ELLIOTTWAVE

 Developed by Ralph Nelson Elliott in the 1930s, Elliott Wave Theory was originally designed to forecast stock price movement. Overtime however, the theory has been applied to a variety of markets, particularly foreign exchange. Elliott Wave Theory is now a very popular analytical strategy frequently used by the technicians of leading investment banks and intermarket players. The Elliott Wave Theory is founded on the notion that markets are not perfectly efficient. As a result, prices from one moment to the next are not random but rather subject to changes in overall investor behavior—changes that can be predictable with an understanding of mass psychology.

The center of the Elliott Wave Theory rests on the idea that security prices move in waves: impulsive  and corrective . As indicated in the diagram below, there are five waves defining the direction of the near term trend followed by three corrective waves.

To fully understand the Elliot Wave Theory, it is important to understand the psychological rationale for each of these waves since the zigzag movement of prices represents the ebb and flow of investor optimism and pessimism. Given in an up trending market: 

Wave 1 (Impulsive): Minor Up wave In Major Bull Move – In Wave 1, prices rise as a relatively small number of market participants, pushing prices higher. 

Wave 2 (Corrective): Minor Down wave In Major Bull Move ‐ After a significant run‐up, investors may get fundamental or technical signals indicating the market is overbought. At such time, Wave 2 develops when original buyers decide to take profits while newcomers initiate short positions. Price action reverses, but generally does not retrace beyond its initial low that attracted buyers at Wave 1. 

Wave 3 (Impulsive): Minor Up wave In Major Bull Move ‐ Often the longest wave of the five, Wave 3 represents a sustained rally, as a larger number of investors use the Wave 2 dip as a buying opportunity. With a broader range of buyers, the security enjoys a stronger push higher, with prices extending beyond the top formed at Wave 1

Wave 4 (Corrective): Minor Down wave In Major Bull Move ‐ By Wave 4, buyers begin to become exhausted and again take profits in reaction to overbought signals. Generally, there is still a fair amount of buyers, so the retracement here is relatively shallow. 

Wave 5 (Impulsive): Minor Up wave In Major Bull Move ‐ Wave 5 represents the final move up in the sequence. At this point, buyers as a whole are motivated more by greed than any fundamental justifications to buy, and bid prices higher irrationally. Prices make a high for the move before a correction or reversal ensues. The high in Wave 5 often coincides with a divergence in the relative strength index (RSI) or MACD.

Wave A: Correction To Rally – Initially Wave A may appear to be a correction to the normal rally. However, if it breaks down into five subwaves, it indicates that a new market trend may have developed. 

Wave B: Bear Market Correction – Wave B tends to give bears an opportunity to sell as others take profit on their short trades or exit their long positions. 

Wave C: Confirms End Of Rally – Wave C is the last wave of the cycle. At this point, Wave 3 typically breaks key support zones and most technical studies confirm that the rally has ended.

While determining waves in real time can be challenging, there are three rules to counting waves that always hold. These rules form the basic tenets of Elliott Wave Theory.

In an impulse:

 • Wave 2 typically retraces 38-78% of wave 1

 • Wave 3 tends to have Fibonacci proportion to the length of wave 1 (1.618, 2.618, 4.23)

 • Wave 4 typically retraces 38% the length of wave 3

 • Wave 5 can become 38% or 61% then length of waves 1 through 3

Corrective waves: 

• Alternating waves tend to have equality or Fibonacci relationships to their distances ( wave C = wave A, or wave C = .618 x wave A) 

• In a complex correction, the distance of wave Y tends to have an equality or Fibonacci relationship to the distance of wave W • Corrections to a completed impulse wave tend to retrace back to the previous 4th wave of that impulse