Elliott Wave Principle
Chapter 1
Introduction
Introduction
Objectives
Scope of Study
Abstract
Research Methodology
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Elliott Wave Principle
General Introduction
The Elliott Wave Principle is a form of technical analysis that some traders
use to analyze financial market cycles and forecast market trends by identifying
extremes in investor psychology, highs and lows in prices, and other collective
factors. Ralph Nelson Elliott (1871–1948), a professional accountant, discovered the
underlying social principles and developed the analytical tools in the 1930s. He
proposed that market prices unfold in specific patterns, which practitioners today call
Elliott waves, or simply waves
Objectives of study
To understand the concept of Elliot wave theory.
To apply the concept in Financial Market.
To understand the changing trend of the Equity Market.
To prove that Elliott Wave analysis is the better tool to analyze the market.
Scope of Study
Will highlight the concept, features and applicability of the Elliot wave in the
Equity Market.
Will help to understand the trend of the market.
Review of Literature
Abstract 1
Topic :- Stock Market Crashes, Precursors and Replicas
Author :- Physicist Didier Sornette
It is intriguing that the log-periodic structures documented here bear some
similarity with the "Elliott waves" of technical analysis ... A lot of effort has been
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Elliott Wave Principle
developed in finance both by academic and trading institutions and more recently by
physicists (using some of their statistical tools developed to deal with complex times
series) to analyze past data to get information on the future. The 'Elliott wave'
technique is probably the most famous in this field. We speculate that the "Elliott
waves", so strongly rooted in the financial analysts’ folklore, could be a signature of
an underlying critical structure of the stock market.
Link :-(http://en.wikipedia.org/wiki/Elliott_Wave_Principle)
Abstract 2
Topic :- Elliott "a classic," and one of "the four Bibles of the business"
Author :- Paul Tudor Jones, the billionaire commodity trader.
Technical Analysis of Stock Trends and The Elliott Wave Theorist both give
very specific and systematic ways to approach developing great reward/risk ratios for
entering into a business contract with the marketplace, which is what every trade
should be if properly and thoughtfully executed.
Link :-(http://en.wikipedia.org/wiki/Elliott_Wave_Principle)
Abstract 3
Topic :- Elliott Wave Heresy: Five Waves Followed by Three Waves is Not Always
Right!
Author :- Steven W. Poser
The Elliott Wave Theory (EWT, also known as the Elliott Wave Principle)
suggests that markets move in five wave impulse moves with the trend, which are
inexorably followed by three wave corrective patterns. Many novices already fail to
understand the fact that this means that five wave price patterns occur with the
underlying price trend, whether that trend is to higher or lower prices. However, the
author shows that even with this added information, the supposition that a never-
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ending spiral of five-wave/three-wave couplets is not always the correct way to view
the markets.
Link:- http://www.mta.org/eweb/DynamicPage.aspx?webcode=journal-2003-summer
Abstract 4
Topic:-SCIENCE IS REVEALING THE MECHANISM OF THE WAVE
PRINCIPLE
Author :- ROBERT R. PRECHTER, JR., CMT
It is one thing to say that the Wave Principle makes sense in the context of
nature and its growth forms. It is another to postulate a hypothesis about its
mechanism. The biological and behavioral sciences have produced enough relevant
work to make a case that unconscious paleomentational processes produce a herding
impulse with Fibonacci-related tendencies in both individuals and collectives. Man’s
unconscious mind, in conjunction with others, is thus disposed toward producing a
pattern having the properties of the Wave Principle.
Link:-http://knowledgebase.mta.org/?
fuseaction=kb.resource&kbDomainID=29CD92B5-EAEE-E17F-
C526BC22E1B6E50C&kbResourceID=29D9F4DB-C49D-B0B8-
1D9E06D34802EFDF
Abstract 5
Topic:-THE METAPHYSICAL IMPLICATIONS OF THE ELLIOTT WAVE
PRINCIPLE
Author:- Jordan E Kotick B.A (Hons), M.A., CMT
It strikes me that a philosophical discussion of the Elliott Wave Principle is a
worthwhile and relevant pursuit, especially since some of its most noted practitioners,
such as A. J. Frost and Robert Prechter, do not hesitate to discuss philosophical issues
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in their writing nor do they fail to quote various philosophers in connection with their
own advocations. I believe that Frost was the first to specifically articulate the
connection between philosophy and the Wave Principle as evidenced by his
observation that “[i]t is possible to read into stock market behavior a philosophical
significance under the basic tenets of the Elliott Wave Principle.”
There is no shortage of philosophical issues that can be discussed in relation to
the Wave Principle, but the limitations inherent in this paper force me to zero in on a
select few. As such, I have decided to examine determinism and specifically whether
it should be said from a philosophical point of view that the Wave Principle is
inherently deterministic. This consideration also seemed to have occurred to Frost: “It
is an open question whether or not man is a puppet on a string. In the short term he is
not, but over the longer period he may be” and Prechter, “the Wave Principle form
shows that a collective system is...deterministic.”
Link:- http://knowledgebase.mta.org/?
fuseaction=kb.resource&kbResourceID=292331E8-0868-9928-
B7C037D94813E3EC&r=1
Abstract 6
Topic:- SCIENCE IS VALIDATING THE CONCEPT OF THE WAVE PRINCIPLE
Author:- Robert R. Prechter, Jr., CMT
The latest scientific research is racing headlong toward validating the concept
of the Wave Principle, and not just in its simple expression as a financial multifractal.
It is also supporting its grander implications that nature’s living fractals are robust,
that they are governed by Fibonacci, that one of them governs the entire activity of
social man, and therefore that the mathematical basis of man’s sociocultural progress
and of other natural growth systems is the same.
The level of aggregate stock prices is not a m _ tiqsity but a direct and
immediate measure of the popular valuation of man’s total productive capability. That
this valuation has aform is a fact of profound implications that should ultimately
revolutionize the social sciences.
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Link:- http://knowledgebase.mta.org/?
fuseaction=kb.resource&kbResourceID=29F48E6F-DDAF-854F-
FC27D989DE2791AF
Abstract 7
Topic:- Riding the Waves: Applying Elliott Wave Theory to the Financial and
Commodity Markets
Author:-Robin Wilkin, Ex-Global Head of FX and Commodity Technical Strategy
"the Elliott Wave principle ... provides a probability framework as to when to
enter a particular market and where to get out, whether for a profit or a loss
Link:- http://en.wikipedia.org/wiki/Elliott_Wave_Principle
Abstract 8
Topic:-An Introduction to the Elliott Wave Principle The Alchemist November 2005
Author:-Jordan Kotick, Global Head of Technical Strategy at Barclays Capital
"discovery was well ahead of its time. In fact, over the last decade or two,
many prominent academics have embraced Elliott’s idea and have been aggressively
advocating the existence of financial market fractals."
Link:- http://en.wikipedia.org/wiki/Elliott_Wave_Principle
Abstract 9
Topic:- Evidence-Based Technical Analysis
Author:- David Aronson
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Elliott Wave Principle
The Elliott Wave Principle, as popularly practiced, is not a legitimate theory,
but a story, and a compelling one that is eloquently told by Robert Prechter. The
account is especially persuasive because EWP has the seemingly remarkable ability to
fit any segment of market history down to its most minute fluctuations. I contend this
is made possible by the method's loosely defined rules and the ability to postulate a
large number of nested waves of varying magnitude. This gives the Elliott analyst the
same freedom and flexibility that allowed pre-Copernican astronomers to explain all
observed planet movements even though their underlying theory of an Earth-centered
universe was wrong.
Link:- http://en.wikipedia.org/wiki/Elliott_Wave_Principle
Abstract 10
Topic:- The (mis)Behavior of Markets
Author:- Mandelbrot, Benoit and Richard L. Hudson
Wave prediction is a very uncertain business. It is an art to which the
subjective judgement of the chartists matters more than the objective, replicable
verdict of the numbers. The record of this, as of most technical analysis, is at best
mixed
Link:- http://en.wikipedia.org/wiki/Elliott_Wave_Principle
Research Methodology
Statement of problem
Is Elliott wave applicable in Equity market?
Do market trend make a similar patterns over a period of time?
Hypothesis
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Elliott Wave Principle
Elliot Wave is one of the best technical analysis tool to understand the trend
of the Market.
Methods of Collection of data
Secondary data from Odin Diet(Share khan Software) and
www.netdania.com (Live Chart)
Research Instrument
Odin Diet(Share khan Software) and www.netdania.com (Live Chart)
Research Limitation
Elliot wave is complex concept and it takes lot of experience and study to
implement it in the real market.
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Elliott Wave Principle
Chapter 2
Basic Theory
A complete Cycle
Number of Waves at Each Degree
WHY 5 -3?
