Question of the Week: 9/6/2006
Which works better, analyzing the smallest time frame and building up, or the largest time frame and working down?
This is an extremely important question sent in by an anonymous, European client. Nearly everyone who studies wave theory is tempted to start from the smallest time frame and work their way up, as if they were constructing a building. Unfortunately, as is usually the case with markets, whatever feels right is usually wrong.
Until a larger structure is nearing completion, structure on smaller time frames can be ambiguous, presenting multiple scenarios or leaving the analyst with no logical options. Once a larger pattern approaches conclusion, then smaller structure will begin to make sense, but only in the context of the larger scenario. When a larger pattern appears to be concluding, you can bet the smaller time frame will find ways to stretch out its conclusion in ways never imagined. That is why it always takes a market longer to top or bottom than anyone expects.
So, to answer the question, it is never appropriate to build wave counts from the bottom up, but should always be started from the longest time frame possible first. For example, as structure on a monthly time frame begins to clear and there is only one viable option, drop down to the weekly time frame, using monthly structure as a guide to constructing your weekly wave count. Once weekly structure begins to clear, drop down to a daily time frame. As daily structure approaches the conclusion of an identifiable pattern, drop down to 1/5 the size of the daily time frame (for 24-hour markets, use a 288 minute chart; for U.S. stocks, use a 78 minute chart [i.e., 6.5 hours divided 5]). Make sure your daily structure guides the design of your intra-day chart.
Those who construct counts from the top down will always have a more accurate view of future price action and potential and will not be fooled into excessively trading highly complex, non-trending market environments
Click here to view NEoWave's Question Of The Week archive