Elliott wave principle :
Elliott Wave Theory is named after Ralph Nelson Elliott (28 July 1871 – 15 January 1948). He was an American accountant and author. Inspired by the Dow Theory and by observations found throughout nature, Elliott concluded that the movement of the stock market could be predicted by observing and identifying a repetitive pattern of waves.
Elliott was able to analyze markets in greater depth, identifying the specific characteristics of wave patterns and making detailed market predictions based on the patterns. Elliott based part his work on the Dow Theory, which also defines price movement in terms of waves, but Elliott discovered the fractal nature of the market action. Elliott first published his theory of the market patterns in the book titled The Wave Principle in 1938.3
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The patterns link to form five and three-wave structures which themselves underlie self-similar wave structures of
increasing size or higher degree. Note the lowermost of the three idealized cycles. In the first small five-wave
sequence, waves 1, 3 and 5 are motive, while waves 2 and 4 are corrective. This signals that the movement of the
wave one degree higher is upward. It also signals the start of the first small three-wave corrective sequence. After the
initial five waves up and three waves down, the sequence begins again and the self-similar fractal geometry begins to
unfold according to the five and three-wave structure which it underlies one degree higher. The completed motive
pattern includes 89 waves, followed by a completed corrective pattern of 55 waves.
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. (Definitions assume a bull market in equities; the characteristics apply
in reverse in bear markets.)
|Five wave pattern (dominant trend||Three wave pattern (corrective 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. The volume might increase a bit as prices rise,
but not by enough to alert many technical analysts.
|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
|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 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
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
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 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 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
|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 (recall how forecasts
for a top in the stock market during 2000 were received).
Elliott wave rules and guidelines:
A correct Elliott wave “count” must observe three rules: 1) Wave 2 always retraces less than 100% of wave 1; 2)
Wave 3 cannot be the shortest of the three impulse waves, namely waves 1, 3 and 5; 3) Wave 4 does not overlap with
the price territory of wave 1, except in the rare case of a diagonal triangle. A common guideline observes that in a
five-wave pattern, waves 2 and 4 will often take alternate forms; a sharp move in wave 2, for example, will suggest a
mild move in wave 4. Corrective wave patterns unfold in forms known as zigzags, flats, or triangles. In turn, these
corrective patterns can come together to form more complex corrections