Trend-Wave Trading Harnessing the Power of the with the Discipline of Trend Following

June 2011

Murray Gunn CFTe Head of Technical Analysis HSBC Bank plc +44 20 7991 6797 [email protected]

View HSBC Global Research at: http://www.research.hsbc.com Issuer of report: HSBC Bank plc Disclosures and Disclaimer This report must be read with the disclosures and the analyst ABC certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it Global Research1 The Elliott Wave Principle – A Basic Guide

1 Elliott Wave Principle A Fractal Design (5)  (3) (B)  Price action occurs in regular patterns

Long  5 moves (or waves) in the direction of the primary Term 2 (4) 5 (A) trend 2 (1) 3 C 4 2 (C)  3 moves (or waves) when the price action is 1 A 4 correcting against the primary trend 5 1 3 B 1 4 (2) B 5  Repeat at every time frame or fractal Medium 3 Term 3 A 2 1 5  Mass human psychology is patterned C 1 4 5 B (5)  Ratio analysis/natural mathematics (Phi, the golden 3 5 (B) 2 2 C ratio, 1.618, Leonardo Fibonacci) 1 4 A C 3 4 2 (3) 1 A 2 5 1 4 4  Elliott heavily influenced by Charles Dow Short B 3 B 1 Term 5  Wave Principle is the purest form of TA 3 A 2 (A) 3 (1) 5 The 1 C 5 4 (C) Full 3 B (4) Putting it all Cycle 1 A 2 together 2 4 C 2 (2) 2 Waves Are Self Similar in FORM…  …but they do NOT have to be self similar in TIME or depth (AMPLITUDE)

(5) Much more like REALITY 5 (3) 3 1 5 3

B 4 D 4 2

1 E (4) (1) 5 C 3

4 B 2 A 1

A

2 C 3 (2) Elliott’s Wave Principle is technical analysis

 Elliott heavily influenced by Charles Dow  Empirical observations confirmed Dow’s Theory  Refined Dow’s work into more detail  Price and = pure technical analysis  Edwards & Magee pattern recognition a derivative of Dow and Elliott

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• Charles Dow’s editorials in his Journal around 1900 • Analysis of price action of the market averages (Dow Industrials, Transports, Utilities) Distribution • Markets have 3 “movements” (value, primary and phase secondary movement). Concept of market “value” Source: istockphoto was important to Dow’s analysis. • Trends have 3 phases (accumulation, public participation, distribution)

Participation phase Increasing Confirmed end of bull volume trend. Previous low point broken. No more higher lows.

Accumulation • The stock market discounts all news • Stock market averages must confirm each other. If it’s a Primary bull phase market the Industrials must be making higher highs along with the Transports etc and vice versa. • Trends are confirmed by volume (an uptrend on declining volume is an unconfirmed uptrend) • Trends exist until definitive proof that they have ended (defined by a lower high and a lower low after an uptrend)

5 Distribution from strong Cycles Of Psychology hands to weak hands Mania, euphoria, complacency Relief, hope, Reference: Frost & Prechter “Elliott Wave Principle”, 1978 5 denial, lack of Bubble, speculation, Broad, breadth narrow breadth best destructive B “fundamentals” / 3 decline, news flow “fundamentals” / news flow 3 turn negative Strongest, broadest move, A “fundamentals” / news flow turn Shock, denial, positive 4 “buy the dips” mentality Consternation, impatience 1 C “Fundamentals” Despair, fear / news flow still negative

2

Denial, comfort that Despair, fear bear is back

Accumulation by strong hands from weak hands 6 Elliott’s Wave Principle is technical analysis

 Head & Shoulders = Elliott A B C correction or truncated fifth  Flags = Elliott flats  Pennant = Elliott  Double tops / bottoms = Elliott flat or truncated fifth  Rising / Falling Wedge = Elliott ending diagonal

7 The Elliott Wave Principle – A Basic Guide Rules & Guidelines Elliott’s empirical observations led to his conclusion that there were various rules and guidelines that wave formation held to. It is the existence of these rules that makes the Wave Principle relatively objective compared with other forms of market analysis. The rules must be respected. Guidelines point to tendencies.

