Enrique Santos

MONOGRAPH
Corrective patterns
Electronic edition
Acknowledgements

To my friend Clare Hartland for her indefatigable proof reading.

Copyright © Enrique Santos 2014

ISBN: 978-84-606-5520-6
Translated by : Rudolf Krzos
Corver desing: Juliana Serri
All rights reserved. The contents of this publication may not be
reproduced, in any form or part, or transmitted, or registered by any
system of data recovery, in any form or any means, without previous
permission in writing from the author.
Corrective Patterns Enrique Santos

CONTENTS

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 5

Chapter I: Flat Patterns. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 6

I.1. Definition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 7
I.2. Typology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 8
I.3. A flat and a trend. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 11
I.4. Wave B and a trend. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 13
I.5. Confirmation of the pattern: line O-B. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 20
I.6. Flats and indicators. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 34
I.6.1. RSI. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 34
I.6.1.1. Divergences. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 36
I.6.2. MACD . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 37
I.6.3. An ideal figure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 40

Chapter II: Triangles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 48

II.1. A triangle and the direction of a price. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 50
II.2. Price structure, requirements and objectives. . . . . . . . . . . . . . . . . . . . . . . . p. 53
II.3. The first wave. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 55
II.4. Wave four . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 57
II.5. A continuation pattern or an exhaustion pattern. . . . . . . . . . . . . . . . . . . . . . p. 62
II.5.1. The feeling . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 69
II.6. The three bars . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 70
II.7. The triangle of gold. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 73
II.8. Conclusion. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 76

3
Corrective Patterns Enrique Santos

Chapter III: Zigzags. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 78

III.1. Price development of wave C. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 83
III.2. Confirmation of the pattern. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 84
III.3. A bullish trend and correction in a zigzags. . . . . . . . . . . . . . . . . . . . . . . . . . p. 86

Appendix: Corrective patterns. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 91

4
Corrective Patterns Enrique Santos

1. Introduction
The term “corrective pattern” includes all patterns that are not impulse patterns.

This definition is so general that it leaves an immense number of patterns among which
we can distinguish three groups: flat patterns, triangles and zigzags.

The principal objective of this book is the same as that of the first monograph in the
series, namely to help you identify the patterns at a glance, as we know that this constitutes
the main difficulty that someone with theoretical knowledge of these techniques will have,
when faced with a real chart.

For this reason we have selected a series of figures which will help you exercise this
recognition and then pinpoint the moment when the correction ends.

In the first monograph we studied impulse patterns and observed that it was necessary
for the structure of the pattern under analysis to comply with a series of rules.

Once we had made that analysis we were able to know we were dealing with one of
them and consequently had a good chance of accurately predicting the price movement
subsequent to the exhaustion of the pattern. In many cases the technique made it possible
for us to establish the objectives of the price movement in the development of the pattern.

In summary, we were within a framework where the price movements were relatively
controlled. This will not occur with the study of corrective patterns. There are very few rules
which can define a flat pattern. For this reason the framework within which the price will
move in its development is much more open than in the case of impulse patterns and in
consequence is much less foreseeable.

We will identify the common typical features of a large number of patterns in order
to identify them more easily, although I must emphasise, that the task will be much more
complicated than in the case of impulse patterns, for the reasons just presented.

When we were analyzing impulse patterns we tried to predict when the trend was going
to reach exhaustion. What we will try to interpret now is when the trend comes back.

As always, it is indispensable that the analysis based on patterns should be accompanied

by the analysis of the current indicators to be able to complete a system that can permit us
to follow the market with a certain guarantee of success.

5
Corrective Patterns Enrique Santos

Chapter I

Flat Patterns

I.1. Definition
I.2. Typology
I.3. A flat and a trend
I.4. Wave B and a trend
I.5. Confirmation of the pattern: line O-B
I.6. Flats and indicators
I.6.1. RSI
I.6.1.1. Divergences
I.6.2. MACD
I.6.3. An ideal figure

6
Corrective Patterns Enrique Santos

I.1. Definition

The Elliot Wave Theory defines a flat pattern as that formed by three waves (a, b and
c), of which the first two have a corrective structure and the third has an impulse structure.

