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Elliott Wave Theory Ubs Formation

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Anatomy of Price Action
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Elliott Wave Theory Taso Anastasiou Director: FX/PM Global Technical Strategy Group UBS Investment Bank Phone : +44 (0)20 7567 6870 E-Mail : [email protected]
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Page 1: Elliott Wave Theory Ubs Formation

Elliott Wave Theory

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

Phone : +44 (0)20 7567 6870E-Mail : [email protected]

Page 2: Elliott Wave Theory Ubs Formation

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Elliott Wave theory

1

2

3

4

5

a

b

c

Page 3: Elliott Wave Theory Ubs Formation

Market PsychologySECTION 1

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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

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♦ 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

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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 �

Page 7: Elliott Wave Theory Ubs Formation

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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

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♦ 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

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♦ 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

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

Page 11: Elliott Wave Theory Ubs Formation

The Basics�Building on Dow theorySECTION 2

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♦ 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

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♦ 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

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♦ 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

Page 15: Elliott Wave Theory Ubs Formation

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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

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♦ 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

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♦ 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

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1

2

3

4

5

Summary of wave structure

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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

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1

2

3

4

5

Waves 2�4 are counter trend movements

Summary of wave structure (continued)

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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)

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USD/CAD

11

2

3

4

c

a

b

5

1

2

1

2

1

2

Page 23: Elliott Wave Theory Ubs Formation

Impulsive waves 1�3�5 SECTION 3

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♦ 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

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♦ 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

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♦ 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

Page 27: Elliott Wave Theory Ubs Formation

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♦ 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

Page 28: Elliott Wave Theory Ubs Formation

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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

Page 29: Elliott Wave Theory Ubs Formation

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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

Page 30: Elliott Wave Theory Ubs Formation

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Example of an extension

A

C

B

1

2

3

4

5

i

ii

v

iii

iv1

2

3

4

1

5

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In Practice - GBP/USD

Page 32: Elliott Wave Theory Ubs Formation

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In Practice - GBP/USD

1

2

3

4

5

Page 33: Elliott Wave Theory Ubs Formation

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In Practice - GBP/USD

1

2

3

4

5

a

a

b

c

b

c

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In Practice - GBP/USD

1

2

3

4

5

a

a

b

c

b

c

i

ii

iii

iv

v

Page 35: Elliott Wave Theory Ubs Formation

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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

Page 36: Elliott Wave Theory Ubs Formation

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Ending diagonal triangles

1

2

3

4

5

i

ii

iii

iv

iv

Page 37: Elliott Wave Theory Ubs Formation

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Ending diagonal triangles

1

2

3

4

5

1

2

3

4

5

Page 38: Elliott Wave Theory Ubs Formation

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♦ 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

Page 39: Elliott Wave Theory Ubs Formation

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♦ 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

Page 40: Elliott Wave Theory Ubs Formation

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Failed fifth waves & leading diagonal

1

2

3

4

5

1

4

3

2

5

Page 41: Elliott Wave Theory Ubs Formation

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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

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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

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The Trap...

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Successful Trend Definition Is Essential

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

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Trend Definition Is Essential

Page 46: Elliott Wave Theory Ubs Formation

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Ground Rules

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

Page 47: Elliott Wave Theory Ubs Formation

Corrective waves a�b�cSECTION 4

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♦ 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

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♦ 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

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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

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♦ 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

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Example of a Zig-Zag correction

A

B

C

1

2

3

4

5

5

4

3

2

1

A = C

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Bull market correction Bear market correction

a

b

c

a

b

c

Flat corrections 3�3�5

Page 54: Elliott Wave Theory Ubs Formation

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Example of a flat correction

A

B

C

a

b

c

1

v

2

5

4i

ii

iii

iv

3

Page 55: Elliott Wave Theory Ubs Formation

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Bull market correction Bear market correction

a

b

c

a

b

c

Irregular flats 3�3�5

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♦ 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

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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

Page 58: Elliott Wave Theory Ubs Formation

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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

Page 59: Elliott Wave Theory Ubs Formation

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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

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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

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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

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Flat -x- flat

a

b

c a

b

c

x

Complex corrective forms (double threes) flat

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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

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Flat -x- triangle

a

b

c

d

e

a

b

c

x

Complex corrective forms (double threes) flat

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Flat -x- irregular

a

b

ca

b

c

x

Complex corrective forms (double threes) flat

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b

Irregular -x- irregular

x

a

b

c

ac

Complex corrective forms (double threes)

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Irregular flat -x- flat

x

a

b

ca

b

c

Complex corrective forms (double threes)

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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)

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Irregular flat -x- Zig-Zag

x

a

b

c

d

e

a

b

c

Complex corrective forms (double threes)

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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

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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

Page 72: Elliott Wave Theory Ubs Formation

The rule of alternationSECTION 5

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♦ 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

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1

2

3

4

5

1

2

3

4

5

1

2

3

4

5

1

2

3

4

5

Alternation

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The rule of alternation

1

2

5

4

3

a

b d

ec

b

a

c

TRIANGLE

FLAT

Page 76: Elliott Wave Theory Ubs Formation

The depth of corrective wavesSECTION 6

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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

Page 78: Elliott Wave Theory Ubs Formation

The Fibonacci sequence and its applicationSECTION 7

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♦ 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

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0

10024.6

38.2

50.0

61.8

76.4

100Typical of Wave 2 Typical of Wave 4

RetracementsTypical retracement levels

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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

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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

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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

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Flat Irregular flat

Corrective wave multiples (continued)

a

b

c

a

b

c

1.00

1.00

.618 1.618

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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

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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

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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

Page 88: Elliott Wave Theory Ubs Formation

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

Page 89: Elliott Wave Theory Ubs Formation

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 ?

Page 90: Elliott Wave Theory Ubs Formation

3070446AL.ppt 89

Fibonacci Relationships - S&P Cash

1

2

3

4

5

i

ii

iii

iv

v

Page 91: Elliott Wave Theory Ubs Formation

3070446AL.ppt 90

Analyse

Page 92: Elliott Wave Theory Ubs Formation

3070446AL.ppt 91

Analyse

Page 93: Elliott Wave Theory Ubs Formation

3070446AL.ppt 92

Analyse

Page 94: Elliott Wave Theory Ubs Formation

3070446AL.ppt 93

Analyse

Page 95: Elliott Wave Theory Ubs Formation

3070446AL.ppt 94

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