Don’t Let An Elliot Wave 5 Capsize A Portfolio

Do you remember the bear markets of the dot.com bubble of 2000, the financial crisis of 2007, the boom and bust bear market of 2011, the stock market crash of 2020?  Every single one of them had the same thing in common; they happened precisely after they hit an Elliot Wave 5 target.

When it comes to stock market forecasting, a picture is worth much more than a thousand words if you pay attention to it. I can’t take any credit for the “picture” presented in the charts that follow. I have to give that credit to Richard Nelson Elliot who came up with the style of analysis now named after him nearly 100 years ago. You will “see” that these Wave 5 tops happen again … and again … and again.

The top now forming is like a dress pattern of the previous tops. After you read this article, you will be in a group of people who has this insight before hitting these targets. I am certainly not recommending moving 100% to cash or to panic. You have to decide for yourself if and what precautions to take after you read this article.

Let’s take a look at the run-up to the dot.com bubble of 2000.

The reason I became a student of the Elliot Wave style of analysis is because it provides you information in advance. It isn’t a standalone trading system, in my opinion. It is simply a very precise system of target setting.

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What do I do when what my mind “thinks” about the market conflicts with what my eyes “see”? I tend to go with my eyes because for my style it is more objective. I see what I see, period. If you have never “seen” an Elliot Wave pattern look at the one above. The 1, 3 5 waves go with the trend. The 2 and 4 waves are counter-trend.

The targets are projected using Fibonacci numbers from the prior waves. As a rule, Wave 3 is the dominant of the 5 waves. The 1 Wave is the hardest to spot because the pattern is just beginning and after the 5 Wave comes a trend change. The 2 and 4 waves make great setups for dip buying during a bull trend. You can spot these waves on intraday, daily, weekly and monthly charts. My preference is weekly charts for the long-term trends and daily charts for what to do now.

In 2007, we hit the second Wave 5 target, pulled back, and leaped to the stretch Wave 5 target. But that “leap” was like a bungee cord that broke – ouch! A Wave 5 also can collapse before hitting any targets. That is known as a “failed fifth wave.” Once we approach a Wave 5 target, the risk/reward ratio of being on the long side is very close to being on the “wrong” side. My preference is to sell into Wave 5 strength as we near a top and start packing a “parachute” type of portfolio. It’s called a parachute portfolio because you may not need a parachute but it is wonderful to have one when you do.

By the way, the 2011 market peaked in May in a year ending in a 1 (2011). This year also ends in a 1 (2021) and we are also rolling up on a Wave 5 target as we move into May. This sounds like a comic book plot I know, but it is another layer of “coincidence.”

When I created this chart for my Feb. 18, 2020, newsletter, I knew only that we were about to hit a Wave 5 target. I had no idea the bear market that followed would happen so quickly. Everyone can see the pattern we are now in is about the same as the last four bull markets. Elliot Wave style forecasting can be used many ways. One way is like a weatherman pointing to the storm clouds in the sky or a hurricane forming on the radar. It is up to you to decide what precautions to take, or not.

Today you have a Wave 5 pattern just like the previous charts. You have the luxury of being notified in advance of potential Wave 5 targets being hit. If this forecast is wrong, we should know by Memorial Day or no later than July 4. I like to use Wave 5 rallies to take profits and then put on positions to make a profit if the market reverses. So what are some other defensive strategies?

• Rebalance your asset allocations.
• Shift assets away from equities and into assets that survive or thrive during volatility.
• Do nothing.
• Add some defensive strategies to the mix. 

Todd Colbeck, MBA, is owner of Colbeck Coaching Group, Miami Beach, Fla. He formerly was brokerage vice president of the northeast U.S. region at American Express Financial Advisors. Contact him at Todd.Colbeck@innfeedback.com.

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