Elliott Wave personality and characteristics
Wave Patterns
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Elliott Wave Principle
According to physical law: “Every action creates an equal and opposite
reaction”. The same goes for the financial markets. A price movement up or down
must be followed by a contrary movement, as the saying goes: “What goes up must
come down”( and vice versa). The Elliott Wave Principle posits that collective
investor psychology, or crowd psychology, moves between optimism and pessimism
in natural sequences. These mood swings create patterns evidenced in the price
movements of markets at every degree of trend or time scale.
The Wave principle is governed by man’s social nature, and since he has such
a nature, its expression generates forms. As the forms are repetitive, they have
predictive value. The market progression unfolds in waves. Waves are patterns of
directional movement. More specifically, a wave is any one of the patterns which are
formed naturally. In markets, progress ultimately takes the form of five waves of a
specific structure. Three of these waves, which are labeled 1, 3 and 5, actually effect
the directional movement. They are separated by two countertrend interruptions,
which are labeled 2 and 4, as shown in Figure 1.
A complete Cycle
Price movements can be divided into trends on the one hand and corrections or
sideways movements on the other hand. Trends show the main direction of prices,
while corrections move against the trend. In Elliott terminology these are called
Impulsive waves and Corrective waves. Thus two modes of wave development are
formed: motive and corrective. Motive waves have a five wave structure,
whilecorrective waves have a three wave structure or a variation thereof. Motive
mode is employed by both the five wave pattern of Figure 1 and its same-directional
components, i.e., waves 1, 3 and 5. Their structures are called "motive" because they
powerfully impel the market. Corrective mode is employed by all countertrend
interruptions, which include waves 2 and 4 in Figure 2. Their structures are called
"corrective" because they can accomplish only a partial retracement, or "correction,"
of the progress achieved by any preceding motive wave. Thus, the two modes are
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fundamentally different, both in their roles and in their construction, as will be
detailed throughout this project.
Figure 2
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. Corrective waves subdivide
into 3 smaller-degree waves starting with a five-wave counter-trend impulse, a
retrace, and another impulse. In a bear market the dominant trend is downward, so the
pattern is reversed—five waves down and three up. Motive waves always move with
the trend, while corrective waves move against it. Thus a complete cycle of 8 waves is
made up by this two distinct phases,
At the terminus of the eight-wave cycle shown in Figure 2 begins a second
similar cycle of five upward waves followed by three downward waves. A third
advance then develops, also consisting of five waves up. This third advance completes
a five wave movement of one degree larger than the waves of which it is composed.
The result is as shown in Figure 1-3 up to the peak labeled (5).
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Figure 3
At the peak of wave (5) begins a down movement of correspondingly larger
degree, composed once again of three waves. These three larger waves down
"correct" the entire movement of five larger waves up. The result is another complete,
yet larger, cycle, as shown in Figure 3. As Figure 3 illustrates, then, each same-
direction component of a motive wave, and each full-cycle component (i.e., waves 1 +
2, or waves 3 + 4) of a cycle, is a smaller version of itself.
It is crucial to understand an essential point: Figure 3 not only illustrates a
larger version of Figure 2, it also illustrates Figure 2 itself, in greater detail. In Figure
2, each subwave 1, 3 and 5 is a motive wave that will subdivide into a "five," and
each subwave 2 and 4 is a corrective wave that will subdivide into an a, b, c. Waves
(1) and (2) in Figure 1-3, if examined under a "microscope," would take the same
form as waves [1]* and [2]. All these figures illustrate the phenomenon of constant
form within ever-changing degree.
The market's compound construction is such that two waves of a particular
degree subdivide into eight waves of the next lower degree, and those eight waves
subdivide in exactly the same manner into thirty-four waves of the next lower degree.
The Wave Principle, then, reflects the fact that waves of any degree in any series
always subdivide and re-subdivide into waves of lesser degree and simultaneously are
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Elliott Wave Principle
components of waves of higher degree. Thus, we can use Figure 3 to illustrate two
waves, eight waves or thirty-four waves, depending upon the degree to which we are
referring.
Now observe that within the corrective pattern illustrated as wave [2] in Figure
3, waves (a) and (c), which point downward, are composed of five waves: 1, 2, 3, 4
and 5. Similarly, wave (b), which points upward, is composed of three waves: a, b and
c. This construction discloses a crucial point: that motive waves do not always point
upward, and corrective waves do not always point downward. The mode of a wave is
determined not by its absolute direction but primarily by its relative direction. Aside
from four specific exceptions, which will be discussed later in this course, waves
divide in motive mode (five waves) when trending in the same direction as the wave
of one larger degree of which it is a part, and in corrective mode (three waves or a
variation) when trending in the opposite direction. Waves (a) and (c) are motive,
trending in the same direction as wave [2]. Wave (b) is corrective because it corrects
wave (a) and is countertrend to wave [2]. In summary, the essential underlying
tendency of the Wave Principle is that action in the same direction as the one larger
trend develops in five waves, while reaction against the one larger trend develops in
three waves, at all degrees of trend.
The phenomena of form, degree and relative direction are carried one step
further in Figure 4. This illustration reflects the general principle that in any market
cycle, waves will subdivide as shown in the following table.
Number of Waves at Each Degree
Impulse + Correction = Cycle
Largest waves 1 + 1 =2
Largest subdivisions 5 + 3 =8
Next subdivisions 21 + 13 =34
Next subdivisions 89 + 55 =144
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Figure 4
As with Figures 2 and 3, neither does Figure 4 imply finality. As before, the
termination of yet another eight wave movement (five up and three down) completes
a cycle that automatically becomes two subdivisions of the wave of next higher
degree. As long as progress continues, the process of building to greater degrees
continues. The reverse process of subdividing into lesser degrees apparently continues
indefinitely as well. As far as we can determine, then, all waves both have and are
component waves.
WHY 5 -3?
Elliott himself never speculated on why the market's essential form was five waves to
progress and three waves to regress. He simply noted that that was what was
happening. Does the essential form have to be five waves and three waves? Think
about it and you will realize that this is the minimum requirement for, and therefore
the most efficient method of, achieving both fluctuation and progress in linear
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Elliott Wave Principle
movement. One wave does not allow fluctuation. The fewest subdivisions to create
fluctuation is three waves. Three waves in both directions does not allow progress. To
progress in one direction despite periods of regress, movements in the main trend
must be at least five waves, simply to cover more ground than the three waves and
still contain fluctuation. While there could be more waves than that, the most efficient
form of punctuated progress is 5-3, and nature typically follows the most efficient
path.
WAVE DEGREE
All waves may be categorized by relative size, or degree. Elliott discerned nine
degrees of waves, from the smallest wiggle on an hourly chart to the largest wave he
could assume existed from the data then available. He chose the names listed below to
label these degrees, from largest to smallest:
“Grand Supercycle”, “ Supercycle”, “ Cycle”, “ Primary”, “Intermediate”, “Minor”,
“Minute”, “Minuette”, “Subminuette”
Cycle waves subdivide into Primary waves that subdivide into Intermediate waves
that in turn subdivide into Minor and sub-Minor waves. By using this nomenclature,
the analyst can identify precisely the position of a wave in the overall progression of
the market, much as longitude and latitude are used to identify a geographical
location.
When numbering and lettering waves, some scheme such as the one shown
below is recommended to differentiate the degrees of waves in the stock market's
progression:
Wave Degree 5s With the Trend 3s Against the Trend
Supercycle (I) (II) (III) (IV) (V) (A) (B) (C)
Cycle I II III IV V A B C
Primary [1] [2] [3] [4] [5] [A] [B] [C]
Intermediate (1) (2) (3) (4) (5) (a) (b) (c)
Minor 1 2 3 4 5 A B C
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Minute i ii iii iv v a b c
Minuette 1 2 3 4 5 a b c
The above labels preserve most closely Elliott's notations and are traditional, but a list
such as that shown below provides a more orderly use of symbols:
Wave Degree 5s With the Trend 3s Against the Trend
Grand Supercycle [I] [II] [III] [IV] [V] [A] [B] [C]
Supercycle (I) (II) (III) (IV) (V) (A) (B) (C)
Cycle I II III IV V A B C
Primary I II III IV V A B C
Intermediate [1] [2] [3] [4] [5] [a] [b] [c]
Minor (1) (2) (3) (4) (5) (a) (b) (c)
Minute 1 2 3 4 5 a b c
Minuette 1 2 3 4 5 a b c
Elliott Wave personality and characteristics
Elliott wave analysts (or Elliotticians) hold that each individual wave has its own
signature or characteristic, which typically reflects the psychology of the moment.
Understanding those personalities is key to the application of the Wave Principle; they
are defined below.
Five wave pattern (dominant trend)
Wave 1: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.