Three (of many) cardinal rules of Elliott’s Wave Principle are: Wave 2 Can Never Retrace More Than 100% Wave 3 Is Never The Shortest Wave Wave 4 Can Never End In The Price Of Wave 1. 5 5 Territory Of Wave 1. 11 3 3 3

3 1 4 1 1 1 4 4 2 2 4 2 2 2 Incorrect 2 Correct Incorrect Correct Incorrect Correct

2nd waves of a motive wave can be very deep but 3rd waves are usually the most powerful. They can be The end of the 4th wave must never overlap the end of wave 1. they cannot move beyond the start of wave 1. shorter than 1 or 5 but they must never be the shortest Note that if wave 4 is a flat or a triangle the first corrective of 1,3 and 5. waves could overlap wave 1 so long as the ending wave does not. Three (of many) guidelines of Elliott’s Wave Principle are: Alternation: Wave 4 Will Usually Be A Different When Wave 3 Is Extended, Waves 1 And 5 Will Wave 4 Usually Terminates Near The Corrective Pattern From Wave 2 Tend To Equality Or A Fibonacci Ratio Previous Wave 4 Of Lesser Degree 5 (3) 5 5 5 5 3 3 3 3 100% 161.8% 3 1 4 1 4 (1) 1 4 1 4 (4) 1 4 100% 100% 2 2 (2) 2 2 2 Zig Zag then Triangle Flat then Zig Zag When wave 3 is extended, wave 5 will tend to end when it equals A 4th wave will tend to finish in the price zone of wave 4 of the the size of wave 1 or a ratio such as 1.618 times the size of wave 1. just ended wave 3. 2nd waves tend to be zig zags and 4th waves tend to be triangles or flats. 8 The Elliott Wave Principle – A Basic Guide (5) (5) (9) 5 (3) 3 (7) Motive Waves 5 1 (3) Motive (or impulse) waves are the trending 3 (5) part of the cycle. These waves are relatively (8) 4 straightforward to identify due to their (3) dynamic, thrusting nature and volume 1 4 (4) 2 normally increases during wave three (1) (6) (4) (1) indicating a market where the participants (1) are motivated to participate. These 2 (4) examples show bull market motive waves. Bear market motive waves are simply the (2) reverse. (2) (2) Extensions Extension (Nine Wave) Ending Diagonal Extensions occur when one of the motive waves Quite rarely an extension will occur where Also known as a rising or falling wedge, the ending is prolonged and subdivides into amplified each subdivided wave is of roughly equal diagonal is a 5th wave that can subdivide into five waves. Frequently occurring in the wave 3 amplitude. This results in the entire motive overlapping waves of 3 waves each (zigzags). It is a position, normally only one wave within a motive wave looking like a nine wave move. sign of an exhausted trend. wave will be extended. (5) (5) (5) 5 (3) (5) 3 3 5 (3) (3) 1 (3) 1 4 2 (1) (1) (4) (4) 5 (4) 5 4 3 2 (1) 3 (4) (1) 1 1 4 4 (2) 2 (2) (2) 2 (2) Leading Diagonal Leading Diagonal Expanding Diagonal Truncated Fifth

th Added to Ellliott’s original work after The leading diagonal can also subdivide into five A 5 wave that subdivides into fives waves of Sometimes the trend is so exhausted by the time th observations by Frost & Prechter, a diagonal overlapping waves of the normal 5 motive 3 three. The expanding nature of the price action the 5 wave comes that the wave does not even can also occur in the wave 1 position and corrective waves. Divergence between price and points to increasing that can signal the move past the wave 3 top or bottom. It is a sign subdivides into five waves of three moves. oscillators are normal characteristics of diagonals. end of a trend. of a very tired . 9 The Elliott Wave Principle – A Basic Guide (B) Corrective Waves (B) C (B) C 2 2 Elliott observed a number of ways that prices C B 2 A consolidate. Zig Zags and Flats have three wave B movements with the final wave C being an impulse A 2 A 4 4 or motive. The powerful nature of this C wave is a 4 1 1 1 B result of a crowd psychology panicking in either 4 A B B A closing shorts or bailing out of longs. It clears the 1 weak hands out of the market out so that the trend 3 3 C 3 can continue. Triangles on the other hand exhibit C 5 (A) 5 five wave movements. 3 (A) 5 (A) (C) (C) 5 ZigZag (5-3-5)(C) Flat (Regular) (3-3-5) Flat (Expanded) (3-3-5) A sharp correction consisting of two motive A sideways correction where wave (B) Also known as an Irregular Flat, this is a waves (A) and (C) separated by a corrective retraces close to 100% of wave (A) followed sideways correction where wave (B) wave (B). by a motive wave (C) sharp move. retraces more than 100% of wave (A) followed by a motive wave (C) sharp move.

