Stocks & Commodities V. 8:9 (353-356): Fibonacci, Elliott And Volatility by Paul G.

Williams

Fibonacci, Elliott And Volatility

by Paul G. Williams

uppose we could chart volatility just as we chart conventional prices. Then we could use Elliott wave

analysis, Fibonacci characteristics and cycle techniques to forecast greater or lesser volatility. And very
high volatilityperhaps resulting in a market crashshould be preceded by a bullish pattern in the
volatility chart.
Now suppose we could calculate and plot market volatility with a unique method that no one else was
using. The volatility patterns would display the same type of structures as conventional price
chartswhich everyone looks atbut the clarity of the wave structure and precision of the Fibonacci
timing patterns might be on a much higher level because no one else was able to see and act on them. The
market would be free to create well-formed and highly predictable patterns.
In autumn 1987 I discovered a simple method of plotting market volatility, which, from my viewpoint,
achieves all these desirable features (Figure 1). See if you agree.
The method
To represent the market I use the active New York Futures Exchange (NYFE) futures contract and follow
every single tick (as opposed to daily data only, or half-hourly sampled data, and so forth). Let's say I
bought one NYFE futures contract and the position is profitable. The NYFE reaches a high of 180.00. If
it turns down by 0.77% from this high, I reverse position by selling two NYFE futures.
0.0077 180.00 = 1.386; closest tick = 1.40
Thus, if the NYFE declines 1.40 to 178.60, I reverse position and go short.
In the short position the NYFE hits a low of 176.65 and turns up. If it reaches a point 0.77% higher than
this low point, I again reverse position, this time to long.
0.0077 176.65 = 1.36; closest tick = 1.35

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FIGURE 1. The stock market tumble of October 1987 was part of a very
well-timed volatility pattern. Exceptionally bullish structure preceded
crash.

FIGURE 2. Joining consecutive reversal signals creates the

volatility plot.

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Stocks & Commodities V. 8:9 (353-356): Fibonacci, Elliott And Volatility by Paul G. Williams

If the market gains 1.35 up to 178.00 within, say, two hours, I reverse back to a long position. While all
this is going on, I plot the changes to create a volatility plot, which has now risen by 0.60 within a
two-hour period. The volatility chart is therefore equivalent to the net gains and losses of trading in this
fixed-percentage reversal system (Figure 2). The two most important features of this method are its
fixed-percentage reversalin this case, 0.77%whether the NYFE is at 180.00 or 140.00, and that it
takes into account all market activity (that is, every tick).
In practice I use 10-minute high-low bars when running the tick data through the reversal program for
periods of normal market activity.
Reversals are calculated only on the most actively traded futures contract, which introduces the problem
of handling rollovers from one contract to the next. Here's how I handle the rollovers: On Wednesday,
September 9,1987, the December NYFE became the actively traded contract, replacing the September
NYFE. The premium of the December contract over the September at the close on September 8 was 1.85.
This premium of 1.85 is therefore added to the last low or high point reached in the September NYFE in
order to calculate the next 0.77% reversal in the December NYFE. For example, late on September 8 the
September NYFE hit a high since the last reversal to a long position of 176.15. By adding 1.85 for the
December NYFE at the close on September 8, that high point becomes equivalent to 178.00 for the
December contract, and thus a reversal of 0.77% to 176.65 in the December NYFE on September 9
constitutes the next reversal to a short position. Figure 3 has been adjusted slightly to reflect this
theoretical high of 178.00 in the December NYFE late on September 8 (the actual December contract
high at this point was 177.90).

The wave structure itself is very bullishfor volatility (Figure 1).

With the B wave traveling vertically 1.42 times higher than wave A
in points, this is defined as an irregular correction and indicates
strength.
A volatility plot declines during choppy market activity when its high-low swings are greater than 0.77%
and less than twice that amount, l .54%. It rises when wider swings (greater than 1.54%)whether up or
downare dominant (see Figure 4). (If we display the effect of market action between the reversal
signals, we get the plot shown in Figure 5. Experience has shown that this additional detail can be very
useful in pinpointing the completion of various waves.)
In this way we have a measure of volatility derived directly from the conventional price structure. By
applying the 0.77% reversal technique to the active NYFE contract between April and October 1987, we
produce exactly the picture shown in Figure 1. It is intriguing, at least to me, that the volatility plot
should contain such well-formed structures and timing patterns produced directly from the
harder-to-interpret conventional price structure.
Fibonacci and Elliott
Now examine Figure 1 more closely. Some might dispute the wave labeling, but to me it is clear that we
have a distinctly bullish and very well-timed Elliott wave structure preceding the 1987 stock market crash.
Only trading days are represented on the chart; there are no gaps for market days off. Wave A lasts for

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FIGURE 3. The 100th day consisted of several consecutive

high-low swings of just over 0.77%

FIGURE 4. The volatility plot declines when market activity

is choppy and rises when wider market swings are dominant.
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FIGURE 5. Market action between reversal signals adds detail useful in short-term
timing.

