Elliott Wave Theory

Taso Anastasiou Director: FX/PM Global Technical Strategy GroupUBS Investment Bank

Phone : +44 (0)20 7567 6870E-Mail : taso.anastasiou@ubs.com

3070446AL.ppt 1

Elliott Wave theory

1

2

3

4

5

a

b

c

Market PsychologySECTION 1

3070446AL.ppt 3

Traders of my generation armed themselves with charts and computer-generated graphics that predicted future price direction. We sat day after day in front of these screens, mesmerised by blinking lights and ever-changing numbersin a deafening cacophony of information overload.With the possible exception of Elliott wave theory, an intellectual framework for understanding the course of social, political, and economic events was noticeably forgotten in favour of just making sure that one was part of the ever quickening process.

Paul Tudor Jones II, The alchemy of finance by George Soros

A Quotation

3070446AL.ppt 4

♦ The averages discount everything

♦ The market has three trends

♦Major trends have three phases

♦ The averages must confirm each other

♦ Volume must confirm the trend

♦A trend is assumed to be in effect until it gives definite signals that it has reversed

Dow Theory - Important Elements

3070446AL.ppt 5

Anatomy of Price Action

♦ Trend

♦ Consolidation

♦ Reversal

Market will always be in one of these 3 modes

S t r o n g d - t r e n d

C o n s o l id a t io n

W e a k r e s u m p t io n

W e a k t e s t

S t r o n g r e v e r s a l

C o n s o l id a t io n

S t r o n g r e s u m p t io n

C o n s o l id a t io n

W e a k r e s u m p t io n

W e a k t e s t

S t r o n gr e v e r s a l

surp

rise

but

�

surp

rise

bu

t �

3070446AL.ppt 6

Psychological Make up of a trend - Phase 1

♦ A trend is very difficult to detect at this stage

♦ Very few traders and investors will actually open positions inthis phase

♦ Economic news and cycles are generally still bad but improving

♦ No public participation

♦ Most traders will still be trying to sell into the rallies

1

3070446AL.ppt 7

♦ Market exceeds previous top trend is now identified

♦ Traders begin to buy as bearish sentiment fades

♦ Economic news generally improving

♦ Media starts to report a new bull phase

♦ Public begins to participate

♦ Traders are now buying the dips

♦ Is the most powerful phase of the three and most profits are generated in this phase

Phase 2

2

3070446AL.ppt 8

♦ Market once again exceeds previous top as trend is confirmed

♦ Fear of intervention makes traders wary

♦ Fundamental factors peaking

♦ Media still reporting positive news but now wondering how far we can go

♦ Increased public participation

♦ A few scares and profit taking causes concern stops are raised

♦ Blow off occurs as stops triggered

♦ Generally the weakest of the three phases

Phase 3

3

1

2

3

3070446AL.ppt 9

Awareness of market psychology and how it affects trading activity is essential for a greater understanding of the Elliott Wave Theory.

The Basics�Building on Dow theorySECTION 2

3070446AL.ppt 11

♦ Elliott isolated 13 waves, or price patterns of directional movement that recur in markets and are repetitive in their form

♦ His descriptions constitute a set of empirically derived rules and guidelines for interpreting market action

♦ First we must look at the basic structure or the fivewave pattern

The Building Blocks

3070446AL.ppt 12

♦ Any major movement will unfold in a pattern of five waves and in turn will be corrected by a pattern of three waves going in the opposite direction

♦ The five wave movement can be split into two distinctive segments

� the numbered phase� the lettered Phase

1

2

3

4a

b

c

5

The basic five wave structure

3070446AL.ppt 13

♦ The Trend phase is known as the impulse

♦ This the numbered phase

♦ An impulsive segment (1-5) is itself constructed as a series of five waves of which 1�3�5 are impulses of a minor degree

1

2

3

4a

b

c

5Impulsive segment

The impulse

3070446AL.ppt 14

The impulsive segment

1

2

3

4a

b

c

5Impulsive segment

1

2

3

4a

b

c

1

2

3

4a

b

c

1

2

3

4a

b

c

5

5

5Zoomed in

Phase

3070446AL.ppt 15

♦ Trends move in a series of peaks and troughs

♦ The lettered phase is known as the corrective segment and is always counted in threes, a�b�c

