September 2012 Ride The Wave, - Summit Energy · Introduction To Elliott Wave wave structures, to...

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• Introduction to Elliott Wave

• Fractal in Nature

• The Three Hard Rules

• German Power Analyzed

Ride The Wave, Elliott: Prices Remain High, While Demand Remains Low

Chart View

EU Month-Ahead Prices pg 7

Chinese Coal Imports pg 9

Carbon Credits pg 14

Nordpool Hydro Capacity pg 16

September 2012

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September 2012 European Power & Carbon

Schneider Electric | Professional Services

For this month’s European Power outlook, let’s swan dive into the depths of the Elliott Wave Principle. This concept is simple, but the application gets quite complex.

The main focus will be the key concepts one should understand when applying a basic understanding of Elliott Wave to commodity charts. Elli-ott Wave principles and concepts are based on a theory of social mood and progress. When applied it helps explain both sentiment and investor psychology in the market.

First let’s look at a little history behind Elliott Wave.

After the market crash of 1929, as a hobby, Ralph Nelson Elliott studied charts religiously. His devotion to charts helped him discover prices mov-ing in certain patterns, or waves as he would call them. He found a five-wave advancing structure and a three-wave corrective structure. This eight-wave structure in Figure 1 is now known as an "Elliott Wave" and can be used to predict future market moves.

Looking deeper into the eight-wave structure Elliott noticed the inter-workings of the Fibonacci sequence. Prices seemed to be governed by rules of a natural order. In other words, none of it was truly "random" in the larger sense, but had some sort of pattern within the chaos.

Click this link to pull up the document written about the Fibonacci se-quence as a refresher. Knowing the Fibonacci sequence will help under-stand the ties to the socio-economic mood found in markets.

The key concept to be found when applying the waves (or counts) is that in theory social progress is not based on a series of random events, nor is it based on a continuous feedback loop. It seems, as found within the

Introduction To Elliott Wave

wave structures, to be based on something that is measurable in their advance, yet flexible enough to allow a freedom of variety.

Figure 1: Total UK Demand A typical five-wave advance is called an impulse wave, and a three-wave correction is called a corrective wave. This makes up the Elliott Wave pattern.

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•A “Minute” wave is days

•A “Minuette” wave is hours

•A “Sub-Minuette” wave is minutes

Most analysis done here in risk management uses “Primary” waves or smaller to help validate future price movements. Now that we see the depth of waves used, let’s move onto the basic definitions for wave counts.

The basic wave structure can occur in many layers, or “degrees”. Wave degrees start very small with “Sub-Minuette” size waves or even smaller, and then get extremely large up to a “Grand Super Cycle” wave, and per-haps beyond.

As far as wave theory is concerned, social progress is always advancing through time, three steps forward, two steps back in many layers. The two steps back seems to be a necessary correcting mechanism, which could be nature's way of correcting progress when we get too far ahead of things.

Elliott waves are fractal. This means that a wave structure for a “Grand Super Cycle” is the same as for a “Sub-Minuette” wave, it is just the time period that is different. It does not matter how big or how small the wave is, impulse waves take on a five-wave sequence and corrective waves take on a three-wave sequence. Any impulse wave subdivides into five smaller waves, and any corrective wave subdivides into three smaller waves. Figure 2 shows the fractal nature of waves. Elliott divided wave patterns into time cycles:

•A “Grand Super Cycle” wave is a multi-century pattern

•A “Super Cycle” wave is a multi-decade pattern lasting 40 to 70 years

•A “Cycle” wave is typically one year to several years

•A “Primary” wave is one month to a couple years

•An “Intermediate” wave is weeks to months

•A “Minor” wave is weeks

Figure 2: The Fractal Nature Of Wave Counts Notice how Fibonacci numbers come into play. There are 21 waves in the (1) wave, and 13 waves in the (2) wave.

Fractal in Nature

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See Figure 1 to view where Wave C ends the correction above Wave 4.

There are many more guidelines that cannot be covered in this outlook. However, many more tools are being used to help forecast power and carbon prices. Let’s take a look at the 2013 German Power contract and apply Elliott Wave analysis.

Figure 3: The Three Hard Rules These rules are a must for any five-wave pattern to form, regardless of what time cycle you are analyzing.

There are many guidelines, but believe it or not, there are only three hard rules that are unbreakable in Elliott theory. These rules only apply to a five-wave sequence. Corrective waves, which are much more compli-cated, are given a lot more leeway when it comes to interpretation, and due to their complexity this document will only cover a few of the key guidelines to follow.

Rule #1: Wave 2 cannot retrace more than 100% of Wave 1

Rule #2: Wave 3 can never be the shortest of the three impulse waves

Rule #3: Wave 4 can never overlap Wave 1

In contrast to the hard rules above, guidelines should hold true the major-ity of the time, but not necessarily all of the time. One key guideline typi-cally followed within the industry when applying wave analysis is when Wave 3 is the longest impulse wave, Wave 5 will likely be the same dis-tance as Wave 1. This helps in validating a price objective.

Another key guideline used is that Waves 2 and 4 (the corrective down waves) will alternate. In other words, if Wave 2 is a sharp correction, and drops quickly, Wave 4 will likely be a much flatter corrective wave. Vice-versa, if Wave 2 is a flat correction, Wave 4 will likely be a sharp drop.

The last key guideline for this overview is after a five-wave move a three-wave correction is likely. Wave C of a three-wave lower typically ends around the low price area of Wave 4, ending the correction.

The Three Hard Rules

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Elliott Wave analysis will likely not be published in our daily technical analysis documents due to the complexity of applying the rules and guidelines, but just know it is being applied to better serve you, our client.

By using Elliott Wave as another tool in the shed to help validate price moves, we called the break of the 50 euro level for 2013 German Power back in mid-April.

According to Elliott Wave we were in a fifth-wave lower. The reason we could be confident, along with validation from other technical analysis, was that the hard rules were not breaking down. Wave (4) on Figure 4 did not overlap Wave (1). By that rule holding, the rest of the wave count fell into place to let us know we were in a Wave (5) lower situation.

So, the movement of Wave (5) had a high likelihood of breaking through the low of Wave (3) to finish out a five-point bearish impulse wave.

To help verify the call of Wave (2) to Wave (3) being correct, a five-count wave was easily placed within Wave (2) and Wave (3). This is where the fractal nature of wave analysis helps validate the “depth” and “degree” of wave counts.

Using the wave count as a forecasting tool helps determine which way prices could be headed. Looking at Figure 4, if the low at Wave (5) holds here in the next week or so as the low at Wave (3) is tested, the wave count would erase the current A-B-C correction that is marked and would be replaced with the beginning of a Wave 1-Wave 2 pattern starting a move higher.

However, if a new low below Wave (5) happens here in the coming weeks, the A-B-C correction that is marked would be correct. This would make this leg lower the beginning of a new Wave (1).

By using this type of analysis with other technical tools, we can determine that the German Power price is more likely to make a new low here in the near-term.

Figure 4: Next Wave Count Being Formed Current wave count shows a high likelihood of a new low being made in the German Power 2013 contract in the coming weeks.

German Power Analyzed

September 2012

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European Power Pricing M+1

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UK M+1 Germany M+1

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European Power Pricing Y+1

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Chinese Coal Imports

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Month and Year Ahead Coal Prices

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German M+1 Spark Spreads

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Nordpool Hydro Capacity

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September 2012 Ride The Wave, - Summit Energy · Introduction To Elliott Wave wave structures, to...

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