Apart from that, the retracement of the second wave over the first has to be of at least
61.8% and the price development of the third wave must be more than 38.2% of the price
development of the first.

PB >PAx0.618 AND PC>PAx0.382

Flat patterns are continuation patterns, that is to say once a flat pattern is completed,
the trend previous to the beginning of the pattern will manifest itself again.

In the first chart we can see the first of the twenty flat patterns that we are going to
analyze in this Monograph.

a 5 c

2
O b

Fig. 1. A flat pattern

In this case, the price developments of the three waves are equal. The previous trend
(downtrend) stops when it gets to point o, the origin of wave a.

As a continuation, wave b retraces by 100% the price movement of wave a and then
it bounces up unfolding the third wave which, as we can see in the chart, has an impulse
structure. Therefore, with the line 2-4 crossover we get the confirmation of the exhaustion of
wave c, the first sign of the ending of the flat and the return of the trend.
7
Corrective Patterns Enrique Santos

We obtain a graphic confirmation of the ending of the pattern when the price drops below
the support defined by line o-b.

Please note that the structure of wave b is more complex than that of wave a which is
formed by three segments, while wave b is formed by five. We can also see that wave b
takes more time to form than wave a and wave c.

This observation is important because although it is not considered a compulsory rule,

in practice the second wave of the flat will have a more complex structure than the other two
and will also take more time to form.

I.2. Typology

The definition of flat patterns provided by Elliot gives space to an ample variety of forms.
This variety is, in turn, a result of the diversity of the structures of the second of the three
waves, namely wave b.

When studying impulse patterns, we said that the complication lay in knowing where
wave four ended and the decisive factor was the exhaustion of wave five. In the case of flat
patterns, it is difficult to know when wave b has ended and our decisive factor is knowing
when wave c has finished.

The first wave will not give us problems as generally it will have a simple structure,
formed, on many occasions, by only one segment.

The third wave, wave c, has to be an impulse pattern, so whether complex or simple, its
structure will be defined by the rules we already know.

However, wave b will cause us many a headache as we will not be able to determine
what structure it has. At times wave b will be another flat. Other times, wave b will be a
triangle, but in a great number of figures, it will not be of any identifiable pattern.

This can sometimes make it difficult to find the end of the correction, until we realize we
have come across a very advanced wave c.

Let us look at some examples.

In Fig. 2 we can see a wave -b-, which is a flat. The retracement of -b- over -a- is more
than 61.8% but less than100%. The previous trend is bullish and if we compare the structure
of -a- with that of -b-, we can see that -b- is more complex and takes longer to form than

8
Corrective Patterns Enrique Santos

-a- but not as long as -c- 1.

-o-

-b-
c

a 2

b 1
-a-
4

5
-c-

Fig. 2. Dax-Xetra. Continuous Future. 15- min chart.

In Fig. 3 the flat pattern is wave 4 of an upward impulse pattern. On the left part of the
figure we observe the last wave of -3- unfold. The price stops to unfold a corrective pattern
in three waves which form major degree wave -4-. Waves a and c are very fast and almost
equal in price movement and wave b is a triangle.

Wave b retraces wave a by more than 61.8% , and wave c retraces wave b by more than
38.2% and has an impulse structure2.

1  Ta=88, Tb=79 and Tc=66 periods.

2  The level of retracement is measured from the end of a wave.

9
Corrective Patterns Enrique Santos

-3-
5

3
b

1
4

1 a

3
5
c
-4-

Fig. 3. USD-YEN. 5- min. chart.

To finish, let us have a look at a typical example of the second wave of a flat: neither a
triangle, nor a flat: simply a corrective pattern.

A C

Fig. 4. IBEX-3 Index. 15- min. chart.

10
Corrective Patterns Enrique Santos

I.3. A flat and a trend

As we have already said, flat patterns are considered to be continuation patterns of a

trend. We will often find flat patterns in waves two and four of impulse patterns. As we can
see in Fig. 5 once a pattern ends, the trend continues and the price returns to the direction
it followed before the beginning of the correction.

We know that in impulse patterns, waves two and four are corrective patterns and
therefore it will be in them that we will be able to find flat patterns.

a
c

Fig. 5. NIKKEI 221 Index. Daily chart.

