He was an American accountant and author. Inspired by the Dow Theory and by observations found throughout nature, Elliott concluded that the movement of the stock market could be predicted by observing and identifying a repetitive pattern of waves. Elliott was able to analyze markets in greater depth, identifying the specific characteristics of wave patterns and making detailed market predictions based on the patterns. Elliott based part his work on the Dow Theory, which also defines price movement in terms of waves, but Elliott discovered the fractal nature of market action. Elliott first published his theory of the market patterns in the book titled The Wave Principle in
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He was an American accountant and author. Inspired by the Dow Theory and by observations found throughout nature, Elliott concluded that the movement of the stock market could be predicted by observing and identifying a repetitive pattern of waves. Elliott was able to analyze markets in greater depth, identifying the specific characteristics of wave patterns and making detailed market predictions based on the patterns.
Elliott based part his work on the Dow Theory, which also defines price movement in terms of waves, but Elliott discovered the fractal nature of market action. Elliott first published his theory of the market patterns in the book titled The Wave Principle in Simply put, movement in the direction of the trend is unfolding in 5 waves called motive wave while any correction against the trend is in three waves called corrective wave.
The movement in the direction of the trend is labelled as 1, 2, 3, 4, and 5. The three wave correction is labelled as a, b, and c. These patterns can be seen in long term as well as short term charts. Ideally, smaller patterns can be identified within bigger patterns.
In this sense, Elliott Waves are like a piece of broccoli, where the smaller piece, if broken off from the bigger piece, does, in fact, look like the big piece. Impulses are always subdivided into a set of 5 lower-degree waves, alternating again between motive and corrective character, so that waves 1, 3, and 5 are impulses, and waves 2 and 4 are smaller retraces of waves 1 and 3.
In Figure 1, wave 1, 3 and 5 are motive waves and they are subdivided into 5 smaller degree impulses labelled as i , ii , iii , iv , and v.
Wave 2 and 4 are corrective waves and they are subdivided into 3 smaller degree waves labelled as a , b , and c. The 5 waves move in wave 1, 2, 3, 4, and 5 make up a larger degree motive wave 1. Corrective waves subdivide into 3 smaller-degree waves, denoted as ABC. Corrective waves start with a five-wave counter-trend impulse wave A , a retrace wave B , and another impulse wave C. The 3 waves A, B, and C make up a larger degree corrective wave 2.
In a bear market the dominant trend is downward, so the pattern is reversed—five waves down and three up. Elliott Wave degree is an Elliott Wave language to identify cycles so that analyst can identify position of a wave within overall progress of the market. Elliott acknowledged 9 degrees of waves from the Grand Super Cycle degree which is usually found in weekly and monthly time frame to Subminuette degree which is found in the hourly time frame.
The development of computer technology and Internet is perhaps the most important progress that shape and characterize the 21st century. The proliferation of computer-based and algorithmic trading breed a new category of traders who trade purely based on technicals, probabilities, and statistics without the human emotional aspect. In addition, these machines trade ultra fast in seconds or even milliseconds buying and selling based on proprietary algos.
We have four major classes of market: Stock market, forex, commodities, and bonds. Dow Theory , but certain markets such as forex exhibit more of a ranging market.
In addition, market can keep moving in a corrective structure in the same direction. In other words, the market can trend in a corrective structure; it keeps moving in the sequence of 3 waves, getting a pullback, then continue the same direction again in a 3 waves corrective move.
Leonardo Fibonacci da Pisa is a thirteenth century mathematician who discovered the Fibonacci sequence. In , he published a paper entitled Liber Abacci which introduced the decimal system. The basis of the work came from a two-year study of the pyramids at Giza. One of the most popular discoveries by Leonardo Fibonacci is the Fibonacci Summation series. This series takes 0 and adds 1 as the first two numbers. Succeeding numbers in the series adds the previous two numbers and thus we have 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89 to infinity.
The Golden Ratio 1. As an example, 89 divided by 55 would result in 1. Various Fibonacci ratios can be created in a table shown below where a Fibonacci number numerator is divided by another Fibonacci number denominator. These ratios, and several others derived from them, appear in nature everywhere, and in the financial markets. They often indicate levels at which strong resistance and support will be found.
They are easily seen in nature seashell spirals, flower petals, structure of tree branches, etc , art, geometry, architecture, and music. For example, 89 divided by 55, divided by Fibonacci Retracement in technical analysis and in Elliott Wave Theory refers to a market correction counter trend which is expected to end at the areas of support or resistance denoted by key Fibonacci levels. The market is then expected to turn and resume the trend again in the primary direction. Fibonacci Extension refers to the market moving with the primary trend into an areas of support and resistance at key Fibonacci levels where target profit is measured.