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Wave 2: Wave two corrects wave one, but can never extend beyond the starting point
of wave one. Typically, the news is still bad. As prices retest the prior low, bearish
sentiment quickly builds, and "the crowd" haughtily reminds all that the bear market
is still deeply ensconced. 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 61.8% (see Fibonacci section below) of the wave one gains, and
prices should fall in a three wave pattern.
Wave 3: 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. Anyone
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looking to "get in on a pullback" will likely miss the boat. As wave three starts, the
news is probably still bearish, and most market players remain negative; but by wave
three's midpoint, "the crowd" will often join the new bullish trend. Wave three often
extends wave one by a ratio of 1.618:1.
Wave 4: Wave four is typically clearly corrective. Prices may meander sideways for
an extended period, and wave four typically retraces less than 38.2% of wave three
(see Fibonacci relationships below). 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: 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
Three wave pattern (corrective trend)
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. By this point, fundamentals are probably no longer
improving, but they most likely have not yet turned negative.
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Wave C: Prices move impulsively lower in five waves. Volume picks up, and by the
third leg of wave C, almost everyone realizes that a bear market is firmly entrenched.
Wave C is typically at least as large as wave A and often extends to 1.618 times wave
A or beyond.
Wave Patterns
A complete wave is divided into 5 impulse waves and 3 corrective waves.
Various patterns are form to make a complete impulse wave and corrective wave.
Studying the patterns is very important in order to apply the Elliott Wave Principle
correctly. The pattern of the market action, if correctly determined, not only tells you
to what price levels the market will rise or decline, but also in which way (or pattern)
this will happen.
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Chapter 3
Motive Wave
Impulse Wave
Extension
Truncation
Diagonal triangle
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Motive waves subdivide into five waves with certain characteristics and always
move in the same direction as the trend of one larger degree. They are straightforward
and relatively easy to recognize and interpret. There are two types of motive waves:
impulses and diagonal triangles.
A) Impulse Wave
Impulses are always composed of five waves, labeled 1,2,3,4,5. Waves 1, 3
and 5 are themselves each impulsive patterns and are approximately equal in length.
Waves 2 and 4 on the contrary are always corrective patterns. Figure 3 are example of
impulse wave. Figure 5 shows the formation of impulse wave during bull and bear
market.
Bull(motive) Figure 5 Bear(corrective)
Rules and guidelines
The most important rules and guidelines are:
Wave 2 cannot be longer in price than wave 1, and it must not go beyond the
origin of wave 1.
Wave 3 is never the shortest when compared to waves 1 and 5.
Wave 4 cannot overlap wave 1, except in diagonal triangles and sometimes in
wave 1 or A waves, but never in a third wave. In most cases there should not
be an overlap between wave 1 and A.
As a guideline the third wave shows the greatest momentum, except when the
fifth is the extended wave.
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Wave 5 must exceed the end of wave 3.
The internal wave structure should show alternation, which means different
kind of corrective structures in wave 2 and 4.
Formed in which wave?
Impulse patterns occur in waves 1, 3, 5 and in waves A and C of a correction( this correction
Could be a wave 2, 4 or a wave B, D, E or wave X).
Internal structure It is composed of five waves. The internal structure of these waves is 5-3-5-3-
5. Note that the mentioned 3s are corrective waves, which should be composed
of 5 waves in a corrective triangle.
B) Extension
Bull(motive) Figure 6 Bear(corrective)
Most impulses contain what Elliott called an extension. Extensions are
elongated impulses with exaggerated subdivisions. The vast majority of impulse
waves do contain an extension in one and only one of their three actionary subwaves.
At times, the subdivisions of an extended wave are nearly the same amplitude and
duration as the other four waves of the larger impulse, giving a total count of nine
waves of similar size rather than the normal count of "five" for the sequence. In a
nine-wave sequence, it is occasionally difficult to say which wave extended.
However, it is usually irrelevant anyway, since under the Elliott system, a count of
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nine and a count of five have the same technical significance. The diagrams in Figure
6, illustrating extensions, will clarify this point.
It is quite common that one of these waves will extend, which is normally the
third wave. The two other waves then tend to equal each other. In our pattern
definitions we call it an Extension1 if the first wave Extends, an Extension3 if the 3rd
wave extends and an Extension5 if the 5th wave extends.
Rules and guidelines
The most important rules and guidelines concerning an extended wave are:
It is composed of 5, 9, 13 or 17 waves.
Wave 2 cannot be longer in price length than wave 1, so it should not go
beyond the origin of wave 1.
Wave 3 is never the shortest when compared to waves 1 and 5.
Wave 4 cannot overlap wave 1.
Wave 5 exceeds the end of wave 3.
The extended wave normally shows the highest acceleration.
Formed in which wave?
Extensions occur in waves 1, 3, 5, and in A and C waves, when compared to
each other
Internal structure
As a minimum it is composed of 9 waves, though 13 or 17 waves could occur.
The minimal internal structure of the 9 waves is 5-3-5-3-5-3-5-3-5.
Note that the 3s mentioned are corrective waves, which could be composed of 5
waves in the case of a corrective triangle.
C) Truncation
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Bull(motive) Figure 7 Bear(corrective)
Elliott used the word "failure" to describe a situation in which the fifth wave does not
move beyond the end of the third. We prefer the less connotative term, "truncation,"
or "truncated fifth." A truncation can usually be verified by noting that the presumed
fifth wave contains the necessary five subwaves, as illustrated in 7. Truncation often
occurs following an extensively strong third wave.
Rules and guidelines
The most important rules and guidelines are:
Wave 2 cannot be longer in price distance than wave 1, so it should not go beyond
the origin of wave 1.
Wave 3 is never the shortest when compared to waves 1 and 5.
Wave 4 cannot overlap wave 1, except for diagonal triangles and sometimes in
waves 1 or A, but never in a third wave. There should not be overlap between
wave 1 and A.
Wave 5 fails to go beyond the end of wave 3.
As a guideline the third wave shows the greatest momentum.
As a guideline the internal wave structure should show alternation, which means
different kinds of corrective structures.
Formed in which wave?
A failure can only occur in a fifth wave or a C wave, but normally not in the
fifth wave of wave 3.
Internal structure
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Elliott Wave Principle
Composed of Five wave.
D) Diagonal triangle
A diagonal triangle is a motive pattern yet not an impulse, as it has one or two
corrective characteristics. Diagonal triangles substitute for impulses at specific
locations in the wave structure. As with impulses, no reactionary subwave fully
retraces the preceding actionary subwave, and the third subwave is never the shortest.
However, diagonal triangles are the only five-wave structures in the direction of the
main trend within which wave four almost always moves into the price territory of
(i.e., overlaps) wave one. On rare occasions, a diagonal triangle may end in a
truncation, although in our experience such truncations occur only by the slimmest of
margins.
There are two type of diaonal:-a) Ending Diagonalb) Leading Diagonal
a)Ending Diagonal
Bull(motive) Figure 8 Bear(corrective)
An ending diagonal is a special type of wave that occurs primarily in the fifth
wave position at times when the preceding move has gone "too far too fast," as Elliott
put it. A very small percentage of ending diagonals appear in the C wave position of
A-B-C formations. In double or triple threes , they appear only as the final "C" wave.
In all cases, they are found at the termination points of larger patterns, indicating
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exhaustion of the larger movement. Ending diagonals take a wedge shape within two
converging lines, with each subwave, including waves 1, 3 and 5, subdividing into a
"three," which is otherwise a corrective wave phenomenon. The ending diagonal is
illustrated in Figures 8.
Rules and guidelines
The most important rules and guidelines are:
It is composed of 5 waves.
Waves 4 and 1 do overlap.
Wave 4 can’t go beyond the origin of wave 3.
Wave 3 cannot be the shortest wave.
Internally all waves of the diagonal have a corrective wave structure.
Wave 1 is the longest wave and wave 5 the shortest.
The channel lines of Diagonals must converge.
As a guideline the internal wave structure should show alternation, which
means different kind of corrective structures.
Formed in which wave?
Ending Diagonal triangles type 1 occur in waves 5, C and sometimes in wave
1.
Internal structure
The internal structure of the five waves is 3-3-3-3-3.
b) Leading Diagonal
When diagonal triangles occur in the wave 5 or C position, they take the 3-3-
3-3-3 shape that Elliott described. However, it has recently come to light that a
variation on this pattern occasionally appears in the wave 1 position of impulses and
in the wave A position of zigzags. The characteristic overlapping of waves 1 and 4
and the convergence of boundary lines into a wedge shape remain as in the ending
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Elliott Wave Principle
diagonal triangle. However, the subdivisions are different, tracing out a 5-3-5-3-5
pattern. The structure of this formation (see Figure 9) fits the spirit of the Wave
Principle in that the five wave subdivisions in the direction of the larger trend
communicate a "continuation" message as opposed to the "termination" implication of
the three-wave subdivisions in the ending diagonal. Analysts must be aware of this
pattern to avoid mistaking it for a far more common development, a series of first and
second waves. The main key to recognizing this pattern is the decided slowing of
price change in the fifth subwave relative to the third. By contrast, in developing first
and second waves, short term speed typically increases, and breadth (i.e., the number
of stocks or subindexes participating) often expands.