Triangles (3-3-3-3-3) (B) (A) C (D) (D) (B) (D) C (B) (C) B (E) A B B A A A A B B (E) C (A) (C) C (E) (C) (E) (A) C (C) (B) (D) (A) Triangle (Symmetrical) Triangle (Reverse Symmetrical) Triangle (Ascending) Triangle (Descending) Triangles usually occur in the 4th wave The reverse symmetrical or expanding This pattern reflects a situation where there This pattern reflects a situation where there position of a motive wave and represent triangle is relatively rare. is equilibrium in the price but the bulls are is equilibrium in the price but the bears are periods of equilibrium between bulls and increasingly gaining the upper hand increasingly gaining the upper hand bears. They consist of five waves A-B-C-D- resulting in an upward break in price. resulting in a downward break in price. E each subdividing into three waves. 10 Alternative Wave Counts

 Two or more valid wave counts at any one time  Job of the analyst is to find the most probable  Not 100% sure what the wave is until it is over

 But ALL analysis is EX-POST  Also gives us Plan A, B and C etc

 Analysis is one skill

 Trading is another skill

Charts Source: Bloomberg, Updata, HSBC 11 Trend-Wave Trading

12 The “Get It” Moment

 Newcomers to Elliott initially like it  Then realise the existence of “alternative” wave counts  Most leave  The ones who stay struggle with how to actually use (trade) it  Then the light bulb moment  ELLIOTT IS NOT A TRADING SYSTEM  ELLIOTT DESCRIBES THE EVOLUTION OF MARKET PRICE

 IT IS AN EXERCISE IN PROBABILITY Source: istockphoto  ELLIOTT SETS THE CONTEXT FOR THE PROBABLE NEXT MOVE

13 (3) or (C) Trend-Wave Trading (1) or (A) 5

B 3  High probability Elliott set ups

 5 waves followed by 3 waves A 1 4  Next wave is highly probable C (2) or (B) 2 Significant Low Significant High 2 (2) or (B) C 4 1 A

3 B 5 (1) or (A)

(3) or (C) 14 Trend Following

 A life philosophy

 Run winners. Cut losers.

 Disciplined

 It works (John Henry)

 Live in the moment psychology Source: istockphoto

15 Keep It Simple

 A trend is a trend

 Moving Averages

 Optimisation Shmoptimisation

 No magic, just discipline

 5, 40 and 200 Source: istockphoto

16 Tee It Up, Get In The Zone & Let It Happen

 Psychology

 Golf & The Markets

 Pre shot routine

 Automatic

 Make the swing

Source: istockphoto

17 Tee It Up, Get In The Zone & Let It Happen

 Step 1: Identify an Elliott Wave Principle set up

 Step 2: Switch on your automatic Trend Following routine

 Step 3: Take the shot

 Step 4: Trail stop and take profit

 Pros: Simple Defined risk management process

Mitigates cognitive dissonance Source: istockphoto Applicable over all time scales  Cons: Not for top or bottom pickers

18 Trend-Wave Trading (Day Traders)

19 Source: Bloomberg, Updata, HSBC Trend-Wave Trading (Swing Traders)

20 Source: Bloomberg, Updata, HSBC Trend-Wave Trading (Swing Traders)

21 Source: Bloomberg, Updata, HSBC Trend-Wave Trading (Portfolio Managers)

22 Source: Bloomberg, Updata, HSBC Trend-Wave Trading (Asset Allocators)

23 Source: Bloomberg, Updata, HSBC Trend-Wave Trading

 Counting 5’s and 3’s is not as objective as some like  Why not use moving averages as an objective proxy for waves  Short, Medium and Long (5,40,200)  A “Trend-Wave” positive signal is given when 5 crosses above 40 and price is above 200  A “Trend-Wave” negative signal is given when 5 crosses below 40 and price is below 200  Trading / investing in the direction of the bigger trend  Buying / selling pullbacks in a bigger trend (just like 5’s and 3’s)

24 Trend-Wave Trading

25 Source: Bloomberg, Updata, HSBC Trend-Wave Trading

Continuous % Winners Win / Loss Trend-Wave Trend-Wave % Winners Win / Loss Continuous Return (10% (Trades) Ratio Trading Trading (Trades) Ratio Return Position Size) (Return) Return (10% Return (20% (Return) (Variable Position Size) Position Size) Position Size, 5% and 20%)