Traders use the Fibonacci Extension to determine their target profit. Below is the list of important Fibonacci Retracement and Fibonacci Extension ratios for the financial market:.
Different waves in an Elliott Wave structure relates to one another with Fibonacci Ratio. For example, in impulse wave:. Traders can thus use the information above to determine the point of entry and profit target when entering into a trade. In Elliott Wave Theory, the traditional definition of motive wave is a 5 wave move in the same direction as the trend of one larger degree.
There are three different variations of a 5 wave move which is considered a motive wave: Impulse wave, Impulse with extension, and diagonal. EWF prefers to define motive wave in a different way.
We agree that motive waves move in the same direction as the trend and we also agree that 5 waves move is a motive wave. However, we think that motive waves do not have to be in 5 waves. For this reason, we prefer to call it motive sequence instead.
We instead prefer to call it motive sequence. We define a motive sequence simply as an incomplete sequence of waves swings. The structure of the waves can be corrective, but the sequence of the swings will be able to tell us whether the move is over or whether we should expect an extension in the existing direction.
Motive sequence is much like the Fibonacci number sequence. If we discover the number of swings on the chart is one of the numbers in the motive sequence, then we can expect the current trend to extend further. Wave 1: In Elliott Wave Theory, wave one is rarely obvious at its inception. When the first wave of a new bull market begins, the fundamental news is almost universally negative. The previous trend is considered still strongly in force.
Fundamental analysts continue to revise their earnings estimates lower; the economy probably does not look strong. Sentiment surveys are decidedly bearish, put options are in vogue, and implied volatility in the options market is high.
Volume might increase a bit as prices rise, but not by enough to alert many technical analysts. Wave 2: In Elliott Wave Theory, wave two corrects wave one, but can never extend beyond the starting point of wave one. Typically, the news is still bad. Still, some positive signs appear for those who are looking: volume should be lower during wave two than during wave one, prices usually do not retrace more than Wave 3: In Elliott Wave Theory, wave three is usually the largest and most powerful wave in a trend although some research suggests that in commodity markets, wave five is the largest.
The news is now positive and fundamental analysts start to raise earnings estimates. Prices rise quickly, corrections are short-lived and shallow. Wave three often extends wave one by a ratio of 1. Wave 3 rally picks up steam and takes the top of Wave 1.
As soon as the Wave 1 high is exceeded, the stops are taken out. Depending on the number of stops, gaps are left open. Gaps are a good indication of a Wave 3 in progress. After taking the stops out, the Wave 3 rally has caught the attention of traders. At the end of wave 4, more buying sets in and prices start to rally again. Wave four is typically clearly corrective. Prices may meander sideways for an extended period, and wave four typically retraces less than Volume is well below than that of wave three.
This is a good place to buy a pull back if you understand the potential ahead for wave 5. Still, fourth waves are often frustrating because of their lack of progress in the larger trend. Wave 5: In Elliott Wave Theory, wave five is the final leg in the direction of the dominant trend.
The news is almost universally positive and everyone is bullish. Unfortunately, this is when many average investors finally buy in, right before the top. Volume is often lower in wave five than in wave three, and many momentum indicators start to show divergences prices reach a new high but the indicators do not reach a new peak.
At the end of a major bull market, bears may very well be ridiculed recall how forecasts for a top in the stock market during were received. The wave 5 lacks huge enthusiasm and strength found in the wave 3 rally. Wave 5 advance is caused by a small group of traders.
Although the prices make a new high above the top of wave 3, the rate of power or strength inside wave 5 advance is very small when compared to wave 3 advance. Wave A: Corrections are typically harder to identify than impulse moves. In wave A of a bear market, the fundamental news is usually still positive. Most analysts see the drop as a correction in a still-active bull market. Some technical indicators that accompany wave A include increased volume, rising implied volatility in the options markets and possibly a turn higher in open interest in related futures markets.
Wave B: Prices reverse higher, which many see as a resumption of the now long-gone bull market. Those familiar with classical technical analysis may see the peak as the right shoulder of a head and shoulders reversal pattern. The volume during wave B should be lower than in wave A.
Trading with Elliott Waves using Fibonacci retracement levels
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Elliott Wave Theory : Rules, Guidelines and Basic Structures