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Understanding Markets

Structure

With the increased ability to store data of market prices, analysts began to seek structure in the rhythms of market prices on charts. One of those early holistic methods was called the Elliott Wave Principle (EWP). By holistic, I mean the attempt to define continuous structure to a market, in lieu of discrete identifiable patterns amidst seeming randomness. Later on, this approach was attempted to be quantified with rigorous rules and called neoWave (NW). Whereas there would be constant subjectivity in attempting to define the structure of a market chart using EWT, NW tried to remove much of that through the use of mathematical limits and ratios.

We will go into both of these approaches in some detail in this chapter. The intention behind doing so is not necessarily due to the utility of either approach, rather to instill a process into your mind of looking at market structure holistically (all together) and granularly (in detail). That is, maintaining a free-flowing macroscopic point of view on the market, while perpetually studying microscopic details for clues into the shifts of the macroscopic changes. Throughout the exercise, hesitate away from clear and firm labels, and toward leaving your mind to assess probabilities of possible scenarios. The over-arching philosophy will lean on my own approach to labelling structure, which is separate from the rules in EWT and NW.

Firstly, one must decide whether the current market evolution is part of a longer term trend in the same direction, or countertrend to the longer term trend. Here arrives the first, of a plethora, of such issues we will have with subjectivity. What is the "longer term" time horizon of the trend? Common practice is for people to use charts with each bar representing 1 minute, 5 minute, 15 minute, 60 minute, .... Daily, Weekly, Monthly data, and choose the next time horizon outward in this ratio of "somewhere" between 3-5. There is some value to this, not the least of which is time efficiency, however it is not the optimal approach. For the purposes of simplicity, we will use a ratio of 4:1.

In the image above, we see a 240 minute bar chart, and an example of a longer term trend shift at point 0. At this point, we speculate that the "trend" is no longer down, and now becomes up. Thus, we begin to label odd numbered fractals in the upward direction and even numbered fractals downward. Below, on the next level up time horizon (a Daily), we see how this looks in the context of a more macroscopic view.

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According to the EWP and NW, fractals in the direction of the longer term trend always contain 5 components, and (most) fractals going countertrend contain 3 components (although there are exceptions containing 5 components in a "triangle"-like structure in EWP and up 9 components in similar structures in NW). The primary rule for the 5 component trending patterns is that the end of 3 is higher than the high of 1, and the end of 4 is also higher than the high of 1 (except in so-called "ending wedge" structures where it can end in the space of 2, but not below it, and which we are told conclude a longer term trend).

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Instead of focusing on labelling fractals correctly according to a static set of rules, we aim to shift our focus toward looking at the structure through proportion and, later on, logic. Within proportion, there are several elements.

Firstly, the fractals will (generally) tend toward a symmetry or likeness in their time and distance. This does not mean that each up move will be equal in time and/or price to each down move. In fact, that will rarely will be the case. Yet, there will be repeatable similarity.

In the first segment (between the first two vertical lines in grey), the market is finding it easier to move down then up. Once the segment concludes, the market moves rapidly to the upside. And then in the third segment, the pressure repeats to the downside, until the fourth vertical line, when again, longer term trend resumes its impetus and the market again moves rapidly to the upside. These segments may be equally spaced out, as in this case, or they may alternate [(time of first segment) = x1, (time of second segment) = x2, (time of third segment) = x3, (time of fourth segment) = x1, (time of fifth segment) = x2,.....], or they may have a different proportion from 1:1.

In an expanding market, we may anticipate the space & time taken by subsequent fractals to progressively rise, often with proportion between the space travelled by the trend fractal and the time of the countertrend fractal. In a contracting market, the reverse would make sense, or it would be a seemingly random mixture. I have found that in contracting markets, proportion tends to be consistently respected often in a linear manner. In expanding markets, the evolution becomes more non-linear because of the dispersion of entropy into or out of the market. However, do not become complacent with an observation of mine; the idea is to investigate the markets within this foundational principle (of expansion and contraction, and proportion), and develop insight through your point of view. I promise you that you will begin to observe a harmony to the seeming chaos, and the explanation for this is that liquid markets are a natural phenomena (as distinct from illiquid markets which can be easily manipulated by single/group entities and thus tend more toward artificial phenomena).

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Logic

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Last modified 1yr ago

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