[Please note this post is from 5/30/07; work and life intervened, and I’m publishing it a day late– ed.]
Today I noticed a pattern forming on the Qs, started drawing lines here and there, and lo and behold, a beautiful example emerged.
I’m talking about the Three Little Indians setup popularized by Linda Bradford Raschke (also known as Three Pushes to a Top, Three Drives, Three Waves to a Peak, Three Monkeys on a Branch, etc), and also the concept of the Wolfe Wave, a subset of Three Little Indians which has more particular rules, but which in return provides clear entry and exit targets.
Three Little Indians
Around midday, I was looking at the smooth swings the chart of the Qs was making as price methodically plodded higher. It’s gotta run out of steam at some point, I was thinking. Suddenly it occurred to me that I was looking at Three Little Indians:
Three higher highs, three higher lows. Time to watch for a double-top and failure.
Then I got to looking closer, saw that the second higher low was below the first peak at “1“, and realized I was looking at the elusive Wolfe Wave.
In Wolfe Waves, the three highs are numbered according to the thrust, or “wave”:
Wolfe Waves have more stringent requirements than Three Little Indians. I’m no expert on them, so do your own homework, but on the chart above the following would be necessary:
The thrusts must be evenly spaced, time-wise
High “3” must be higher than high “1“
Low “4” must retrace to below High “1” but not beyond Low “2“
And so on… (to quote Vonnegut)
So, realizing we have a Wolfe Wave, we draw lines through 1-3 and 2-4. These lines should form a rising wedge in an uptrend and a falling wedge in a downtrend. We see on this chart they do:
Now the Wolfe Wave strategy says that point “5” typically is an exhaustion spike which exceeds the 1-3 trendline. A short could be entered on the failure back below that line. We see on the above chart that the price went ahead and walked up to the point of the wedge, still a good place to short.
What are we shooting (shorting) for? Wolfe gives us a target: The extension of a line between High “1” and Low “4“:
Enough already. What happened?
At this point one could theoretically flip and go back long (the primary direction of the day, after all), with an appropriate stop loss, of course. That would have worked to perfection today:
Again, I’m not an expert here. Caviar Emperor, as the Romans say.