The first objective of technical analysis is to identify which trend underlies the
movement of the price.

Sometimes it will be easier to identify that trend than other times, but there will be
situations when it will be impossible, because there will be no trend at all.

Our interest will concentrate on those situations where an identifiable trend stops
momentarily to unfold a corrective movement.

If this corrective movement is a flat pattern, we will look for its end before we see the
trend continue. In other words, we will look for the exhaustion of the third wave (wave c),
which will always be, as we have already said, an impulse pattern, and when we confirm its
11
Corrective Patterns Enrique Santos

exhaustion we will have a signal to enter the trend.

In the following chart you can see another example of how a bearish trend continues
once a flat has ended. You can see this in more detail in Fig. 7.

-a- b -c-

c -b-

Fig. 6. USD-YEN. 15- min. chart.

Thanks to the impulse structure of waves c and to what we have already learnt about
them, we can detect the exhaustion of the minor and major degree flats, namely waves c
and -c-, respectively.

12
Corrective Patterns Enrique Santos

b -c-
-a- 5

x3
2

4
1

a
1
4

2
x3
c 5
-b-

Fig. 7.- USD-YEN. 10- min. chart.

It is obviously major degree (-c-) which interests us in this case because it ends the
correction and we can adopt positions again in the direction of the trend; bearish in this case.

I.4. Wave B and a trend

As we have said, there is a very diverse typology of the flats from the point of view of
their structure. This diversity is caused by the second wave.

Wave b is very useful for one particular reason: it give us a sample of the state of the
trend.

In fact wave b of a flat moves in the same direction as the trend previous to the
beginning of the pattern.

Starting with this fact, the price development of wave b in relation to that of wave a will
give us a graphic estimation of the state of the trend previous to the beginning of the flat and
a possible development after wave c.

The table that follows sums up the most common relations between the waves of a flat

13
Corrective Patterns Enrique Santos

pattern, depending on the retracement of wave b over wave a.

When the trend is strong, wave b will be strong and will have to surpass the origin of
wave a. That is to say, the retracement of wave b over wave a will be more than 100% and
when this happens wave c will retrace wave b by less than 100%.

WAVE B RETRACEMENT OF B OVER A RETRACEMENT OF C OVER B

WEAK 61.8% - 80% > 100%

NORMAL 81%-100% 100% - 138.2%

STRONG 100%-123.6% 100%

STRONG + >123.6% <100%

Table 1. Flat patterns. Most common relations between waves.

This is what happens in Fig. 9, a little flat formed by Euro stoxx 50 at the beginning of
April 2009.

A month before the stock exchanges had reached the lowest trough after 21months of falls.
The Euro stoxx 50 bounced up on March 9 after a descent of 61.39%3.

The degree of overbought reached in February 2009 was the highest since the creation
of the index in 1998 and much higher than that of September 2002, which triggered a bullish
outbreak of the prices.

A strong bounce caused the Euro stoxx 50 to rise by +12.7% in 10 days. It stopped on
March 19 and the first correction unfolded; it was a flat which started by leaving a gap of -4%
at the opening on March 20 and which reached exhaustion on April 1. (See Fig. 8)

3  The Euro stoxx Index fell 2,807 points from 19 June 2007 to 9 March 2009. From the peaks on 3 July 2007 to the
trough on 9 March, when it also reached the lowest trough, The DAX-Xetra lost 4,563, which was 56%.
14
Corrective Patterns Enrique Santos

b
1
5
3 b ii
v
iii
iv
xi i
1 iv
v c
a 4
ii
xiii v
a c
xiii
2
iv
2

ii

Fig.8. DJ Euro stoxx 50. Continuous Future. Hourly chart.

When the correction ended Eurostoxx continued rising. In the short-term the trend was
bullish, which meant that the small flats that kept forming had one strong wave b which
surpassed the origin of wave a and following that, wave c reached exhaustion before
completely retracing wave b.

15
Corrective Patterns Enrique Santos

c
a

Fig. 9. DJ Euro stoxx 50. Future Continuos. 10- min. chart.