♦ Wave 2 corrects Wave 1

♦ Wave 4 corrects Wave 3

♦ a�b�c corrects Waves 1 to 5

1

2

3

4a

b

c

5Correction

The corrective phase

3070446AL.ppt 16

♦ Your start point should always be a significant highor low

♦ Start point is labelled 0, the impulse segment in this phase is labelled 1 and is corrected by the lettered phase labelled 2

In Practice

0

1

2

3070446AL.ppt 17

1

2

3

4

5

Summary of wave structure

3070446AL.ppt 18

Waves 1�3�5 are impulses moving in the direction of the trend

Summary of wave structure (continued)

1

2

3

4

5

1

2

3

4

5

a

b

c

3070446AL.ppt 19

1

2

3

4

5

Waves 2�4 are counter trend movements

Summary of wave structure (continued)

3070446AL.ppt 20

3

5

2

1

2

3

4

5

a

b

c

1

2

3

4

5

a

b

c

1

2

3

4

5

a

b

c

1

2

41

3

4

51

2

3

4

5

a

b

c

The complete structure

Summary of wave structure (continued)

3070446AL.ppt 21

USD/CAD

11

2

3

4

c

a

b

5

1

2

1

2

1

2

Impulsive waves 1�3�5 SECTION 3

3070446AL.ppt 23

♦ There are three basic ground rules used when defining an impulsive phase

♦ The first inviolable rule is that from your start point at 0 (major high or low) Wave 2 must never move below the start of Wave 1 at 0

1

2

00

Rule 1

3070446AL.ppt 24

♦ Wave 3 can never be the shortest wave in the impulse

♦ This doesn�t mean that it is necessarily the longest

♦ In the example the alternative count provides the clue as Wave 3 is probably extending

1

2

3

4

5Incorrect count

1

2

i

ii

iiiAlternative count

Rule 2

3070446AL.ppt 25

♦ Wave 4 should not overlap Wave 1

♦ There are two exceptions to this rule:♦ Wave 1 can be a leading

diagonal triangle and price action can overlap (wedge)

♦ Wave 5 can be an ending diagonal triangle where price action overlaps (wedge)

1

2

3

4

5

Rule 3

3070446AL.ppt 26

♦ An extension can only occur in one of the impulse waves 1�3�5. Most extensions will actually occur in the 3rd wave. Extensions may also occur in the extending wave itself

1

2

3

4

5

i

ii

iii

iv

v

1

2

3

4

5

a

b

c

Impulse waves�the extension

3070446AL.ppt 27

Grand super cycle

0 1 2 3 4 5 A B C Super cycle

0 I II III IV V A B C Cycle

Primary

Intermediate

Minor0 1 2 3 4 5 a b c

Minute0 i ii iii iv v a b c

Sub-minuette0. i. ii. iii. iv. v. a. b. c.

Minuette0 1 2 3 4 5 a b c

0 I II III IV V a b c Micro

0 i ii iii iv v a b c Sub-micro

Labelling the cycles

1 2 3 4 A B C50

(0)(I) (2) (3) (4) (5) (a) (b) (c)

1 2 3 4 A B C50

3070446AL.ppt 28

1

2

4

5

6

8

Extensions

1

2

3

4

5

1

2

3

4

5

1

2

3

4

5

1

2

3

4

5

1

2

3

4

5

6

7

8

9

1

2

3

4

5

1

2

3

4

5

1

2

3

9

3

7

0101092L.ppt 29

Example of an extension

A

C

B

1

2

3

4

5

i

ii

v

iii

iv1

2

3

4

1

5

3070446AL.ppt 30

In Practice - GBP/USD

3070446AL.ppt 31

In Practice - GBP/USD

1

2

3

4

5

3070446AL.ppt 32

In Practice - GBP/USD

1

2

3

4

5

a

a

b

c

b

c

3070446AL.ppt 33

In Practice - GBP/USD

1

2

3

4

5

a

a

b

c

b

c

i

ii

iii

iv

v

3070446AL.ppt 34

4

1

2

3

5

i

ii

iii

iv

v

An ending diagonal triangle is counted as a five wave up but sub-dividesinto threes