US Dollar 4.95% 42% of 85 3.02 3.39% 6.86% 49% of 45 3.28 7.61% Index S&P 500 -2.08% 45% of 119 1.17 3.44% 6.88% 56% of 63 1.22 4.10%

 Results from 2000 – 2011 using daily charts / moving averages  Trend-Wave Trading produces higher Win / Loss Ratio than a Continuous system  Results show a small but significant edge

26 Current Market Outlook

27 Defender of the Dean…

28 Source: HSBC, Bloomberg The most important chart in the world…

29 Source: Bloomberg, Updata, HSBC Breadth and sector rotation negative…

30 Source: Bloomberg, Updata, HSBC Topping out…

31 Source: Bloomberg, Updata, HSBC OBV worries…

32 Source: Bloomberg, Updata, HSBC A very BULLISH chart…

33 Source: Bloomberg, Updata, HSBC Korea also very bullish…

34 Source: Bloomberg, Updata, HSBC Chance of a big shake out in Gold…

35 Source: Bloomberg, Updata, HSBC The bell is rung…

36 Source: Bloomberg, Updata, HSBC As it was here…

37 Source: Bloomberg, Updata, HSBC And here…

38 Source: Bloomberg, Updata, HSBC Oil near a top…

39 Source: Bloomberg, Updata, HSBC Dollar bull market…

40 Source: Bloomberg, Updata, HSBC A stirring in long end Gilts…

41 Source: Bloomberg, Updata, HSBC Suggesting big changes to come…

42 Source: Bloomberg, Updata, HSBC Summary

 Elliott Wave Principle is purest form of technical analysis  Price and volume create patterns of psychology  Natural proportionality to mass human behaviour  Elliott Wave is NOT a trading system

 Running winners and cutting losers makes money  Combining Elliott with Trend Following makes sense  Zones in on high probability set ups

 Live in the moment Zen psychology Source: istockphoto

43 HSBC Technical Analysis

 Day Traders Support & Resistance Levels (Daily)  Short Cycle Report (Twice per Week)  Wave Principle Letter (Weekly)  Trend-Wave Trading Signals (Ad-hoc trade ideas / portfolio) …coming soon….  Long Wave & Socionomic Journal (Semi-Annual) www.hsbcnet.hsbc/research

44 Disclosure appendix

Analyst Certification The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Murray Gunn Important disclosures This report is designed for, and should only be utilised by, institutional . Furthermore, HSBC believes an 's decision to make an investment should depend on individual circumstances such as the investor's existing holdings and other considerations. This document has been prepared and is being distributed by the Research Department of HSBC and is intended solely for the clients of HSBC and is not for publication to other persons, whether through the press or by other means. This document is for information purposes only and it should not be regarded as an offer to sell or as a solicitation of an offer to buy the securities or other investment products mentioned in it and/or to participate in any trading strategy. Advice in this document is general and should not be construed as personal advice, given it has been prepared without taking account of the objectives, financial situation or needs of any particular investor. Accordingly, investors should, before acting on the advice, consider the appropriateness of the advice, having regard to their objectives, financial situation and needs. If necessary, seek professional investment and tax advice. Certain investment products mentioned in this document may not be eligible for sale in some states or countries, and they may not be suitable for all types of investors. Investors should consult with their HSBC representative regarding the suitability of the investment products mentioned in this document and take into account their specific investment objectives, financial situation or particular needs before making a commitment to purchase investment products. The value of and the income produced by the investment products mentioned in this document may fluctuate, so that an investor may get back less than originally invested. Certain high- volatility investments can be subject to sudden and large falls in value that could equal or exceed the amount invested. Value and income from investment products may be adversely affected by exchange rates, interest rates, or other factors. Past performance of a particular investment product is not indicative of future results. Analysts, economists, and strategists are paid in part by reference to the profitability of HSBC which includes investment banking revenues. For disclosures in respect of any company mentioned in this report, please see the most recently published report on that company available at www.hsbcnet.com/research. HSBC Legal Entities are listed in the Disclaimer below. Additional disclosures This report is dated as at 08 June 2011. All market data included in this report are dated as at close 07 June 2011, unless otherwise indicated in the report. HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its Research business. HSBC's analysts and its other staff who are involved in the preparation and dissemination of Research operate and have a management reporting line independent of HSBC's Investment Banking business. Information Barrier procedures are in place between the Investment Banking and Research businesses to ensure that any confidential and/or price sensitive information is handled in an appropriate manner. 45 Disclaimer

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