Elliott Wave Theory

The Elliot Wave Theory represents a development from the well-known Dow theory. It relates to any freely traded property, liabilities, or goods (shares, obligations, oil, gold, etc. ). The Wave Theory was proposed by accountant and business expert Ralph Nelson Elliott in her study titled The Wave Principle published in 1938.
After he‘d retired and a significant illness were discovered in her organism, Elliott started to observe stock markets and the charts inside the hope of comprehending the market behavior. After he‘d performed a big work, he concluded the market, as like a product of predominant psychology from the masses, followed some laws.
The Elliott Wave Theory is founded on a particular cyclic laws in human behavior psychology. Consistent with Elliott, the marketplace price behavior could be clearly estimated and shown inside the chart as waves (wave is here an explicit price move ). The Elliott Wave Theory says the market could be by 50 percent large phases : Bull Market and Bear Market.
Elliott proposes, also, that each one price moves in the marketplace are divided into :
five waves inside the direction from the main trend (waves 1 to 5 in Fig. 1 ) ;
three corrective waves (waves A, B, C in Fig. 1 ).
The waves are divided into :
impulses that produce a directed trend (bull or bear ) and cause the marketplace to maneuver very actively (waves 1, 3, 5, А, С in Fig. 1 ) ;
corrections (rollbacks ) which are seen as a moving against the tendancy (waves 2, 4, in Fig. 1 ).

Figure 1. A part of bear trend.

In his Wave Theory, Eliott was driven by waves subdivision principle. Which means that every wave is part of a longer wave and it is subdivided into shorter waves itself (Fig. 2 ). Every wave is subdivided into 3 or 5 waves. This subdivision depends upon the direction from the longer wave.

The most principle inside the Elliott's theory is every impulse wave includes five shorter waves and each corrective wave (against the tendancy ) consists of three waves, which may be well seen in Fig. 2. For instance, Wave 1 in Fig. 2 consists of 5 shorter waves since It‘s an impulse wave that creates the tendancy.

The longest cycle, consistent with Elliott, is known as Grand Supercycle that‘s compose of 8 Supercycle waves. The latter ones are each composed of 8 Cycles, etc. For instance, Fig. 2 shows 3 basic cycles. It may easily be seen that impulse waves and also the subsequent corrective waves are proportional. The stronger impulse is, the stronger correction is, and vice versa.

The Elliott Wave Theory is criticized in order because there Isn‘t always a transparent definition of each time a wave starts or ends. Corrections are especially difficult during this regard.

Elliott Wave Theory and Fibonacci Numbers 

Fibonacci Numbers supply the mathematical foundation to the Elliott Wave Theory. Fibonacci numbers play a crucial role inside the construction from the complete market cycle described using the Elliott's waves. Each one of the cycles Elliott defined are comprised of the total wave count that falls inside the Fibonacci number sequence.

Under closer examination of Fig. 2, it‘s possible to notice the complete market cycle consists of two large waves, eight middle waves, and 34 small waves. Similarly, with a bull market, we will see that the bull Grand Supercycle consists of one large wave, five middle waves, and 21 small waves. If we continue this subdivision, we can observe the consequent 89 even smaller waves, etc.

Respectively, a bear Grand Supercycle consists of one large wave, three middle waves, and 13 small waves. In the next sublevel, there will be 55 very small waves, etc.

Figure 2

This principle is normally utilized in the Elliott Wave Theory as follows : movement in a particular direction should continue until it reaches some point in concordance using the summational Fibonacci number sequence.
For instance, when the time, during which the tendancy doesn‘t change, exceeds 3 days, this direction Shouldn‘t reverse till the 5th day begins. Similarly, the tendancy should continue as much as 8 days if this has not changed the direction within 5 days. 9-day trend shouldn‘t be completed till the 13th day begins, etc. This basic pattern of how the tendancy movements could be calculated equally applies for both hourly, daily, weekly, or monthly data. However, this really is just an ideal model, and nobody can get that prices' behavior will certainly be so definite and predictable. Elliott noted that deviations may occur both in some serious amounts of in amplitude and individual waves would hardly develop exactly during these regular forms.

Characteristics of Waves 

Calculations inside the Elliott Wave Theory resemble a road-map. Every wave has some characteristics. These characteristics are depending on market behavior of masses.

Inside the Elliott Wave Theory, a special attention is paid to individual description of each and every wave. Besides, there will be certain laws employed for proportional formations of Elliott waves (Fig. 3 ). These laws enable proper definition of in which the wave starts and just how long It‘s. The wave lengths are measured from high to low from the corresponding wave.

Figure 3

The above mentioned classical relations between waves are confirmed by actual ones having a 10%-error. Such error could be explained through short-term influences of a couple technical or fundamental factors. In whole, the data are rather relative. Important is that each one relations between all waves may take values of 0. 382, 0. 50, 0. 618, 1. 618. By applying this, we will calculate relations between both wave heights and wave lengths. Allow us to consider characteristics of each and every wave :

Wave 1

Happens once the «market psychology» is practically bearish. News remain negative. Like a rule, it is extremely strong if this represents a leap (change from bear trend towards the bull trend, penetration straight into the might resistance level, etc. ). Inside a state of tranquillity, it usually demonstrates insignificant price moves inside the background of general wavering.

Wave 2

Happens once the market rapidly rolls back coming from the recent, hard-won profitable positions. It may roll to almost 100% of Wave 1, although not below its starting level. It usually makes 60% of Wave 1 and develops inside the background of prevailing level of investors preferring to repair their profits.

Wave 3

Is just what the Elliott's followers live for. Rapid increase of investors' optimism is observed. It‘s the mightest and also the longest wave of rise (it cannot function as the shortest ) where prices are accelerated and also the volumes are increased. A typical Wave 3 exceeds Wave 1 by, a minimum of, 1. 618 times, or much more.

Wave 4

Often difficult to recognize. It usually rolls back by less than 38% of Wave 3. Its depth and length are normally not very significant. Optimistic moods remain prevailing out there. Wave 4 might not overlap Wave 2 till the five-wave cycle is really a section of the end triangle.

Wave 5

Is usually identified using momentum divergences. The prices increases at middle-sized trade volumes. The wave is formed inside the background of mass agiotage. At the conclusion from the wave, the trade volumes often rise sharply.

Wave A

Many traders still think about the rise to create a sharp come-back. Though there appear some traders sure from the contrary. Characteristics of the wave tend to be greatly a similar as those of Wave 1.

Wave B

Often resembles Wave 4 greatly and is extremely difficult to recognize. Shows insignificant movements upwards upon the rests of optimism.

Wave C

A robust decreasing wave inside the background of general persuasion that the new, descreasing trend has started. Inside the meantime, some investors start buying cautiously. This wave is seen as a high momentum (five waves ) and lengthiness as much as 1. 618-fold Wave 3.
Unfortunately, Elliott's waves are very well observed inside the old market, but you are rather dimmed for future years. This really is why practical use from the Elliott Wave Theory is usually difficult and requires special knowledge.