Bull(motive) Figure 9 Bear(corrective)
Rules and guidelines
The most important rules and guidelines are:
It is composed of 5 waves.
Wave 4 and 1 do overlap.
Wave 4 can’t go beyond the origin of wave 3.
Wave 3) cannot be the shortest wave.
Internally waves 1, 3 and 5 have an impulsive wave structure.
Wave 1 is the longest wave and wave 5 the shortest.
As a guideline the internal wave structure should show alternation, which
means that wave 2 and 4 show a different kind of corrective structure.
Formed in which wave?
Leading diagonal triangles type 2 occur in waves 1 and A.
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Elliott Wave Principle
Internal structure
The five waves of the diagonal type 2 show an internal structure of 5-3-5-3-5.
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Elliott Wave Principle
Chapter 4
Corrective Wave
Zigzags (5-3-5)
Flat (3-3-5)
Triangles(3-3-3-3-3)
Corrective Combinations
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Elliott Wave Principle
Markets move against the trend of one greater degree only with a seeming
struggle. Resistance from the larger trend appears to prevent a correction from
developing a full motive structure. This struggle between the two oppositely trending
degrees generally makes corrective waves less clearly identifiable than motive waves,
which always flow with comparative ease in the direction of the one larger trend. As
another result of this conflict between trends, corrective waves are quite a bit more
varied than motive waves. Further, they occasionally increase or decrease in
complexity as they unfold so that what are technically subwaves of the same degree
can by their complexity or time length appear to be of different degree. For all these
reasons, it can be difficult at times to fit corrective waves into recognizable patterns
until they are completed and behind us. As the terminations of corrective waves are
less predictable than those for motive waves, the Elliott analyst must exercise more
caution in his analysis when the market is in a meandering corrective mood than when
prices are in a persistently motive trend.
The single most important rule that can be gleaned from a study of the various
corrective patterns is that corrections are never fives. Only motive waves are fives.
For this reason, an initial five-wave movement against the larger trend is never the
end of a correction, only part of it. Corrective processes come in two styles. Sharp
corrections angle steeply against the larger trend. Sideways corrections, while always
producing a net retracement of the preceding wave, typically contain a movement that
carries back to or beyond its starting level, thus producing an overall sideways
appearance.
Specific corrective patterns fall into four main categories:
Zigzags (5-3-5; includes three types: single, double, and triple);
Flats (3-3-5; includes three types: regular, expanded, and running);
Triangles (3-3-3-3-3; four types: three of the contracting variety (ascending,
descending, and symmetrical) and one of the expanding variety (reverse
symmetrical);
Double threes and triple threes (combined structures).
Zigzags (5-3-5)
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Elliott Wave Principle
A Zigzag is the most common corrective structure, which starts a sharp
reversal. Often it looks like an impulsive wave, because of the acceleration it shows.
A zigzag can extend itself into a double or triple zigzag, although this is not very
common, because it lacks alternation (the same two patterns follow each other).
Notice that the zigzag can only be the first part of a corrective structure. Figure 10
illustrate the example of ZigZag Wave.
Bull(motive) Figure 10 Bear(corrective)
Rules and guidelines
It is composed of 3 waves.
Waves A and C are impulses, wave B is corrective.
The B wave retraces no more then 61.8% of A.
The C wave must go beyond the end of A.
The C wave normally is at least equal to A.
Formed in which wave?
Most of the time it happens in A, X or 2. Also quite common in B waves as a part
of a Flat,
Internal structure
A single Zigzag is composed of 3 waves, a double of 7 waves separated by an X
wave in the middle, a triple of 11 waves separated by two X waves (see pictures
below).
The internal structure of the 3 waves is 5-3-5 in a single Zigzag, 5-3-5-3-5-3-5 in a
double.
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Elliott Wave Principle
Example of a Double Zigzag
As you have noticed we have a more modern representation of the Double
Zigzag using the labels WXY instead of ABCXABC. This is more consistent, since
this way 2 zigzags of lower degree get connected to each other by waves of higher
degree. On top if that, our automatic analysis needed such a consistent method of
labeling to reach maximum performance. Instead of labeling 7 waves (ABCXABC),
in our daily analysis we need to label only 3 waves (WXY). According to the same
method a Triple Zigzag is represented by WXYXZ instead of ABCXABCXABC.
This way the number of waves was reduced to five instead of eleven. Figure 11.
Bull(motive) Figure 11 Bear(corrective)
Flat (3-3-5)
A flat correction differs from a zigzag in that the subwave sequence is 3-3-5,
as shown in Figures 12. Since the first actionary wave, wave A, lacks sufficient
downward force to unfold into a full five waves as it does in a zigzag, the B wave
reaction, not surprisingly, seems to inherit this lack of countertrend pressure and
terminates near the start of wave A. Wave C, in turn, generally terminates just slightly
beyond the end of wave A rather than significantly beyond as in zigzags
Flat corrections usually retrace less of preceding impulse waves than do
zigzags. They participate in periods involving a strong larger trend and thus virtually
always precede or follow extensions. The more powerful the underlying trend, the
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Elliott Wave Principle
briefer the flat tends to be. Within impulses, fourth waves frequently sport flats, while
second waves do so less commonly.
A) Regular Flat
Flats are very common forms of corrective patterns, which generally show a
sideways direction. Waves A and B of the Flat are both corrective patterns. Wave C
on the contrary is an impulsive pattern. Normally wave C will not go beyond the end
of wave A. Illustrated in Figure 12.
Bull(motive) Figure 12 Bear(corrective)
Rules and guidelines
It is composed of 3 waves.
Wave C is an impulse, wave A and B are corrective.
Wave B retraces more then 61.8% of A.
Wave B often shows a complete retracement to the end of the previous
impulse wave.
Wave C shouldn’t go beyond the end of A.
Normally wave C is at least equal to A.
Formed in which wave?
It occurs mostly in B waves, though also quite common in 4 and 2.
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Elliott Wave Principle
Internal structure
As mentioned before a Flat consists of 3 waves.
Both waves A and B normally are Zigzags and Wave C is an impulse form.
B) Expanded Flat or Irregular Flat
Bull(motive) Figure 13 Bear(corrective)
This is a common special type of Flat. Here the B wave is extended and goes
beyond the (orthodox) end of the previous impulsive wave. The strength of the B
wave shows that the market wants to go in the direction of B. Often a strong
acceleration will take place, which starts a third wave or an extended fifth. If the C
wave is much longer then A, the strength will be less. Illustrated in Figure 13.
Rules and guidelines
It is composed of 3 waves.
Wave C is an impulse, waves A and B are corrective.
Wave B retraces beyond the end of the previous impulse, which is the start
of wave A. The C wave normally is much longer then A.
Formed in which wave?
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Elliott Wave Principle
This corrective pattern can happen in 2, 4, B and X. If it happens in 2 and C is
relatively short, normally an acceleration in the third will take place.
Internal structure
It is composed of three waves, which have an internal structure of 3-3-5.
C) Running Flat
There are hardly any examples of this type of correction in the price record.
Wave B goes beyond the starting level of wave A as the sentiments are towards the
wave of higher degree but Wave C neither ends near the level of wave A nor above
that. Wave C ends near 61.8% of Wave B.
Bull(motive) Figure 14 Bear(corrective)
Rules and guidelines
It is composed of 3 waves.
Wave C is an impulse, waves A and B are corrective.
Wave B retraces beyond the end of the previous impulse, which is the start
of wave A. The C wave do not goes beyond the starting of Wave B.
Formed in which wave?
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Elliott Wave Principle
This corrective pattern can happen in 2, 4, B and X. If it happens in 2 and C is
relatively short, normally an acceleration in the third will take place.
Internal structure
It is composed of three waves, which have an internal structure of 3-3-5.
Triangles(3-3-3-3-3)
Triangles appear to reflect a balance of forces, causing a sideways movement
that is usually associated with decreasing volume and volatility. Triangles contain five
overlapping waves that subdivide 3-3-3-3-3 and are labeled a-b-c-d-e. A triangle is
delineated by connecting the termination points of waves a and c, and b and d. Wave e
can undershoot or overshoot the a-c line, and in fact, our experience tells us that it
happens more often than not. There are two varieties of triangles: contracting and
expanding. Within the contracting variety, there are three types: symmetrical,
ascending, and descending. A triangle is a corrective pattern, which can contract or
expand. Furthermore it can ascend or descend. It is composed of five waves, each of
them has a corrective nature
A) Contracting Triangle
. Contracting Triangle is a pattern where the size of the triangle keeps on
contracting as the pattern is formed and wave E is the shortest wave and wave A will
be longest.