Let us see another case in Fig. 10: we are dealing with a flat correction (-a-,-b-,-c-) in
which wave -b- is in its turn another flat (a, b, c).

This case is contrary to the previous one in which wave b was weak and it retraced
slightly more than 61.8% over wave -a-.

The pattern in Fig. 10 complies with the minimum retracement required to be a flat, but
it stays far from correcting wave -a- by 100%; it moves by exactly 74.63%, which we can
interpret as a weakening of the trend previous to the beginning of the pattern (bullish like
wave -b-), which leads us to expect that wave -c- will retrace wave -b- by more than 100%,
which is what actually happened: the retracement of -c- over -b- was of 211%.

In the minor degree flat (a, b, c) we also come across a normal b, which retraces wave
a by 83.33%. After that, wave c reaches exhaustion beyond the origin of wave b, retracing
it by 133.85%.

16
Corrective Patterns Enrique Santos

100.0%

-b-
c
61.8% a
2
50.0%
38.2%

23.6%

1
b
-a-
4
Rb/a: 74,63%
Rc/b: 211,00%

FLAT OF
MINOR DEGREE 3

Rb/a: 83,33%
Rc/b: 133,85%
5
-c-

Fig. 10. DAX-Xetra. Future Continuous. 15- min. chart.

-b-c
5

a
3

4
1

2
b
-a-

Fig. 11. DAX-Xetra. Future Continuous. 15- min. chart.

Fig.11 shows minor degree wave c in detail. If we have a close look at wave -c-, we get
a confirmation of how the Fibonacci relations between waves 1, 3 and 5 made it possible
for us to estimate the exhaustion zone of wave -c- and consequently of the flat. Sufficient
elements are provided to be able to detect the moment to enter the bullish trend again, a

17
Corrective Patterns Enrique Santos

trend which continues after the flat. (Fig. 12)

To sum up what has been said in this section, it is clear that a strong wave b equals a
previous strong trend, and that a weak wave b equals a previous weak trend.

And in the same way a strong wave b, will probably give way to a weak wave c just as
a weak wave b will give way to a strong wave c.

I must point out that these are theoretical considerations. These are the most common
relations between the waves of a flat, but they will not be fulfilled in all cases.

Although we might often be astonished by the precision of the fulfilment of these

theoretical requirements, this matter is very far indeed from being a pure science.

Nevertheless, in my opinion, what we are observing in this section should be incorporated

as another element of pattern analysis; useful when it comes to interpreting the price
movement. It teaches us to observe the movement of a price and to understand the structure
of a pattern, and on the basis of that observation to try to interpret the state of a trend.

Fig. 12. DAX-Xetra. Future Continuous. Hourly chart.

18
Corrective Patterns Enrique Santos

To conclude, let us see an example of wave b retracing wave a by between 80 and 100%
of wave a.

According to the classification which we saw in Table 1, we are dealing with a wave b
whose path is normal in relation to wave a.

On this occasion we are observing a daily chart of the NASDAQ 100 index.

The flat that serves as an example here is the wave b of a big major degree flat which
was unfolded by NASDAQ 100 in the first semester of 2004, after which the bullish trend
took on again.

It is a typical lateral movement in which the price developments of the three waves are
almost equal which makes it evident that there is a balance between buying forces and
selling forces, a balance which will break when the flat ends, as we can see in Fig. 14.

c B
a 5

x3

4
1

A b

Fig. 13. Nasdaq 100. Daily chart.

19
Corrective Patterns Enrique Santos

B
a c

b
A

Fig. 14. Nasdaq 100. Daily chart.

I.5. Confirmation of the pattern: line O-B

In the study of impulse patterns, we saw that the crossover of line 2-4 in less time than
that taken by the fifth and last wave to form, gave us confirmation of the exhaustion of the
pattern. In the case of flat patterns we will obtain this information from a line, equivalent to
line 2-4, which we will call line OB.

Line OB is a straight line made by joining the origin of the first wave of the flat (wave a)
with the end of the second wave (wave b).

To obtain confirmation of a flat pattern, the price must cross line OB in less time than that
taken by wave c to form.

Apart from that, the Elliott Wave Theory requires that wave c should be retraced
completely in less time than it took to form.

20