the
histogram is below the signal line, take shorts. If the histogram is above the signal line, take longs.

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This is a chart of the GBP/USD from December 2004 to December 2005.
This chart with the awesome oscillator clearly shows what is referred to as
divergence. The price trend is in one direction, in this case down, and the oscillator
is diverging by making higher lows. This is a classic condition for trend reversal.
Whenever we see divergence between the wave 3 bottom and the wave 5 bottom,
we look for a potential reversal.

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This is a chart of the EUR/USD from November 2005 to December 2006.
This chart with the awesome oscillator clearly shows what is referred to as
divergence. The price trend is in one direction, in this case up, and the oscillator is
diverging by making lower highs. This is a classic condition for trend reversal.
Whenever we see divergence between the wave 3 top and the wave 5 top, we look
for a potential reversal.

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The Elliott Wave Principle attempts to provide order to the markets by providing a framework within
which market moves occur. We have now looked at the various patterns which fit into this framework.
Elliott’s interpretation of chart patterns parallels the classical use of these patterns but with added
precision. To apply Elliott Wave analysis correctly, one needs to look for the chart patterns in the
price data, and understand that they can be explained by the wave principle. Elliott Wave Analysis
places such reversal patterns as head and shoulder formations, 1-2-3 patterns, rising and falling
wedges, and double and triple tops and bottoms into perspective.
This chart summarizes some of the classical chart patterns and what their equivalents would be
using Elliott Wave terminology. Let’s take them one by one. The first reversal chart pattern is the
rising and falling wedge which in Elliott wave terminology is equivalent to diagonal triangles. The
classic head and shoulders pattern is also a reversal pattern and shows up at the ends of moves, in
Elliott wave terms, the end of a 5 wave sequence. Imagine completing a wave 3, 4 and 5, which is
the left shoulder and the head, followed by the abc correction, which forms the right shoulder. Waves
3 and B form the shoulders and wave 5 is the head. A break of the neckline would be consistent with
the c wave, which is an impulse 5 wave move in itself.
A double top and bottom is similar to a wave 1 and 2 where 2 corrects the full length of 1, or a failed
5th wave where the wave 5 fails to go above wave 3. Triple tops and bottoms are equivalent to 1-2-1-
2-patterns, the beginning of an extended wave 3 in Elliott wave terms. And finally, a 1-2-3 reversal
pattern is the beginning of a new trend in Elliott wave analysis, waves 1 and 2, and the start of 3, or
waves a, b, and the start of c.

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You might be asking, how does a Fibonacci sequence of EMAs point to the end of a
trend? The answer is, the most efficient tools are trend related and using a
Fibonacci sequence EMA filter is a great way to exit a position after a 5-wave
sequence. Let’s illustrate. You are now very familiar with a 5-wave sequence, and
understand which waves move with the trend, waves 1, 3 and 5, and which waves
move countertrend, waves 2 and 4.
If you observe enough charts of varying time frames, especially the hourly and 15-
minute, you will become familiar with the wave 1 start of the trend, the wave 3
impulsive thrust of the trend, and the wave 5 completeness of the trend, and of
course, the corrective pauses in between. This description holds true for every five
wave sequence of every degree. In fact, taking apart trends will become intuitive
after a while.
One simple and efficient tool to use to analyze the end of trends is the 5/34/5 MACD
or the awesome oscillator. A second simple and efficient tool which complements
the MACD is using a combination of 8, 13, 21 and 34-period EMAs. Notice that
these EMAs are part of the Fibonacci sequence, as are the moving averages in the
MACD. The smallest EMA, the 8-period, is the most volatile and creates market
whipsaws, as it hugs the price action very well, whereas the 34-period is the least
volatile of this EMA series.

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Note some observations.
•When the 8-period EMA is pierced by a candle, it acts as a warning of a hesitation in the trend if the
candle pierces but stays below the 8-period EMA. The trend will continue if the close is below all 4
EMAs.
•But if the close is above the 21 and the 34-period EMA, it’s a signal that an eventual pullback or
reversal may be imminent. At this point, the 8-period EMA will cross above the other averages and
you will see convergence and crossover. This is exactly the time to exit a position, signaling the end
of a 5-wave move. If however, this crossover occurs at the end of a wave 3, it might also be time to
exit in the case of a prolonged wave 4 correction.
•Another observation is how the price action hugs the moving averages. Notice that at the end of the
wave 1, 3 and 5, the price action moves away from the averages in an impulsive frenzy. This is
trader’s emotional desires to stay with the trend, even if there are signs of a completion of the trend.
What you see next, is that the price action always comes back to the averages. There is little value in
entering a position at this stage of the game, as the price will revert to the mean a few price bars
later.
•Another observation is that when price comes back to the average without piercing it, this indicates
that another move in the direction of the trend is pending. These consolidations may be considered to
be the real catalysts of a trend’s strength. As long as they continue, the current impulsive wave is not
complete, even though it may seem extended at a certain stage. These hugs or resting points are
important factors in determining a trend’s strength. They are necessary halts in a trend which add to
the trend’s momentum.