Rules and guidelines
It is composed of 5 waves.
Wave 4 and 1 do overlap.
Wave 4 can’t go beyond the origin of wave 3.
Wave 3 cannot be the shortest wave.
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Elliott Wave Principle
Internally all waves of the diagonal have a corrective wave structure.
In a contracting Triangle, wave 1 is the longest wave and wave 5 the shortest.
Triangles normally have a wedged shape, which follows from the previous.
As a guideline the internal wave structure should show alternation.
Formed in which wave?
Triangles occur only in waves B, X and 4. Never in wave 2 or A.
Internal structure
It is composed of five waves, of which the internal structure is 3-3-3-3-3.
B) Expanding Triangle
Expanding Triangle is the pattern where the size of the triangle keeps on
increasing as the pattern is formed. The last wave E will be the longest wave and
wave A will be the shortest wave.
Rules and guidelines
It is composed of 5 waves.
Internally all waves of the diagonal have a corrective wave structure.
Triangles normally have a wedged shape, which follows from the previous.
In an expanding Triangle, wave 1 is the shortest and wave 5 the longest.
As a guideline the internal wave structure should show alternation.
Formed in which wave?
Triangles occur only in waves B, X and 4. Never in wave 2 or A.
Internal structure
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Elliott Wave Principle
It is composed of five waves, of which the internal structure is 3-3-3-3-3.
Figure 14
Corrective Combinations
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Elliott Wave Principle
Double and Triple Threes
Elliott called sideways combinations of corrective patterns "double threes" and
"triple threes." While a single three is any zigzag or flat, a triangle is an allowable
final component of such combinations and in this context is called a three." A double
or triple three, then, is a combination of simpler types of corrections, including the
various types of zigzags, flats and triangles. Their occurrence appears to be the flat
correction's way of extending sideways action. As with double and triple zigzags,
each simple corrective pattern is labeled W, Y and Z. The reactionary waves, labeled
X, can take the shape of any corrective pattern but are most commonly zigzags. Many
kinds of combinations are possible. Below a rather complex example has been
depicted in Figure 15.
Figure 15
A Combination combines several types of corrections. These corrections are
labeled as WXY and WXYXZ if it is even more complex. It starts for example with a
Zigzag (wave W), then an intermediate X wave, then a Flat (wave Y) and so on. A so-
called double or triple three is also a Combination, but this pattern combines Flats
separated by X waves.
Rules and guidelines
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Elliott Wave Principle
All types of corrective patterns can combine to form a bigger corrective
pattern.
The rules and guidelines, as mentioned for other corrective patterns apply.
A triangle in a Combination should normally occur at the end.
Corrective patterns in a Combination normally show alternation.
Formed in which wave?
Generally a Combination occurs mostly in B, X and 4, it is less common in A and
rare in 2.
Internal structure
For example a Zigzag, followed by a Flat, followed by a Triangle has the
following 5-3-5(Zigzag)-5-3-5(X)-3-3-5(Flat)-3-3-3-3-3(Triangle).
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Elliott Wave Principle
Chapter 5
CHANNELING
Targets for wave 3
Targets for wave 4
Targets for wave 5
Targets for wave D and E
Targets in a Double Zigzag
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Elliott Wave Principle
Channeling is an important tool not only to determine which sub waves belong
together, but also to project targets for the next wave up.
Channels are parallel lines, which more or less contain the complete price
movement of a wave. Although the trend lines of a Triangle are not parallel lines, they
will also be considered as a channel. Underneath you see an example of a channel in
an impulsive wave and all channels in a corrective wave. Note that all patterns in the
section “Patterns” show their channels.
The picture of the corrective structure labeled A, B, C shows clearly how
channels indicate which waves should be grouped together.
Figure 16
Waves of the same degree can be recognized by drawing channels. Especially
this is the case for Impulse (5) wave structures, Zigzags and Triangles. If these waves
do not equate properly, you have a strong indication to search for an alternative count.
Next is how to draw channels and how to project targets using channels.
Targets for wave 3
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Elliott Wave Principle
To begin with you should draw a channel as soon as waves 1 and 2 are
finished. Connect the origin of wave 1, which has been labeled as zero, and the end of
wave 2. Then draw a parallel line from the top of wave 1.
Generally this channel is regarded as not being very useful, but it is. First of
all, the parallel line serves as an absolute minimum target for the 3rd wave under
development. If the 3rd wave can’t break through the upper line or fails to reach it,
you are probably dealing with a C wave instead of wave 3.
Furthermore the base line from 0 to wave 2 serves as a stop. When this base
line gets broken, there is a strong probability that wave 2 (or B) gets more complex,
thus wave 3 or C has not begun yet.
Keep in mind that wave 3 is normally the strongest wave and often will go far
beyond the upper trend line.
Figure 17
Targets for wave 4
As soon as wave 3 is finished you can draw a channel by connecting the end
of wave 1 and wave 3 with a trend line and drawing a parallel line from the end of
wave 2. In this way you can project a target for wave 4. Keep in mind that normally
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Elliott Wave Principle
the base line from wave 2 will be broken slightly by the price action of wave 4. The
base line serves as a minimum target for wave 4. If wave 4 doesn’t come near the base
line at all, this is a sign of a very strong trend. You are probably still in wave 3 or you
should get ready for a blow off in wave 5.
Figure 18
Targets for wave 5
Method 1
As soon as wave 4 is finished you can draw a channel connecting the end of
wave 2 and wave 4 with a trend line by drawing a parallel line from the end of wave
3. In this way you can project a target for wave 5. In most cases wave 5 will fail to
reach the upper trend line, except when you are dealing with an extension in wave 5
or when wave 3 has been relatively weak. In an extension, which is also indicated by
high volume and momentum indicators, a throw over can occur.
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Elliott Wave Principle
Figure 19
Mostly wave 3 is the strongest wave showing a very fast acceleration relative
to waves 1 and 5. If wave 3 indeed shows a nearly vertical rise or decline, then draw a
trend line connecting wave 2 and 4 and draw a parallel line from wave 1(!). This
parallel line will cut through wave 3 and will target wave 5. Experience shows this to
be a very valuable channel.
Figure 20
Targets for wave D and E
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Elliott Wave Principle
As soon as wave B is finished you can draw a trend line connecting the origin
of wave A and the end of wave B to get a target for wave D, provided a triangle
indeed is developing. This is more certain after completion of wave C.
As soon as wave C is finished you can draw a trend line connecting wave A
and the end of wave C to get a target for wave E. Wave E almost never stops at the
trend line precisely, it either never reaches the trend line or it overshoots the trend line
fast and temporarily.
Figure 21
Targets in a Double Zigzag
Drawing a channel is very useful to separate Double Zigzags from impulsive
waves, which is difficult since both have impulsive characteristics. Double Zigzags
tend to fit a channel almost perfectly, while in an impulsive wave the third wave
clearly breaks out of the channel.
Figure 22
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Elliott Wave Principle
Chapter 5
FIBONACCI RATIO
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Elliott Wave Principle
The Fibonacci series are a mathematical sequence in which any number is the
sum of the two preceding numbers. The sequence goes as follows: 1, 2, 3, 5, 8, 13, 21,
34, 55, 89, 144 and so on. The properties of this sequence appear throughout nature
and in the arts and science. Most notable is the ratio of 1.618 which is called the
“Golden Mean”. It was discovered even in ancient times. The number can be
approached by dividing a Fibonacci number by its preceding number as the sequence
extends into infinity. The ratio of .618 is also very prominent when analyzing
Fibonacci relationships. The wave counts of the impulse and corrective patterns 5 + 3
= 8 are Fibonacci numbers.
Analyzing Fibonacci relationships between price movements is important
for several reasons:
You can control your wave analysis.
The better the Fibonacci ratios of your wave count, the more accurate your
count is, because in some way or the other all waves are related to each other.
You can project realistic targets once you have distinguished different
scenarios, which point in the same direction.
Since Fibonacci manifests itself in the proportions of one wave to another,
waves are often related to each other by the ratios of 2.618, 1.618, 1, 0.618,
0.382 and 0.236. This fact can help you in estimating price targets for
expected waves. If , for example a wave 1 or A of any degree has been
completed, you can project retracements of 0.382, 0.50 and .618 for wave 2 or
B, which will give you your targets.
Most of the time the third wave is the strongest, so often you will find that
wave 3 is approximately 1.618 times wave 1.
Wave 4 normally shows a retracement, which is less than wave 2, like 0.236
or 0.382. If wave three is the longest wave, the relationship between wave 5
and three often is 0.618.
