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
- Elliot wave theory must not be taken as absolute
- 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.
- 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.)
- 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)
- 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 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.
Above is a simple 5 wave impulse structure. following classical rules apply
- Wave 3 is not the shortest wave
- Wave 4 never enters the territory of wave 1
waves 2 and 4 are corrective waves and ‘correct the upward moving waves 1 , 3 and 5.
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-
Now this 5 wave structure is part of a bigger wave 1 (encircled)
This LARGER wave will now correct in 3 waves A, B and C as shown below
Now from C we start the next impulsive 5 waves as shown below
Now from the encircled wave 3 we have another wave 4 (encircled ) down and then the final wave 5 . This process is repetitive and is shown below
The encircled wave 5 will now correct the whole structure from the commencement.
These can replace the 5th wave and at times the 1st wave. In a diagonal the 4th wave always comes into the territory of wave 1.
Below diagram will make it more clear
It is also of importance to note that the corrective waves follow the following pattern.
Wave A and wave C are both impulsive or motive waves but in downward direction and wave B is a 3 wave structure pointing upwards..
Elliot named nine degrees of waves , from the smallest visible ON AN HOURLY CHART.
For sake of recognition , as per the classical elliot wave theory following degrees were named from the largest to the smallest or
Grand Supercycle, Supercycle, Cycle, Primary, Intermediate, Minor, Minute, Minuette, Subminuette.
Although we have shown only the zigzag correction above (ABC) we can divide the type of corrections in three main categories, namely Zigzag, Flat and triangles
- ZIGZAG (535)
This is a typical ABC correction as shown below
This type of ZIGZAG includes an intervening ‘3’ as shown below
FLAT CORRECTION (335)
This differs from the ZIGZAG in this way that the wave A here is a three wave structure instead of 5 waves. Also the wave B goes to the level of starting point of wave A. This is of three types namely regular, expanded and running. We will discuss this one by one.
REGULAR FLAT CORRECTION(335)
Here wave ‘B’ ends near the start of wave A and wave ‘C’ ends just beyond the start of wave B.
EXPANDED FLAT CORRECTION(335)
In expanded flats , wave B finishes beyond the starting point of wave A and C finishes well beyond the end of wave A.
This is a half finished expanded flat. Here wave C finishes short of the start of wave A.
Triangle corrections are always in the form of 3’s. There are three kind of triangle corrections namely contracting, rising or falling(bull and bear market respectively) and expanding. Triangles always occur at the start of a impulsive wave (at the start of wave 3 or 5 or wave c in corrections).
Mostly the triangles are 5 waves but sometimes can occur in 9 waves where the last wave e extends.
This is 5 waves and contracting as a triangle. The last wave E at times may overshoot the boundary line.
RISING AND FALLING TRIANGLE
Below giving all together as a recap
MAIN STRUCTURE CORRECTIONS
GUIDELINES AND RULES FOR ENDING DIAGONAL
GUIDELINES AND RULES FOR IMPULSE WAVE
RULES AND GUIDELINES FOR ZIGZAG
RULES AND GUIDELINES FOR FLAT CORRECTION
- A barrier triangle has the same characteristics as a contracting triangle except that waves B and D end at essentially the same level. We have yet to observe a 9-wave barrier triangle, implying that this form may not extend.
- When wave 5 follows a triangle, it is typically either a brief, rapid movement or an exceptionally long extension.
- Combinations comprise two (or three) corrective patterns separated by one (or two) corrective pattern(s) in the opposite direction, labeled X. (The first corrective pattern is labeled W, the second Y, and the third, if there is one, Z.)
- A zigzag combination comprises two or three zigzags (in which case it is called a double or triple zigzag).
- A “double three” flat combination comprises (in order) a zigzag and a flat, a flat and a zigzag, a flat and a flat, a zigzag and a triangle or a flat and a triangle.
- A rare “triple three” flat combination comprises three flats.
- Double and triple zigzags take the place of zigzags, and double and triple threes take the place of flats and triangles.
- An expanding triangle has yet to be observed as a component of a combination.
- When a zigzag or flat appears too small to be the entire wave with respect to the preceding wave (or, if it is to be wave 4, the preceding wave 2), a combination is likely.
Impulse Wave Price Targets using fibonacci retracements
Price Target for Wave 1
- Wave 1 commences the new impulse wave. It retraces typically between 23.6 and 38.2 percent . However it can retrace more but normally not more than 50 percent.
Price Target for Wave 2
There is no target for wave 2 as it can retrace to any of the fibonacci ratios and even close to 100 percent. The best way is to ensure counting of subwaves as wave 2 moves down. Normally it will retrace at least 38.2 percent.
Price Target for Wave 3
Out of all waves , wave 3 is the most interesting and mostly the strongest. In a rising impulse wave, it can reach 161.8 percent of wave1. (However at times it can be equal to wave 1)
At 161.8 percent , it is to be seen as a NORMAL 3rd wave. However what if it is extended. Out of the three motive waves, one always extends. Wave 3 can extend to beyond the 161.8 to levels of 200%, 261.8% , 300%.
PRICE TARGET OF WAVE 4.
Wave 4 can travel right up to the ending of wave 1. However it can very well end at retracement of 23.6 to 38.2 percent of wave 3
Wave 4 quite often ends in a flat or a combination of zigzag and flat.
Wave 4 can also be measured off in a channel drawn with the top boundary of the channel going through 1 and 3 and the lower one a parallel line thru the same.
PRICE TARGET OF WAVE 5
WAVE 5 TARGETS BY FIBONACCI LEVELS
Wave 5 can be
- equal to wave 1
- 61.8 or 76.4 percent of wave 3
- It can be also 161.8 of wave 3
- or 161.8 percent of combined wave 1 and wave 3.
WAVE 5 TARGETS BY CHANNELLING METHOD
Draw a parallel line through wave 3 OR wave 1.
Ideally draw two parallel lines through 1 and 3. Thus you will have two targets for wave 5.
PRICE TARGETS OF WAVE A , B AND C
Price Target for Wave A
Wave A in a zigzag correction will, most of the time, retrace 38.2% and 50% of the previous 5 wave.
Price Target for Wave B
Wave A in a zig zag correction retrace 38.2 and 50 percent of the previous 5 wave
Wave B in a zigzag correction mostly retraces 38.2% of wave A.
In a flat correction, this will be 100%.
A triangle correction will take back 90% to 100% of wave A.
Price Target for Wave C
Wave C will, many times, equal wave A.
Wave C is a minimum 61.8% of wave A.
In a double zigzag, this is commonly 138.2% of wave W.
In a flat or double flat correction, this often is 138.2% of wave A, or wave Y, respectively.
Wave X of a double zigzag, a double flat correction, or a triple zigzag is, most of the time, 50% of wave W. In a triple flat correction, this will be 76.4% of wave W.