The basic purpose of this article is to discover for oneself when to be ‘cautious’ in the markets. We normally in due course get used to the fact that markets ALWAYS recover. This is true to a large extent as the basic movement of the markets is in the upward direction only(markets can never go to zero but the upside is infinite). However as we do not live to see infinity and want to see results WITHIN our life span , it does become important for us to ensure that during our life we see maximum gains and minimal losses.
To understand the basic tenet of this article, and how to ensure “maximum gains and minimal losses” it will be important to understand the “Basic Fundamentals” of Elliot Wave Analysis.
According to the elliot wave theory , all movements in stock market (Or any movement where large number of participants are there) move up and down(waves) in predesignated patterns which repeat over and over again.
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 (the up and down movement of the stock market on a chart) which are not only repetitive but are also based on fractals OR each wave WAS FOUND to have , when zoomed into , components which are exactly the same as their larger parental waves. This forms the essence of the elliot wave theory which , as we go along will become clearer.
Now for the classical wave theory
In the elliot wave theory there are two types of waves , impulsive and corrective. Impulsive wave are 5 waves and corrective have a three wave structure. Both type of waves occur one after the other as shown below
As can be seen above , wave 2 and 4 correct the waves 1 and wave 3 respectively.
Now the above 5 wave structure can form the part of another LARGER 5 wave structure as shown below. In this case the above 5 wave structure becomes the wave 1 of the new structure as shown below-
Above is to show the FRACTAL NATURE of the wave formation.
So from inception , Any market will show wave formation in different timeframes CONTAINED within the BIGGEST time frame. This largest time frame we can call the cycle wave, which will correct into the super cycle wave (II) once the present cycle wave completes its V waves.
CHARACTERISTIC OF DIFFERENT WAVES
Wave 3 is the fastest and goes up with maximum retail participation egged on by institutions.
Wave 4 is a distribution phase where the operators/institutions book profits.
Wave 5 is egged on/fueled by operators/institutions in order to take the markets as high as POSSIBLE to sell the remaining holdings. The length/size of wave 5 is ALWAYS uncertain and can be even bigger than wave 3 BUT CAN ALSO HAVE AN ABRUPT END
THEREFORE it is always wise to be extra cautious on wave 5, by ALSO looking at external fundamental factors and political conditions.
Before I give below my view as to where we are on the long term elliot wave structure, it is prudent to declare that elliot wave analysis is subjective or different analysts may or may not come out with the same results.
Below I am giving my view and chart of the long term elliot wave count
Above I have given my view of the long term elliot wave count. The red count is the cycle wave which in my opinion is now correcting into wave IV.
Wave IV is a distributive wave or where the OPERATORS AND INSTITUTIONS Book part profit. THEN the wave V to start upwards fuelled by the same institutions UNTIL it is viable for them to book their final profits in this cycle. Prudent to note that wave V can be a mini bull run but by its very nature it can finish off abruptly too and therefore requires vigilance at all times.