♦ Diagonal triangles are formed by two converging lines, in its usual form. This pattern occurs in fifth wave positions

♦ The only exception to the overlap rule between Wave 1�4 can occur in a diagonal

♦ A diagonal can also be located in the C wave positions. As in a rising wedge this is to be considered a termination pattern

The ending diagonal triangle

3070446AL.ppt 35

Ending diagonal triangles

1

2

3

4

5

i

ii

iii

iv

iv

0101092L.ppt 36

Ending diagonal triangles

1

2

3

4

5

1

2

3

4

5

3070446AL.ppt 37

♦ In normal circumstances this pattern would be referred to as a rising wedge and is a bearish pattern as it is assumed that the pattern will break the support

♦ The target on the break would suggest a re-test of the base

♦ This pattern is only found in Wave 1 or A

♦ All other rules applye.g. Wave 3 is not the shortest and 2 doesn�t break below the start point then you must buy the dip as it will turn out to be a bullish pattern

1

2

3

4

5

i

ii

iii

iv

v

Leading diagonal triangles

3070446AL.ppt 38

♦ As Wave 5 is the weakest part of the trend it sometimes has a tendency to fail early, creating what we traditionally call a double top

♦ The Internal wave structure must still count up in five

3

1

2

4

5

The failed fifth wave

3

0101092L.ppt 39

Failed fifth waves & leading diagonal

1

2

3

4

5

1

4

3

2

5

3070446AL.ppt 40

Incorrect counting as Wave (5) would only count up in 3

Failed fifth waves (continued)

3

4

5

60

70

80

90

100

1991 1992 1993 1994 1995

3070446AL.ppt 41

Correct count where (I) is a leading diagonal triangle, (III) has extended and (V) has failed

60

70

80

90

100

Failed fifth waves (continued)

(I)

(II)

(III)

(IV)

(V)

55

a

b

c

a

b

c

1

2

3

1

3

4

91.224

2

1991 1992 1993 1994 1995

3070446AL.ppt 42

The Trap...

3070446AL.ppt 43

Successful Trend Definition Is Essential

♦Analysis and therefore positioning must be biased in the direction of the prevailing trend

3070446AL.ppt 44

Trend Definition Is Essential

3070446AL.ppt 45

Ground Rules

♦ You can quantify trends and market positioning by biasing your position base in the direction of the underlying trend

Corrective waves a�b�cSECTION 4

3070446AL.ppt 47

♦ We have seen that movements against the trend are known as corrective waves, sometimes referred to as consolidations or lettered phase

♦ Identifying and fitting corrections into particular patterns in advance is very difficult

♦ The complexity of corrective waves can increase or decrease without warning

Corrective waves

3070446AL.ppt 48

♦ Zig-Zag 5�3�5 includes three variations single, double and triple

♦ Flats 3�3�5 includes 3 variations, regular, expanded, running

♦ Triangles 3�3�3�3�3 four types, ascending, descending, contracting, expanding

♦ Double and triple threes (combined structures)

The three corrective wave typesCorrective waves fall into four categories

3070446AL.ppt 49

Bear market correction

a

b

c

i

ii

iii

iv

v

a

b

c

i

ii

iii

iv

v

Bull market correction

c

a

b

Zig-Zags 5�3�5

3070446AL.ppt 50

♦ Zig-Zags have a 5�3�5 wave structure

♦ These formations are usually found in Wave 2 position

♦ It would be fair to assume that they would also occur after Wave 5 as a traditional head and shoulders reversal patternis formed

♦ Wave C of the Zig-Zag will typically extend the same distance as Wave A

Zig-Zag corrections

0101092L.ppt 51

Example of a Zig-Zag correction

A

B

C

1

2

3

4

5

5

4

3

2

1

A = C

3070446AL.ppt 52

Bull market correction Bear market correction

a

b

c

a

b

c

Flat corrections 3�3�5

0101092L.ppt 53

Example of a flat correction

A

B

C

a

b

c

1

v

2

5

4i

ii

iii

iv

3

3070446AL.ppt 54

Bull market correction Bear market correction

a

b

c

a

b

c

Irregular flats 3�3�5

3070446AL.ppt 55

♦ Flats are counted as 3�3�5

♦ There are standard flats which are typically ranges

♦ There are irregular flats where the B wave exceeds the high, but can only be counted as a 3-wave affair

