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Complete Elliott Wave Theory

Complete Elliott Wave Theory

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Published by: Sachin2210 on Jun 24, 2009
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page 12
Beginning with Robert Prechter’scall for a strong bull market inthe 1980s – at a time when few were looking for strong gains –the Elliott Wave Principle hascontinued to gain in popularity,though it is often considereddaunting to master.What liesbeneath this intricate look at financial market movements? What does it say not only abouttrading,but also about crowdand,potentially,social psychology? In this first of a two-part series, Jordan Kotick looks at the theory and practise of Elliott Waves.
A Brief History
The Elliott Wave Principle was developed byRalph Nelson Elliot (1871-1948).A financialaccountant by trade,Elliott spent yearsintensely studying price charts with a focus onstock market behaviour.He eventuallyarticulated his theory in a series of twelvearticles for
Financial World 
magazine in 1939.Elliott concluded that his observationsultimately encompassed not only the action of equity market averages but actually a muchlarger law that he believed governedeverything from social interaction to thepatterns seen in natural phenomena.Inessence,Elliott believed he came up with anintricate theory that ultimately explained the behaviour of crowds,exposing theirdichotomous and ongoing swings betweenoptimism and pessimism.The Elliott Wave Principle,essentially thecyclical quantification of investor psychology,rose to prominence in recent times on the back of the now-famous book by A.J.Frostand Robert Prechter,released in November1978,
The Elliott Wave Principle
.This book stillstands as the single best articulation of Elliott’sideas.While many books have been writtensince,the reader who understands Frost andPrechter understands all they need to knowabout the principles of Elliott Wave.
Theoretical Foundationand Fractals
Elliott’s main advocacy wasthat crowd behaviourtrends and reverses inconsistent andrecognisable patterns.Elliott named andillustrated patterns or“waves”that recur inmarkets and arerepetitive in form butnot necessarily in timeor amplitude.He further described howthese structures link togetherto form larger versions of the samepatterns and how those in turn become the building blocks for patterns of the next largersize etc.Regardless of the size,the formremains constant.This discovery was well ahead of its time.In fact,over the last decade or two,manyprominent academics have embraced Elliott’sidea and have been aggressively advocating theexistence of financial market fractals.However,it is important to understand thetype of fractal pattern that Elliott Waverepresents.The traditional line of thought has been that fractals are either self-identical (eachcomponent of the pattern is exactly the sameas the whole) or indefinite (self-similar to theextent that it is similarly irregular at alllevels).Elliott discovered a third type of self-similar fractal that Prechter in his later workscoined a “robust fractal.”This pattern hashighly variable components that fall within acertain defined structure.Prechter noted that“component patterns do not simply displaydiscontinuity similar to that of larger patterns, but they form,with a certain defined latitude,replicas of them.”This latitude reflects nature’srobustness and variability within overalldetermined forms.While it may be an openquestion whether every nuance of this latitudeis determined,the Wave Principleunquestionably rests on the premise thatcertain essential aspects of the design alwaysprevail.In essence,the robust fractal suggests thatas much as the patterns are always self-similar,they are,at the same time,always different.While this may seem a contradiction,it is not.Imagine looking at a forest from one kilometreaway.From this distance,every tree looks thesame.Now imagine that forest from onemeter away – every tree looks different.So itis with Elliott Waves:while the overall patternis the same,the internal make-up (length,amplitude,wave relationships) willdiffer despite the fact that theoverall pattern is self-similar.It is not a co-incidence thatthe words arboration orarborate have been usedin conjunction withElliott Wave analysis.
Figure 1:
The fractilityof mapsillustrates thatnavigating London can be easy or complexdepending on the degree of observation.
Drink Deep,or Taste not theElliotician Spring
Alexander Pope was right:a little knowledgeis a dangerous thing.He could have beenwriting about Elliott Waves,for it is notunusual for a trader/strategist/salesperson toembrace a basic understanding of Elliott,use itfor while,ultimately lose money and thenconclude that Elliott does not work.This all-too-common scenario is based on the falsepremise that you do not have to know theentire theory in order to use Elliott profitably.This is an expensive oversight.Elliott,likeany other technical or fundamentalmethodology,is not an art,it is not a science –it is a skill that needs to be honed over time.The skilled Elliottician should be able todifferentiate all types of waves from the
An Introduction to the Elliott Wave Principle
By Jordan Kotick,Global Head of Technical Strategy,Barclays Capital
impulsive (waves 1,2,3,4,5) to the corrective(waves a,b,c,d,e,w,x,y,z).While it seemsoverly complex,with time and study,thereal-time recognition and application of thesepatterns do come to light.Analogously,whilethe rules of billiards are simple,winninga game of billiards is more complicated.This applies to Elliott Wave in principleand Elliott Wave in practice.
In financial markets,Elliott wave patternsoccur in any market with sufficient volumeand liquidity.While the real-time applicationof Elliott varies between,for example,a commodity market and foreign exchangemarket,or a 5-minute chart and a 5-decadechart,the basic principles governing Elliottare equally applicable.Some debate whetherElliott is most applicable in some marketsversus others.Aside from this being asubjective debate,it should be realised thatElliott can and is widely utilised acrosscommodity,equity,fixed income and foreignexchange markets on all time frames.
The Basic Picture
Financial markets ultimately progress in an“impulsive”or five wave sequence regardlessof whether they are bull or bear markets.Theimpulsive waves – waves 1,3 and 5 as seen inthe basic pattern shown in Figure 1– are thedirectional or trendingwaves.Waves 2 and 4are the corrective orcounter trend waves.This principle applies toall time frames.Asmentioned before,thefractal nature of thepatterns implies that thesmaller patterns are building blocks of thelarger patterns while thelarger patterns,correspondingly,can be broken into theirsmaller subcomponents. Just as market analystsrefer to degrees of trend(intraday,short term,medium term,etc.),theElliottician refers towave degree.Thus while thetrader/strategist mayconclude that themarket is in a short-term downturn within amedium-term bulltrend,the Elliotticianmay refer to the samechart by saying that themarket is,for example,in wave two of three,or four of five…same markets,sametimeframes,same conclusions – just differentmodes of expression.It is worth remembering that successfulmarket forecasting is based on probability andpercentages.Elliott is particularly valuable athelping to identify where the market is in aparticular trend and thus helps ascertain notonly buying and selling peaks,but also suitableplaces to commit capital based on location of the overall wave pattern that is unfolding.If one can correctly identify where the market iswithin an overall pattern (Elliott or otherwise)and can reliably project how the patterns arelikely to complete,then a market opportunityexists.
page 13
and = 2 waves(1), (2), (3), (4), (5), (a), (b), (c) = 8 waves1, 2, 3, 4, 5, a, b, c, etc=34 waves
© July 1996 Elliot Wave International. Inc.© July 1996 Elliot Wave International. Inc.
Fig. 2Fig. 3
    W   a   v   e    1
W   a  v  e   2  
    W   a   v   e    3
W   a  v  e   4  
    W   a   v   e     5
W   a  v  e   A  
  W a  v e   B
W   a  v  e   C   
Figure 2: The basic patternFigure 3: The fractal nature of the basic patternFigure 4: A weekly chart shows a completeElliott Wave pattern for the US Five Year NoteFuture
Figure 5:An intraday chart shows a complete Elliott Wave pattern for USDJPY

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