Elliott Wave Principle

Elliott Wave Principle and the Stock-Market Cycles

 

An American accountant called Ralph Nelson Elliott studied the stock-market volatility during the 30s and concluded that certain price movements (patterns) tend to repeat themselves during different time frames. Until then investors considered market fluctuations as random events. Elliott supported that the stock market is moving in a recognizable pattern and that was called "Elliott Wave Principle".

The most crucial step in implementing the Elliott wave principle is to identify the pattern upon the market is moving today. Wave patterns consist of two phases: an impulsive and a corrective phase. Impulse phase is composed of five sub-waves (graph 1, 2, 3, 4, 5) and move in the same direction of the main trend. Corrective phase is composed of three sub-waves (graph a, b, c), and it moves against the main trend. In the graph below the basic Elliott Wave Pattern is presented.

 

Graph: Elliott Waves

The two Phases of the Elliot Wave Principal

 

 

Impulsive Phase Analysis

 

Wave One:

This wave begins a new uptrend. Before wave-1 the market is bearish so wave-1 marks the beginning of a new bullish market trend. Just before wave-1 is revealing itself usually the market is highly bearish.

 

Wave Two:

Wave-2 begins at the peak of wave-1 and describes a market pullback after the bullish wave-1. Investors are hoping that the wave-3 will occur.

 

Wave Three:

Wave-3 is the longest and the strongest wave in the impulsive phase. That is why wave-3 is signaling an upcoming bullish market so more investors are willing to get on board.

 

Wave Four:

Wave-4 is a second market price pullback (the first pullback was wave-2). Most of the investors hold their positions as they are waiting for wave-5 to occur.

 

Wave Five:

Wave-5 is usually very strong nearly as strong as wave-3. The end of wave-5 marks the end of the whole uptrend. Wave-5 is ending almost all of the times with a significant increase of the market volume. Usually, at the peak of wave-5 record volumes are identified. Another signal of the end of wave-5 is that market makes a high intraday fluctuation and close at its lowest point.

 

 

Corrective Phase Analysis

 

Wave A:

Wave-A indicates the start of a bearish market. Usually, the market during wave-a is dropping at a high rate.

 

Wave B:

Wave-B indicates a short-uptrend correction. Wave B doesn't get higher than wave 5.

 

Wave C:

Wave C is the third wave in a downtrend. When wave-c ends the market is moving to the same pattern starting wave-1 again.

 

Elliott Waves and Degrees

Elliott discerned nine degrees of waves. The smallest degree is a wiggle on an hourly chart. These are all the degrees from smallest to largest:

  1. Subminuette
  2. Minuette
  3. Minute
  4. Minor
  5. Intermediate
  6. Primary
  7. Cycle
  8. Supercycle
  9. Grand Supercycle

Graph: Elliott Wave Degrees and their Symbols on Charts

 

Short-Explanation of Elliott Wave Principle

 

 

Elliott Wave Principle describes how groups of people behave in a stock-market. It identifies that mass psychology of a market alters from pessimism to optimism and back in a natural sequence, creating specific patterns. In a financial market, changing investor psychology is identified in the form of price movements. The principle that markets are moving in recognizable patterns contradicts the Efficient Market Hypothesis, which states that future price movements cannot be predicted.

 

 

The Correlation of the Elliott Wave Principle with the Fibonacci Sequence of Numbers

 

 

A key when applying the Elliott Wave Principle is to understand the Fibonacci ratios. Corrective waves tend to retrace prior impulse waves of the same degree in Fibonacci proportion. The common wave relationships include 38%, 50%, and 62%. Numbers from the Fibonacci sequence repeated in Elliott wave structures, including the impulsive phase (1, 3, 5), the length of a full cycle (8 waves), but also the completed motive (89 waves) and corrective (55 waves) patterns. As Elliott mentioned he developed his Wave Principal before he realized the correlation with the Fibonacci sequence. In addition, the Fibonacci sequence is also correlated with the Golden ratio (1.618). So the Golden Rule is commonly used to establish support and resistance levels for market waves.

 

 

More about the Fibonacci Sequence of Numbers | ► Buy the Fibonacci Tutorial for $3.99 at Amazon Books

 

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