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Stocks & Commodities V. 8:9 (353-356): Fibonacci, Elliott And Volatility by Paul G. Williams

14.9 trading days, wave B for 23.6 trading days and wave C for 61.75 trading days. If we think about
these numbers for a moment, we can see they are approximately 100 times greater than the Fibonacci
ratios of 0.146, 0.236 and 0.618. Their total, fitting for a completed corrective wave, is 100.25 days. In
real time, in autumn 1987, I found this wave timing remarkable.
The wave structure itself is very bullishfor volatility (Figure 1). With the B wave traveling vertically
1.42 times higher than wave A in points, this is defined as an irregular correction and indicates
underlying strength. The C wave is a triangle, which further indicates a powerful upward bias in
volatility. Wave 2 just prior to the crash is another irregular correction with the (b) wave traveling above
the (a) wave and its (c) wave ending above the low of (a)further powerful indications of strength just
prior to the third wave crash.
The overall wave structure, while bullish, also presents an interesting situation. According to Elliott, the
first or A wave of an irregular corrective pattern should have only three waves. Here, without a doubt,
wave A is a five-wave, clearly channeled structure. If you run the 0.77% reversal process on the NYFE
tick data in this period, this is the structure it produces, and I have to believe what I see. Nevertheless,
0.77% as a reversal amount is an arbitrary figure (comfortable in terms of actual trading), and wave
patterns would vary if this figure were adjusted.
The relative nature of the reversal percentage implies that the vertical lengths of the waves in terms of
NYFE points (B = 1.42 A in points, and C = 1.58 A) should be viewed as a general guide. The key
property to pay attention to with this method is the wave timing. This contrasts with conventional price
charts, where most emphasis is usually placed on price (the vertical component). Here, I place greater
emphasis on the horizontal, or time scale.
The lows of C and wave 2 just prior to the crash are separated by 24.0 days. Thus, from the start of A
there are 124.25 days until the completion of wave 2, or 1.239 multiplied by the 100.25 days of the
A-B-C correction. Within the C wave, the a and e lows are separated by 33.2 days; this is 1.383 the
24.0 days from e until the completion of wave 2. This is virtually the Fibonacci 1.382 times the 24 days.
Looking at the cycles between the lows of a and e of wave C, the time from c to e is about the same as
that from (a) of c to the end of c8.3 and 8.2 days, respectively. The total of the above two is 16.5 days,
about the same as the 16.7 days from the low of a to the low of (a) of wave c.
Thus, the crash of October 1987 was, in terms of its volatility plot, part of a very deliberate months-long
pattern and not some random economic debacle. I should be clear that I am not claiming that the
volatility pattern definitely pointed to a crash. All the pattern really indicated was to look for a strong
increase in volatility, whether up or down (although the strongest volatility in the stock market is
normally to the downside), and when to expect it.
The 100th day
The most striking example of the clarity of this timing pattern was the experience of watching the 100th
day unfold to complete the A-B-C correction. I had concluded about eight days earlier that the corrective
pattern was due to complete itself with an e wave down on the 100th day. However, on the 99th day,
September 8,1987, the volatility plot was pointing straight up (against the upper trendline of the C-wave
triangle), and I thought, "How can this be?" There was only one way that the market (that is, the
December NYFE futures contract) could possibly complete the volatility correction on the 100th day,
September 9. It would have to repeatedly make high-low swings of just over 0.77% to bring the volatility

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Stocks & Commodities V. 8:9 (353-356): Fibonacci, Elliott And Volatility by Paul G. Williams

plot down for the fifth wave of the triangle. Figure 3 shows the December NYFE on September 9,1987. It
did exactly what it had to in order to complete the pattern on the 100th dayand this was the most
remarkable day of market activity I had ever experienced. It has been said that the market doesn't have to
do anything at any particular time, yet for me the experience of September 9,1987, indicates that this
statementlogical as it seemsmay not always be true.

Thus, the crash of October 1987 was, in terms of its volatility plot,
part of a very deliberate months-long pattern and not some
random economic debacle.
Of course, if hundreds of market participants had been awaiting this completed pattern and based their
trading decisions on it, it could never have been so clearwhich brings me to my conclusion. Obviously,
these clear-cut timing patterns will break down somewhat as they are used by market participantsthey
will become harder to interpret and forecast. Nevertheless, they should never have less value than
conventional price charts, which everyone examines. Thus, volatility charting should provide
considerable future value to tradersin particular option buyers and sellersalongside their
conventional price analysis techniques.
Paul Williams is a researcher into the practical uses of Fibonacci numbers and ratios. He is currently
assembling his research into a book, entitled Fibonacci: The Next Step. He can be reached at P.O. Box
50142, Pasadena, CA, 91115-0142, (818) 792-1980.
Footnote:
A further practical note: Many bad ticks were sent out for the NYFE during this period of 1987.
Sometimes the high price for the day was reported as a full 1.00 higher than actual trading before being
corrected by day's end. Obviously, this kind of inaccurate data will produce meaningless resultsso the
trader must be sure to run the reversal process on clean and accurate tick data. I can be sure of the
accuracy of my own results in that I plotted them in real time by hand before later programming the
method.

Figures

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