Also wave 5 equals wave 1 most of the time.
The same relationship can be found between A and C waves. Normally C
equals A or is 1.618 times the length of A.
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Elliott Wave Principle
You can even combine waves to find support and resistance zones. For
example the next price movement of wave 1 and 3 times 0.618 creates another
interesting target for wave 5.
It is worthwhile to experiment a lot with your wave count, Fibonacci will help
you to solve the rhythm of the markets.
Expected Targets
Wave 1
The first wave of a new impulsive price movement tends to stop at the base of
the previous correction, which is the B wave. The often coincides with a38.2% or a
61.8% retracement of the previous correction.
Wave 2
Wave 2 minimally retraces 38.2% and mostly 61.8% or more of wave 1. It
often stops at subwave 4 and more often at subwave 2 of previous wave 1. A retrace
of more than 76% is highly suspicious, although it doesn’t break any rules yet.
Figure 23
Above Figure shows that when the correction is sharp the price retrace to 61.8% of the wave 1 and when the correction is side ways the price retrace upto 38.2%.
Wave 3
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Elliott Wave Principle
Wave 3 minimally is equal to wave 1, except for a Triangle. If wave 3 is the
longest wave it will tend to be 161% of wave 1 or even 26l%.
Wave 4
Wave 4 minimally retraces 23% of wave 3 and more often reaches a 38.2%
retracement. It normally reaches the territory of subwave 4 of the previous 3rd wave.
In very strong markets wave 4 could only retrace 14% of wave 3.
Wave 5
Wave 5 normally is equal to wave 1 or travels a distance of 61.8% of the
length of wave 1. It could also have the same relationships to wave 3 or it could travel
61.8% of the net length of wave 1 and 3 together. If wave 5 is the extended wave it
mostly will be 161.8% of wave 3 or 161.8% of the net length of wave 1 and 3
together.
Figure below shows the expected movements of the price in wave 5 (When there is no
extension in the entire wave).
Figure 24
Figure below shows the expected movements of the price in wave 5 (When there is
extension in the entire wave).
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Elliott Wave Principle
Figure 25
Wave A
After a Triangle in a fifth wave, wave A retraces to wave 2 of the Triangle of
previous wave 5. When wave A is part of a Triangle, B or 4 it often retraces 38.2% of
the complete previous 5 wave (so not only the fifth of the fifth) into the territory of
the previous 4th wave. In a Zigzag it often retraces 61.8% of the fifth wave.
Wave B
In a Zigzag wave B mostly retraces 38.2% or 61.8% of wave A. In a Flat, it is
approximately equal to wave A. In an Expanded Flat, it usually will travel a distance
of 138.2% of wave A.
Wave C
Wave C minimally has a length of 61.8% of wave A. It could be shorter in
which case it normally is a failure, which foretells an acceleration in the opposite
direction. Generally wave C is equal to wave A or travels a distance of 161.8% of
wave A. Wave C often reaches 161.8% of the length of wave A in an Expanded Flat.
In a contracting Triangle wave C often is 61.8% of wave A.
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Elliott Wave Principle
Figure 26
Wave D
In a contracting Triangle wave D often travels 61.8% of wave B.
Wave E
In a contracting Triangle wave E often travels 61.8% of wave C. It cannot be longer
than wave C.
Wave X
Wave X minimally retraces 38.2% of the previous A-B-C correction; a retracement of
61.8% is also common.
Explanation of the Fibonacci Retracement example.
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Elliott Wave Principle
Figure 27
Above is the chart of Nifty where we can see an impulse wave divided into:-
Wave 1 which is around 50% retracement of the previous subwave ‘c’ from 4530
to 4800.
Wave 2 retrace around 78.6% of wave 1.
Wave 3 is around 223% of wave 1.
Wave 4 retrace around 23.60% of wave 3.
Wave 5 is around 78.6% of total length of wave 1 and wave 3.
Below is the hierarchy of the whole Elliott wave patterns which is divided into Motive
wave and corrective wave. Both the wave are further divided into more sub-wave and
various patterns are bifurcated. (Figure 28-1 and 28-2)
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Elliott Wave Principle
Figure 28-1
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Elliott Wave Principle
Further Subdivision of combined corrective wave.
Figure 28-2
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Elliott Wave Principle
Chapter 6
TRADING WITH ELLIOTT WAVE
Design alternative scenarios by labeling a
chart.
Design a trading system
Control your emotions
Trading example
Practice
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Elliott Wave Principle
The Elliott Wave Principle provides you with the most objective and
disciplined method available for trading. Only a handful of patterns exist, sometimes
easy to recognize especially in strong impulsive waves. The still validated patterns tell
you where the market is heading, in what way (or structure) this will happen and
under what circumstances the pattern will produce a stronger probability. Also the
pattern will tell you when it is no longer valid due to the occurrence of an intolerable
price action. This makes it possible to exactly determine your entry and exit points,
which is an outstanding characteristic of the Elliott Wave Principle.
Some people, mainly those who can not successfully apply the Elliott Wave
Principle themselves, will tell you either it is too complex and subjective or that the
waves don’t exist at all, suggesting the market follows a random pattern.
Obviously the Elliott Wave Principle can get very complex- especially in
corrective waves- since you will have to look for patterns, which contain patterns,
which contain patterns etc. etc. But it will never lose its objectivity if you apply the
rules and guidelines. The only problem is that sometimes it is not totally clear if the
internal structure of a wave is a 3 wave or a 5 wave. In that case you will have to
determine alternatives for both internal wave structures and look for other
confirmations, such as channels, indicators and Fibonacci ratios.
Below the key steps for Elliott Wave analysis and supply basic trading
patterns to search for.
Now you can use the Automatic Analysis, to trade profitably. The more
probable an outcome the better the opportunities. The more the alternatives point in
the same direction the more certain that the market will move accordingly. The
Automatic analysis will generate an ever objective and consistent wave count and will
always present the most probable outcome first, through applying objective rules and
guidelines and through implementing a true Elliott Wave model.
Those who really would like to learn the Elliott Wave Principle must study the
ins and outs. In the following, we offer some directives. These directives come from
our own experience as well as from many publications on this subject. Of course
every trader or analyst should find his own path to success.
Study the patterns mentioned under the section 1, 2, and 3
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Elliott Wave Principle
Know the rules and guidelines.
Learn the internal structure of the patterns, which will enable you to recognize
a pattern within a pattern.
Remember that only waves 1,3,5, A and C can be impulsive waves.
All other waves are corrective, against the trend, and show overlap in their
internal structure.
Design alternative scenarios by labeling a chart.
1. Start labeling a chart by taking into account the following rules and guidelines:
Separate impulses from corrections. An impulse normally shows
acceleration and no overlap, a correction shows a sideways pattern.
Waves of the same degree should have the same proportions, which is
especially important for waves 2 and 4. A minuscule 4th wave cannot
belong to a big wave 2 and so on.
Wave 2 can never retrace more than 100% nor go beyond the origin of
wave 1.
Wave 3 normally is the longest wave and shows the most powerful
acceleration.
In wave 3 there is never an overlap between wave 4 and 1, as occurs in fifth
waves and first or A waves.
Label the big picture, is it a three or a five?
Label more in detail, by labeling the smaller wave degrees initially, then go
back to the large wave degrees, changing your labels if necessary.
Check if the required internal structure of your waves, comply with the
rules and guidelines. For example a B wave never can consist of five waves
and so on.
Check if the internal structure of the internal structure is correct. For
example an (expanded) Flat consists of a 3 wave, again a 3 wave and a 5-
wave structure. If this is not true, change your labeling.
Check your wave count for alternation, especially with waves 2 and 4. If
wave 2 showed a simple Zigzag, wave 4 should show a complex pattern.
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Elliott Wave Principle
A corrective pattern mostly minimally carries into the territory of the 4th
wave of the previous impulse wave.
Within a 5-wave impulse, two waves will tend to equality. If wave three is
the longest, wave 5 will tend to equality with wave 1.
Use momentum indicators and volume to support your wave labeling.
Wave 3 should have the highest momentum and volume (if it is the longest
wave).
Calculate the Fibonacci relationships. If your wave count reveals a lot of
reasonable Fibonacci ratios, you have found an interesting count.
Draw channels and determine if your wave count more or less fits these
channels. The better the fit, the better the count.
2. Design as many scenarios as the Wave Principle allows, with regard to the
wave degree or time frame you are analysing.
3. Do the same for shorter and longer time frames (or lower and higher wave
degrees) and try to narrow down alternatives by fitting them to a multiple of
wave degrees.
4. Assess the probabilities of these scenarios by studying their compliance with
the permitted internal wave structure, the outcome of the Fibonacci ratios and
the fit of the channels.
5. Draw the expected price action and pattern of each scenario you have
designed, mark price levels where you get signals to enter or exit the market.