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Let’s take our example and have a look at the sub-wave 3 of this 5 wave sequence and see how the
price action trades with the combination of EMAs. I call the tool the 8, 13, 21 and 34-day Fibonacci
EMA filter. Starting at the beginning of wave 1, the Fibonacci filter gets us into our first short position
when the 8-day EMA crosses all three EMAs. We don’t get in at the top but we get in on the 4th down
candle. A less conservative entry would be on the cross of the 8 and 13-day moving averages, as
that would get us in on the third down candle.
If we took 3 lots, we would ride the lots through the end of wave 1. We would exit the first lot when
the 8-day crosses above the 13-day EMA. We would exit the 2nd lot when the 8-day crosses above
the 21-day EMA. Since the 8-day doesn’t cross above the 34-day EMA, we would still be holding
onto 1 lot. Knowing what we know about the wave counts, we see that we have exited the positions
on a wave 2 correction. We look to reestablish the sells when the 8-day moving average crosses
back below the 21-day and 13-day averages. We are now short 3 lots again. We ride the move all the
way down through the completion of the 5-wave sequence and we exit all three lots as the 8-period
moving average crosses back over the 13,21, and 34-day EMAs. This was a successful trade. The
Fibonacci EMA filter keeps us in the trade practically the entire down move.
Notice how the prices hug the 8-day EMA. Notice also that when we move away from the 8-day
EMA, as in the end of the 5-wave sequence, the law of averages brings us back to the EMAs like a
magnet. Knowing that it is a 5-wave sequence, we could decide to exit the trade prior to getting
stopped out. This is where we would draw our channels, and target the end of wave 5 using the
Fibonacci projections. We would also look to see confirmation that there is divergence in the
oscillator.

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This example looks at the sub-wave 5 of the 5-wave sequence and we go through the same
exercise. We sell 3 lots when the 8-day EMA crosses over the other 3 EMAs, and we enter short on
the 8th candle from the top of the sequence. Entering on the cross of the 8 and the 13 EMA would get
us short on the 5th candle. We stay short through wave 4 where we exit 1 out of the 3 lots as soon as
the 8-day crosses back over the 13-day EMA.
We reestablish our short 6 candles later when we see the cross with separation. We stay short until
the end of wave 5 and we exit all three lots at three different levels, as the 8-day EMA crosses over
the 13, 21, and 34-day EMAs. Again, when this is used in combination with the other tools, we are
able to pinpoint the end of the trend so that we can call the start of the new trend. The last tool that
we are going to take a look at is Japanese candlestick reversal patterns.

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The Japanese have used candlesticks as a charting and analysis technique for centuries, but only in
recent years has it become popular in the West. A Japanese candle pattern is a psychological
manifestation of what traders at large are thinking at any given time.
They form both continuation and reversal patterns just like with chart pattern analysis. Whenever a
reversal pattern is bullish, an inversely related pattern is bearish. When there is a pair of patterns
that work in both bullish and bearish situations, they usually have the same name. In a few cases
however, the bullish reversal pattern with its bearish reversal counterpart have completely
different names.
Bearish reversal patterns form in an uptrend at a price peak.
Bullish reversal patterns form in a downtrend at a price low.
A few reversal (bullish) patterns include:
The Piercing Line – This pattern has bullish implications as the downtrend is intact on day 1 but
reverses on day 2 from an opening level lower than the previous day’s close.
The Bullish Engulfing Pattern – With this pattern, day 1 is in a downtrend with a small body. Day 2
reverses where the body completely engulfs the previous day’s body.
A few reversal (bearish) patterns:
The Dark cloud Cover – This is a 2-day reversal pattern that has bearish implications. Its counterpart
is called the Piercing Line. The first candle has a long blue body, confirming the uptrend. The
second candle opens above the high price of the previous day, adding to the bullishness.
However, during the day the sellers emerge and a red body forms, with the closing price at at
least below the midpoint of the first candle. This will force traders to exit the long positions as
there is no follow through; and finally,
The Bearish Engulfing Pattern - The first day is characterized by a small body in an uptrend, followed
by a day whose body completely engulfs the previous day's body.

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Here are a few more of the bullish and bearish reversal patterns, as a confirmation
for the end of a trend. Please note that there are approximately 40 reversal candle
patterns which vary from single candlesticks to groupings of up to 5 candlesticks.
Also, candlestick patterns are best used with other confirmation signals such as
oscillator divergence and reversal chart patterns.

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This concludes this section on Determining the End of a Trend. You now have a
complete toolkit of trend ending indicators and reversal patterns that will take
you a long way compared to other traders.

To summarize, there are several methods of determining the end of a trend. They
include:
1. Channeling to target wave 5
2. Projected price in the target zone for 5-wave sequence and internal sub-wave 5
3. Divergence between waves 3 and 5 and a change in direction of the current
momentum
4. Reversal chart patterns, including
- rising or falling wedges
- broken trendlines
- double tops or triple tops and bottoms
- a 1-2-3 top or bottom; and
5. The 8, 13, 21, and 34 day Fibonacci EMA filter; and finally
6. Candlestick reversal patterns

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This is the end of the learning object. Please continue on to the quiz.

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