♦ Last but not least there are running flats

♦ Flat corrections are typically found in fourth and B wave positions and tend to have lower retracement values

Flats 3�3�5

3070446AL.ppt 56

Bull market correction

Bear market correction

a

b

c

d

e

a

b

c

d

e

Triangles 3�3�3�3�3

♦ Five waves � a / b / c / d / e

♦ Each wave subdivides into 3-waves

♦ Each wave tends to be related to a preceding wave by the 0.618 ratio.

� Wave d will be 0.618 of wave b

� Wave e will be 0.618 of wave c

♦ This correction is typically found in wave-4

3070446AL.ppt 57

Zig-Zag -x- Zig-Zag

Complex corrective forms (double threes) Zig-Zag

Bull market correction

a

b

c

i

ii

iii

iv

v

a

b

c

i

ii

iii

iv

va

b

c

i

ii

iii

iv

v

a

b

c

i

ii

iii

iv

v

x

3070446AL.ppt 58

Zig-Zag -x- flat

a

b

c

a

b

c

i

ii

iii

iv

v

a

b

c

i

ii

iii

iv

v

x

Complex corrective forms (double threes) Zig-Zag

Bull market correction

3070446AL.ppt 59

a

b

c

i

ii

iii

iv

v

a

b

c

i

ii

iii

iv

v

x

Zig-Zag -x- triangle

a

b

c

d

e

Complex corrective forms (double threes) Zig-Zag

Bull market correction

3070446AL.ppt 60

a

b

c

i

ii

iii

iv

v

a

b

c

i

ii

iii

iv

v

x

Zig-Zag -x- irregular flat

a

b

c

Complex corrective forms (double threes) Zig-Zag

Bull market correction

3070446AL.ppt 61

Flat -x- flat

a

b

c a

b

c

x

Complex corrective forms (double threes) flat

3070446AL.ppt 62

Flat -x- Zig-Zag

x

a

b

c

i

ii

iii

iv

v

a

b

c

i

ii

iii

iv

v

a

b

c ii

i

iii

iv

va

a

b

bc

i

ii

iii

iv

vc

Complex corrective forms (double threes) flat

3070446AL.ppt 63

Flat -x- triangle

a

b

c

d

e

a

b

c

x

Complex corrective forms (double threes) flat

3070446AL.ppt 64

Flat -x- irregular

a

b

ca

b

c

x

Complex corrective forms (double threes) flat

3070446AL.ppt 65

b

Irregular -x- irregular

x

a

b

c

ac

Complex corrective forms (double threes)

3070446AL.ppt 66

Irregular flat -x- flat

x

a

b

ca

b

c

Complex corrective forms (double threes)

3070446AL.ppt 67

Irregular flat -x- Zig-Zag

x

a

b

c

i

ii

iii

iv

v

a

b

c

i

ii

iii

iv

va

b

c

Complex corrective forms (double threes)

3070446AL.ppt 68

Irregular flat -x- Zig-Zag

x

a

b

c

d

e

a

b

c

Complex corrective forms (double threes)

3070446AL.ppt 69

To date we have looked at standard corrective waves as well as double complex waves. There is a third type of complex correction which is called the complex triple three.

a

b

c

i

ii

iii

iv

v

a

b

c

i

ii

iii

iv

v a

b

c

d

e

a

b

c

x

a

b

c

x

Zig-Zag Irregular flat Trianglex x

Complex corrective waves

0101092L.ppt 70

Examples of complex corrections

a

c

b

A

B

C

X

A

B

C

FLAT

1

a

c

b

A

B

c

2

i

ii

ZIG-ZAG

IRREGULAR FLAT

FLAT

A

C

B

ZIG-ZAG

A = C

The rule of alternationSECTION 5

3070446AL.ppt 72

♦ This rule is relatively simple as it states that no two corrective phases are similar