Design a trading system
Determine what time frame (or wave degree) you would like to trade.
Determine which patterns and alternative wave counts give the best trading
opportunities, such as when several alternatives all produce a price movement in
the same direction.
Determine objective entry points based on patterns.
Determine objective exit points, also based on patterns. You should for example
exit a trade when a price movement makes your preferred wave count invalid.
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Control your emotions
Don’t be afraid to take a loss if your stop gets hit. This means you will have to
admit you were wrong on this trade. Don’t be afraid of loosing the (little) profit
you have made and only exit if your system or wave analysis tells you to.
Follow the rules of the Elliott Wave Principle and don’t second-guess the market.
Believe what Elliott Wave theory tells you, your stop will protect you.
Of course there will be loosing trades, a 100% score is impossible. But if you limit
your losses (by executing your stop) and let your profits run, you should be very
successful. So maintain your discipline and learn from all trades.
Trading example
In this section you will be shown how to recognize an impulsive wave from a
corrective wave. In the same way as these basic patterns are compared and analysed
here, you can do it yourself with all other patterns.
Suppose the market has experienced a big sell off. From the low it starts to
rise. Wave 1 (or A) and wave 2 (or B) have been completed and the market starts to
rise again. The first picture shows two scenarios possible, either an impulse (1,2,3) or
an A,B,C correction. The pictures thereunder demonstrate which price action to
expect in an impulse or in a correction:
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The pattern can be an impulse only if the 4th wave does not overlap the first, a
level indicated by the horizontal “stop” line. As soon as the price drops under this
line- before wave 5 has been completed- you have your first signal of a pending
correction (picture above at the right). This correction will be confirmed when the
price drops under the origin of wave C, which is the end of wave B. Provided it
doesn’t drop under the “confirmation” line, it could still be an extended 3rd wave that
subdivides. In that case the C or 3 wave is only wave 1 of the third wave! You will
find the pattern called extension under the chapter “Patterns”.
Practice
Now we will try to apply the theory above in practice, step by step.
Figure 29-1
In the previous graph you have already recognized a structure consisting of
three waves. Because there are three waves, we are dealing with a correction, which is
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a movement against the trend. Therefore the long-term trend is up and a new high will
be reached.
Underneath will be shown what happened next. Basically there are two
scenarios which could develop. Firstly the correction could be terminated at point C
and (2), finishing a Single Zigzag. Secondly a Flat or Expanded Flat could be
developing. Then this market at the minimum will reach its high in a 3-wave
structure, decline again to approximately point C and (2). Thereafter the larger
uptrend will resume and the market will reach uncharted territory. With the above in
mind it is crucial to determine if the rise will have the form of a 3 wave or a 5 wave.
Let’s take a look at the picture:
Figure 29-2
To conclude, let’s take a look at the following price action:
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By just looking at its form- the pattern has no overlap, you can tell this
definitely is a 5 wave, not a 3 wave and indeed it reached the old high at 3000.
This 5- wave is the first wave of a larger wave degree, also composed of five waves.
Therefore a minimal price increase of 25% (the same as wave 1) for the larger wave 3can be
Figure 29-3
calculated, which projects a target of approximately 4000.
Since the above chart displays the price action of the Dow Jones, we all know
what happened. The market corrected a bit, accelerated again and met a major
resistance at 4000 as the following picture demonstrates. Around 4000 again a
correction developed, indicating that the main trend was still up and projecting even
higher targets.
The same patterns evolve over and over again, enabling you to forecast the
markets and explain what happened afterwards. Simple, but effective trading strategy.
Since all patterns or their sub patterns are either 3 wave or 5 wave structures, it
follows that at the minimum always three waves will occur, no matter what happens.
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Therefore if you concentrate on the 3rd wave, which will be a wave 3 in an impulse or
wave C in a correction, you have a strong probability of making a profit.
The charts in the following pictures give an example of this strategy in a rising, as
well as a declining market.
Figure 29-4
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Figure 29-5
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Chapter 7
ELLIOTT WAVE AND OTHER INDICATORS
Relative Strength Index (RSI)
Moving Averages
Moving Average Convergence Divergence
(MACD)
Momentum
Rate of Change
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Relative Strength Index (RSI)
Relative Strength Index (RSI) is an oscillator developed by J. Welles Wilder,
JR. It is a very popular indicator and useful when applying the Elliott Wave. RSI
measures the strength of any price action by monitoring changes in its closing prices.
It is a leading or a coincident indicator, it never lags the price action. The RSI
indicator fluctuates between 0 and 100. Horizontal reference lines in the RSI are often
drawn at 30 and 70.
Trading RSI
RSI can give several buy or sell signals, which are divergences, patterns, trend
lines and the absolute level of RSI, the RSI levels as already mentioned. Divergences
are the most important signals.
Tip : Look for a divergence in the RSI within an impulse wave of any degree,
which is very helpful to determine a third wave. Normally a third wave shows the
most extreme reading of the RSI, the fifth wave should fail to surpass the low or high
of the RSI, set in the third wave of the same degree.
Divergences between RSI and prices give the strongest buy and sell signals.
Normally this happens at tops and lows in an impulsive wave, which consists of five
waves. If the C wave is equal in length to wave A, the RSI should also show a
divergence. Generally a divergence indicates that the trend is weak and ready to
reverse.
A bullish divergence gives a buy signal, when prices fall to a new low but RSI
fails to make a new low. You can buy as soon as the first RSI low has been below its
lower reference line (for example at 30) and the second low of the RSI happens above
the reference line. See below Figure 30
A bearish divergence works exactly the same, but the other way round. It
gives sell signals. You can sell as soon as the first RSI high has been above its higher
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reference line (for example at 70) and the second top of the RSI happens underneath
the reference line.
Trend lines, support and resistance lines, and patterns, like “head and
shoulders”, work fine with RSI. Because RSI leads the price chart, it often gives early
warnings of likely trend changes. RSI trend lines are enetrated before it happens in
the price chart and patterns can be completed a few days before completion in the
price chart. Of course the fifth wave of a RSI mostly is a failure, except when the fifth
wave is an extension.
RSI levels indicate that above 70 the market is overbought, which calls for a
correction, although the RSI can reach 80 and more in a bull market. Under 30 the
market is oversold, so a rise can be expected, but be careful because in a bear market
Figure 30
a RSI beneath 20 is quite common. So when the RSI goes above 70 and certainly
above 80, look for a selling opportunity. Beneath 30 and certainly 20 look to buy.
The chart above is shows the price movement of Tata Steel. After the
completion of impulse (motive) a correction of sideways is formed. Now have a look
at RSI indicators. A divergence is seen from a mid of Jan to Feb which gives a selling
signal. But Elliot Wave counts show a expanded flat pattern followed B wave(Zig
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Zag) and then a impulse wave in final C wave. RSI is above 70 right from the wave ,
which indicate selling signals. But price is making a higher high and failing to go
below base of wave 4.
Moving Averages
Moving averages can be calculated as a simple moving average, which gives
each day an equal weight. Also, an exponential moving average can be calculated,
where the latter days are heavier weighted.
A 10-day MA shows the average price for the past 10 days, a 30-day MA
shows the average price for the past 30 days. A moving average normally will be
displayed in the price chart as a line, by connecting each day's MA values.
Tip: Experiment with different time periods for a moving average and try to
figure out for the waves in a pattern if and by how much the MA line gets penetrated
by prices when using a specific period.
For example in a third wave or a C wave- if the time period has been set
correctly- the moving average line should not be penetrated after it has been broken
by the price. Wave 4 will break the moving average line, which tells you the end of
the trend is near.
With a moving average you can see the main trend more easily, because it
filters out the small price movements. When it rises, the moving average shows that
investors become more optimistic. When it falls, investors become more pessimistic.
An exponential moving average (EMA) is a better trend-following indicator
than a simple MA, because it responds faster to the latest price changes than a simple
MA and skips older data which are less relevant.
Trading Moving Averages
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For the investor moving averages are most helpful in following the trend. The
direction of its slope in each time frame tells you what the trend of this specific time
frame is. Be sure to trade in the direction of the trend of the time frame you use. When
you are trading a trend, you can use a short term MA as a stop
In the price chart you could also display a short term MA and a longer term
MA. When the shorter term MA crosses the longer MA in upward direction this is a
buy signal, which confirms the uptrend. When it dips under the longer term MA this
is regarded as a sell signal. Be careful with this signal, because a sideways market
shows a lot of crossovers and thus a lot of false signals.
You can also use a moving average as a stop. The shorter your investment
horizon the shorter your moving average should be. As soon as prices break the
moving average line you can close your position. This can be very useful if you want
to invest in a third wave only.
