Jmcgarry – your post caused me to pull “Elliott Wave Principle” by Frost & Prechter off the shelf – it had been awhile – thanks for the nudge
I was fuzzy on the concept of “5 legs up but only 3 legs down” so I went in search of an answer.
Here is way more than most people want to know about Elliott Wave theory.
This is Prechter talking about why the 5–3 pattern makes sense from a “mother nature” perspective. In a nutshell he is saying that you have to have 5 waves up and only 3 waves down for there to be overall progress made.
“Why 5-3? (pg 26)
Elliott himself never speculated on why the market’s essential form is five waves to progress and three waves to regress. He simply noted that that was what was happening. Does the essential form have to be five waves and three waves? Think about it and you will realize that this is the minimum requirement for, and therefore the most efficient method of, achieving both fluctuation and progress in linear movement. One wave does not allow for fluctuation. The fewest subdivisions to create fluctuation is three waves. Three waves (of unqualified size) in both directions does not allow progress. To progress in one direction despite periods of regress, movements in the main trend must be at least five waves, simply to cover more ground than the three waves and still contain fluctuation. While there could be more waves than that, the most efficient form of punctuated progress is 5-3, and nature typically follows the most efficient path.”
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EW theory provides some clear rules about the five uplegs. For example, leg 3 is always bigger in magnitude than leg 1. Unfortunately there aren’t any clear rules about the size or duration of the 3 downlegs.
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If I understand correctly, jmcgarry, you are implying that we are at the end of downleg number one and therefore due for wave two. EW theory suggests that this wave two could be a mini-rally or just sideways movement as the market marks time.
I think it is too early for wave two. There is a lull in the ARM reset rate that starts in late 2008 (Credit Suisse ARM Reset chart: http://www.bubbleinfo.com/statistics-2007/2007/3/15/arm-reset-schedule.html). I am expecting the RE shills and cheerleaders to point to this data and call bottom. With an election cycle going on there may be enough strength in the markets to support the idea of a bottom. Anyway, I’m not going to be surprised by a mini-rally in late 2008/early 2009 – in EW terms, I think this rally will be wave two of the overall corrective cycle.
In mid to late 2009 election euphoria will have worn off and the Option ARM resets will be on everyone’s radar screen. I expect wave three, the final downleg of the correction, to be caused by these Option ARMs blowing up. They will do so through the end of 2011.
Let’s say there is a six month delay between an ARM reset and getting a property onto the MLS (I think it is taking longer than that now?). That takes us into mid 2012 before distressed inventory stops coming onto the market from toxic mortgages (assuming there aren’t any more in the pipeline).
By this reasoning I believe the earliest that wave three will bottom is mid 2012.
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As I said before, EW theory doesn’t help much for predicting the magnitude of a correction. For guidance in this area I look to prior financial bubbles and what happened as a result. One of the consistent things about financial bubbles is that they are always fully retraced. Let’s take that as a given for now and move on.
The next question becomes: “When did the bubble start?”
We have discussed this question before in numerous forums. I say 1998 and those are the kinds of prices I will be looking for at the bottom. Other people pick different dates.
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I’ve rambled on enough – thanks jmcgarry – I hadn’t considered our RE correction from EW perspective before you posted