♦ If Wave 2 is a Zig-Zag then Wave 4 will probably be a flat ora triangle � typical scenario

♦ The rule also states that only one of the impulse waves will extend (and can itself extend)

♦ If two corrective phases are similar then one will differ in magnitude or length

The rule of alternation

3070446AL.ppt 73

1

2

3

4

5

1

2

3

4

5

1

2

3

4

5

1

2

3

4

5

Alternation

0101092L.ppt 74

The rule of alternation

1

2

5

4

3

a

b d

ec

b

a

c

TRIANGLE

FLAT

The depth of corrective wavesSECTION 6

3070446AL.ppt 76

The depth of corrective wavesNo market approach other than the Elliott Wave Theory gives a satisfactory answer to this question. The primary guideline is that corrections , especially when they themselves are fourth waves tend to register their maximum retracement within the span of travel of the previous fourth wave of one lesser degree which would also represent support (or resistance for a rising market).

1

2

3

4

5

The Fibonacci sequence and its applicationSECTION 7

3070446AL.ppt 78

♦ Ratio analysis has revealed a number of precise price relationships that occur often among waves. There are two categories of relationships: retracements and multiples

Retracements

♦ Fairly often, a correction retraces a Fibonacci percentage of the preceding wave

♦ Sharp corrections tend more often to retrace 61.8% or 50% of the previous wave, particularly when they occur as Wave 2 of an impulse wave, Wave B of a larger Zig-Zag, or Wave X in a multiple Zig-Zag

Ratio analysis

3070446AL.ppt 79

0

10024.6

38.2

50.0

61.8

76.4

100Typical of Wave 2 Typical of Wave 4

RetracementsTypical retracement levels

3070446AL.ppt 80

When Wave 3 has extended, waves 1�5 will tend towards equality (1.00) or a 0.618% relationship. All three impulse waves tend to be related by Fibonacci mathematics whether by equality, 1.618 or 2.618 whose inverses are 0.618 and 0.382

Impulse wave multiples

3070446AL.ppt 81

Impulse wave multiples (continued)

3rd wave extension 5th wave extension 1st wave extension

1

2

3

4

5

1

2

3

4

5

12

3

4

5

1.00

1.00

.382

.618

.618

.382

3070446AL.ppt 82

a

b

c

x

a

b

c

1.00

1.00

/. 618

/2.6

18

Double Zig-Zag

Corrective wave multiples

1.00

1.00

/6.1

8/1.

618

Zig-Zag

3070446AL.ppt 83

Flat Irregular flat

Corrective wave multiples (continued)

a

b

c

a

b

c

1.00

1.00

.618 1.618

3070446AL.ppt 84

Calculating targets

1

2

3 ?

Wav

e 3

= 1

.00/

1.61

8/2.

618

of

Wav

e 1

i

ii1

2

3

4

5 ?

Wav

e 5

can

be

equ

al t

o w

ave

10.

618

of

3 0r

.382

of

wav

es 1

an

d 3

0101092L.ppt 85

Fibonacci relationships

1

2

4

35

i

ii

iii v

iv

Wave 2 retraces just above the 61.8% level of wave-1

Wave 4 retraces just above the 38.2% level of wave-3

Failed 5th

3070446AL.ppt 86

Wave (II) retraces Wave (I) by 50%

Wave II retraces Wave I by 62%

Wave (III)and III retraces Wave (IV) and IV by 24%

Wave III is 2.62 multiplied from the length of wave I

Wave (V) is 1.00 multiplied by the length of wave (I)

(0)

(I)

(II)

(III)

(IV)

(V)

I

II

III

IV

V

Fibonacci relationships (continued)

1.9000

1.6000

1.5000

1.4500

1.4000

1.3500

1.6500

1.5500

May-96 Nov-96 Nov-97May-97May-96 Nov-96

tmta3 © DEM-USD Weekly Bar 06-Mar-95�28-Nov-97 [Zoomed] 1.8904 1.3455 1.7635 0.3685 0.0000V 2.980014 Copyright 1994-1997 Tradermade International Ltd.

