16th feb 20121 A word about elliot wave theory

Elliot wave theory is all about understanding the herd mentality. According to the theory, the masses (or the herd) moves in predefined mathematical structures called waves. These waves can be marked on a chart in different time frames. Looking at the previous wave(or herd movement) one can reportedly predict where the herd is going to go next.

Whatever may be the hundred percent efficacy of this, the fact remains that this theory is being used to trade and predict the stock markets by almost all hedge funds and to a certain degree by individual traders.

However out of all the forms of technical analysis, elliot wave analysis is the least understood. Also its limitations sometimes go unnoticed. Before we start on the understanding of the concept following points must be noted and kept in mind

  1. Elliot wave theory must not be taken as absolute
  2. Labelling the chart with precise numbers and alphabets gives a solidity to the whole analysis which if not careful, can lead to denial when the markets take a different route than analysed.
  3. Trying to analyse the waves in minute waves and marking each and every minutest wave can lead to a wrong direction as we tend to lose sight of the whole picture. (For reading one minutest count wrong, can lead to the whole wave count being wrong.)
  4. Elliot wave count is known to be very subjective. It is at times like interpreting shadows on a wall for followers who have half knowledge or lack of experience. (A shadow appears as a different interpretation  to different people)
  5. Notwithstanding the comments above, it has been my experience that markets do follow the elliot wave theory in a generalised way at times and definitive at others and is definitely one of the biggest tools for success in the stock markets.

If you have a clear strategy for trading , specially momentum stocks , this can be the greatest tool.

Like all cult and dogmas, it is very easy to become a fanatic elliot wave theorist. Although you can use elliot theory as the key methodology for analysing the markets and any individual stock, it should be always kept in mind that this theory was based on herd mentality WITHOUT softwares and algorithms. Nowadays many institutions are using computer generated buy and sell orders. This PROBABLY results in some form of variance from the herd sentiment.

However it is only when you combine the elliot theory along with the other traditional methods , that you start getting into the real rhythms of the markets which can include the ‘grey market forces . This will be discussed in detail in the trading and the master class.

FRACTALS IN ELLIOT WAVE THEORY

Fractals are mathematical structures, which on an ever-smaller scale infinitely repeat themselves. Elliott discovered stock index price patterns were structured in the same way.

Elliot discovered that all herd mentality(which is to be found in a stock market subscribed by millions of people) follow definitive structures and rules. These structures can be likened to waves which are not only repetitive but are also based on fractals OR as each wave have , when zoomed into , components which are exactly the same as their larger parental waves. This forms the essence of the elliot wave theory.
It is my belief that elliot wave theory CAN be used successfully if used in conjunction with other forms of technical analysis.