In Figure 31 you can see the moving averages (10, 25, 50). A signal is given
when a shorter days of moving averages cross a longer days of moving averages. A
10-MA crosess 25-MA at a price of 4850 and 25-MA crosses 50-MA around 5150.
Both signal are given when the Wave 3 was started. A Elliott wave analyst would
have entered the rally either at the start of wave 3 (after confirmation) or wave 1.
Thus Elliott wave helps to enter the market at the right timing.
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Figure 31
In Figure 31 you can see the moving averages (10, 25, 50). A signal is given
when a shorter days of moving averages cross a longer days of moving averages. A
10-MA crosses 25-MA at a price of 4850 and 25-MA crosses 50-MA around 5150.
Both signal are given when the Wave 3 was started. A Elliott wave analyst would
have entered the rally either at the start of wave 3 (after confirmation) or wave 1.
Thus Elliott wave helps to enter the market at the right timing. However moving
averages help us to confirm the trend of the market.
Moving Average Convergence Divergence (MACD)
Gerard Appel has constructed a more advanced indicator, called the Moving
Average Convergence-Divergence, or MACD, which is built of three exponential
moving averages. It is displayed as two lines, the MACD line and a the Signal line.
The MACD line is built out of two exponential moving averages (EMAs). The signal
line is built from the MACD line smoothed with another EMA. The MACD line
responds more quickly to changes in prices. Buy and sell signals occur when the fast
MACD line crosses above or below the slow Signal line.
Trading the MACD
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You can use the crossovers of the MACD and
signal lines to trade with the trend of the market.
The fast MACD line crossing above the slow Signal line gives a buy
signal,
The fast MACD line crossing below the slow Signal line gives a sell
signal
Also you can look for divergences as explained with the RSI to determine the
momentum of the market. Again a wave 3 should have the lowest (bear market) or
highest (bull market) MACD. Divergences in the MACD don’t work on longer term.
Figure 32
The above figure shows the price movement of ABB where the price has
formed a triangle shaped falling wedge (Ending Diagonal). But when you have a look
at MACD indicator the indicator is showing a divergence which gives a rising signal
of the price. The price of the stock is making a lower low but the price MACD
indicator is making a higher low. Normally this gives a buying signal but the falling
diagonal which divides into a, b, c, d and e states a fall in price.
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MACD can be used as a indicator as a divergence which states that there is a
end of the current corrective trend and the new wave or reversal trend is going to start.
Thus thought MACD is a lagging indicator it helps to forecast the change in trend.
Momentum
The Momentum indicator shows how strong the trend is by measuring its
acceleration. The faster Momentum gains or loses speed the more the trend
accelerates. This is a leading indicator, which usually reaches a peak before prices
reach their highs and reaches a low before prices reach their lows.
Trading Momentum
The trend is up as long as Momentum gets higher and higher, you can
normally hold on to your bullish positions. As long as it keeps reaching new lows,
you can hold on to your short trades. Every time Momentum reaches a new high, the
uptrend is still accelerating. Every time Momentum reaches a new low, the downtrend
is still accelerating.
When the direction of Momentum changes, without having set a divergence
already, be prepared for a reversal. You can use Momentum to catch large trends, for
this purpose use a longer time frame. If you want to spot changes in the trend quickly,
then use a shorter period Momentum.
When the direction of Momentum changes the pattern could be the third of a C
wave or the third of a five wave. A small correction will take place to form the 4th
wave. The fifth wave still has to develop in the same direction of the trend. When this
fifth wave is underway, you can cover your shorts or sell your longs.
Again a divergence is one of the most powerful signals, which normally
occurs in every five-wave structure. The bigger the divergence the sharper the
reversal can be. If Momentum fails to make a new high or low, this could be a C wave
or a five-wave structure, which depends on the wave structure of larger degree.
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If you can recognize five waves in a C wave in a larger trend, which points to
the opposite direction, and at the same time Momentum makes a lower top or a
higher low, it is better to close your (trend following) positions at once. After a C
wave the reversal could be quite sharp. On the other hand, if the larger trend is still
up, this only could be wave 3 with wave 4 and 5 to follow. Here you could hold on to
your positions depending on the wave degree you have determined. In a larger degree
a bigger reversal can be expected, making it worthwhile to exit. Later on you could
possibly reenter at a better price.
You can also draw trend lines or channels to identify support and resistance in
indicators. Usually Momentum breaks through its resistance a long time (relatively
speaking) before prices do. See chart below Figure 33 for example.
Figure 33
The gold have now completed the correction pattern of wave ABC . As you
can see in the chart that wave C went up forming a 5 wave pattern. After a correction
of wave 4 the price of gold went up again higher then wave 3, but the momentum
indicator made a lower high. Thus this indicated that the end of wave C.
Rate of Change
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Rate of Change is quite similar to Momentum, since it also measures the
strength of a trend. The only difference is that Rate of Change is calculated
differently. It divides today's price by a past price. The faster Rate of Change gains or
loses speed the more the trend accelerates. This is a leading indicator, which usually
reaches a peak before prices reach their highs and reaches a low before prices reach
their lows.
Trading Rate of Change (ROC)
The trend is up as long as Rate of Change gets higher and higher, you can
normally hold on to your bullish positions. As long as it keeps reaching new lows,
you can hold on to your short trades positions. Every time Rate of Change reaches a
new high, the uptrend is still accelerating. Every time Rate of Change reaches a new
low, the downtrend is still accelerating.
When the direction of Rate of Change changes, without having set a
divergence already, then be prepared for a reversal. You can use Rate of Change to
catch large trends, for this purpose use a longer time frame. If you want to spot
changes in the trend quickly, then use a shorter period for Rate of Change.
When the direction of Rate of Change changes, the pattern could be the third
of a C wave or the third of a five wave. A small correction will take place to form the
4th wave. The fifth wave still has to develop in the same direction of the trend. When
this fifth wave is underway, you can cover your shorts or sell your longs.
Again a divergence is one of the most powerful signals, which normally
occurs in every five-wave structure. The bigger the divergence the sharper the
reversal can be. If Rate of Change fails to make a new high or low, this could be a C
wave or a five-wave structure, which depends on the wave structure of larger degree.
If you can recognize five waves in a C wave in a larger trend, which points to
the opposite direction, and at the same time Rate of Change makes a lower top or a
higher low, it is better to close your (trend following) positions at once. After a C
wave the reversal could be quite sharp. On the other hand, if the larger trend is still
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up, this only could be wave 3 with wave 4 and 5 to follow. Here you could hold on to
your positions depending on the wave degree you have determined. In a larger degree
a bigger reversal can be expected, making it worthwhile to exit. Later on you could
possibly reenter at a better price. See momentum chart below Figure 34 tops for
example.
Figure 34
The chart above show the similar type of pattern and formation where the
price is in the corrective trend and the wave 5 structure is formed downwards which
state that the either end of wave C or Wave A. The formation of pattern in ending
diagonal and the ROC indicator is moving positive. The price of the stock is making
lower low and the ROC is making higher high, thus stating the end of the current
trend and reversal can be seen ahead.
Below are the figure of us dollar index (Fig 35) and Nifty (Fig 36) which
shows that the formation of Elliott wave patterns are formed and once the patterns is
confirmed the market move into predictive movement.
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Figure 35
Figure 36
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Findings
After completion of the project and analyzing the charts in chapter 6 and 7 I have
came down to various findings:
Elliott wave theory is applicable in the equity market to forecast the movement
of the price.
Price move in similar patterns over a period of time.
Other Technical indicators are lagging indicators as compared to Elliott wave
analysis.
Elliott wave theory help us to be precise about the expected movement of the
price in stock.
However other technical analysis indicator can be used to identify the
changing trend of the market.
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Conclusion
The Elliott Wave theory requires a high degree of subjectivity, which is one
reason why using the theory can be so problematic - finding agreement among
Elliott Wave practitioners can be rare.
The most basic tenet of Elliott Wave theory is that market movements are based
on crowd behavior, which can be predicted.
Traders, however, may often recognize a market move only after it has occurred.
Trading with Elliott Wave means applying a principle that is true for all trading in
general: expectations must be realistic, and money management is key to
profitability over the long-term; that is, losses must be kept small and profits must
be allowed to accumulate.
One way to use Elliott Theory is to find specific parts of the theory and transform
them into a workable trading system in which risk can be carefully controlled.
Approaching Elliott Wave may also mean putting less emphasis on the correct
wave count, and more attention on determining the count that has the least penalty
for being wrong. A trader can still be profitable if he or she determines the
primary direction of the trend, properly differentiates between the primary and
corrective waves, and uses tight stops and realistic profit targets.
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Recommendation
One can make use of the various Elliott Wave trading software program to
analyze the price movement and wave.
Use of GANN chart and Fibonacci Time Wave Sequence can be used for
identifying the changing trend.
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