1.7000

1.7500

1.8000

1.8500

1.3811

1.5489

1.6618

1.7207

1.8904

May-95 Nov-95

3070446AL.ppt 87

A word on momentum

1

2

3

4

5

♦ Divergence between price and momentum warns of technical weakness in a trend

♦ Divergence between price and momentum is typical during the 5th and final wave.

♦ One would also expect such a set-up to develop during wave-C

3070446AL.ppt 88

Fibonacci Relationships - S&P Cash

0.618 of wave 1 (1175)

1.00 of wave 1 (1246)

Potential for bearish divergence in momentum

1

2

3

4 ?

3070446AL.ppt 89

Fibonacci Relationships - S&P Cash

1

2

3

4

5

i

ii

iii

iv

v

3070446AL.ppt 90

Analyse

3070446AL.ppt 91

Analyse

3070446AL.ppt 92

Analyse

3070446AL.ppt 93

Analyse

3070446AL.ppt 94

UBS AG, 100 Liverpool Street, London UK EC2M 2RH +44 20 7756 8000This material has been prepared by UBS AG or an affiliate thereof (�UBS�). It has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. It is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. No representation or warranty, either express or implied, is provided in relation to the accuracy, completeness or reliability of the information contained herein, except with respect to information concerning UBS AG, its subsidiaries and affiliates. Opinions expressed herein are subject to change without notice and may differ or be contrary to opinions expressed by other business areas or groups of UBS as a result of using different assumptions and criteria. UBS is under no obligation to update or keep the information current. The securities described herein may not be eligible for sale in all jurisdictions or to certain categories of investors. UBS, its directors, officers and employees (excluding the US broker-dealer unless specifically disclosed under required disclosures)or clients may have or have had interests or long or short positions in the securities or other financial instruments referred to herein, and may at any time make purchases and/or sales in them as principal or agent. UBS (excluding the US broker-dealer unless specifically disclosed under Required Disclosures) may act or have acted as market-maker in the securities or other financial instruments discussed in this material. UBS may provide investment banking and other services to and/or serve as directors of the companies referred to in this report. Neither UBS nor any of its affiliates, nor any of UBS' or any of its affiliates, directors, employees or agents accepts any liability for any loss or damage arising out of the use of all or any part of this report.

United Kingdom and rest of Europe: Except as otherwise specified herein, this material is communicated by UBS Limited, a subsidiary of UBS AG, to persons who are market counterparties or intermediate customers (as detailed in the FSA Rules) and is only available to such persons. The information contained herein does not apply to, and should not be relied upon by, private customers. Switzerland: Distributed by UBS AG to persons who are institutional investors only. Italy: Should persons receiving this research in Italy require additional information or wish to effect transactions in the relevant securities, they should contact Giubergia UBS SIM SpA, an associate of UBS SA, in Milan. South Africa: UBS Securities South Africa (Pty) Limited (incorporating J.D. Anderson & Co.) is a member of the JSE Securities Exchange SA. United States: Distributed to US persons by either UBS Securities LLC or by UBS Financial Services Inc., subsidiaries of UBS AG; or by a group, subsidiary or affiliate of UBS AG that is not registered as a US broker-dealer (a �non-US affiliate�), to major US institutional investors only. UBS Securities LLC or UBS Financial Services Inc. accepts responsibility for the content of a report prepared by another non-US affiliate when distributed to US persons by UBS Securities LLC or UBS Financial Services Inc. All transactions by a US person in the securities mentioned in this report must be effected through UBS Securities LLC or UBS Financial Services Inc., and not through a non-US affiliate. Canada: Distributed by UBS Securities Canada Inc., a subsidiary of UBS AG and a member of the principal Canadian stock exchanges & CIPF. A statement of its financial condition and a list of its directors and senior officers will be provided upon request. Hong Kong: Distributed by UBS Securities Asia Limited. Singapore: Distributed by UBS Securities Singapore Pte. Ltd. Japan: Distributed by UBS Securities Japan Ltd to institutional investors only. Australia: Distributed by UBS Capital Markets Australia Ltd and UBS Securities Australia Ltd licensed securities dealers. New Zealand: Distributed by UBS New Zealand Ltd.

© 2005 UBS. All rights reserved. This report may not be reproduced or distributed in any manner without the permission of UBS.

Disclaimer