Time Series Representation for Elliott Wave Identification

in Stock Market Analysis

Chaliaw Phetking Mohd Noor Md. Sap Ali Selamat
Faculty of Science and Technology Faculty of Comp. Sci. and Info. Sys. Faculty of Comp. Sci. and Info. Sys.
Suan Dusit Rajabhat University Universiti Teknologi Malaysia Universiti Teknologi Malaysia
Bangkok, Thailand Johor, Malaysia Johor, Malaysia
+662-244-5600 +607-553-2419 +607-553-2638
chaliaw_phe@dusit.ac.th mohdnoor@fsksm.utm.my aselamat@fsksm.utm.my

ABSTRACT Unfortunately, Elliott wave identification is a very difficult

Elliott waves are considered as the crowded psychological effect.
In stock market time series, there are several Elliott waves and in
different resolution. To identify existing Elliott wave in time
series, a dimensional reduction technique is determined.
Unfortunately, existing financial time series reduction methods
usually produce the distorted wave-like shape time series which is
difficult to identify Elliott waves. In this study, we propose the
method of financial time series reduction for Elliott Wave
identification based on perceptually important points
identification method. These collected points are used to produce
a wave-like time series by using point-importance order of wave-
like shape preservation. The method is tested in Elliott Wave
identification in real time series.
Categories and Subject Descriptors
Time series analysis.
General Terms
Algorithms, Economics.
Keywords
Financial time series representation, Pattern matching, Elliott
Wave Theory, Fibonacci number.
1. INTRODUCTION
Technical analysis is an attempt to predict the future prices of
securities based on historical prices and volumes rather than
underlying company fundamentals, political events, and economic
factors. Technical analysts believe in chart analysis to looking for
some significant information for predicting the next price
movement. Several chart analysis techniques are considered as
analysis tools. There are three main popular charting techniques:
bar charts, point-and-figure charts, and candlestick charts[1]. All
of them have been focused on attempting to recognize important
patterns. At the very least, chart pattern recognition is a subjective
method open to different interpretations by different individuals
based on their experience. Many researchers have been focusing
their works on technical analysis by automatically applying
several distinguish pattern recognition approaches to improve the
investment return. Many approaches are applied to automatically
recognize the stock chart patterns include; genetic algorithm
[2][3], fuzzy logic [4], neural network[5]. Various supported
theories are implemented including Dow theory and Elliott Wave
theory. Elliott wave theory is widely implemented in various
technical analysis approaches[6][7][8].
task and usually depending on analyst experiences. Further, stock
time series always demonstrates its movement in a fluctuant way
due to some important factors or events. These give the hard
problem of identification of existing Elliott wave. However, with
the time series dimensionality reduction technique, it is available
to identify the existing of Elliott wave.
By considering the time series dimensionality reduction
techniques, many researchers propose various advantage
techniques. The work done by Agrawal et al.(1993)[9] utilizes the
Discrete Fourier Transform(DFT) to reduce the time series
dimensions. However, other techniques are suggested including
Singular Value Decomposition (SVD) [10] and the Discrete
Wavelet Transform (DWT)[11]. Keogh et al.[12] introduce a
novel transforming technique for time series dimensionality
reduction call Piecewise Aggregate Approximation (PAA). This
technique approximates the dimensions by segmenting the
sequences into equi-length sections and recording the mean value
of these sections. The extended versions of PAA can be found by
the works of [13] so-called symbolic aggregate approximation
(SAX), and Extended SAX by [14 ].
Important points are also determined in dimensionality
reduction techniques. Based on identifying the perceptually
importance points (PIPs)[15], Fu et al.[16] proposed SB-Tree
representation to perform financial time series dimensionality
reduction. Fink and Pratt[17] collects the important points in time
series by considering some of its minima and maxima and
discards the other points. Among the minima and maxima
important points collecting, Bao[18] interests in local minimal and
maximal points and considers them as the turning points.
In this research, we propose the method of time series
dimensionality reduction for Elliott wave identification in stock
market time series. We also improve the technique of Elliott wave
pattern matching.
This paper is organized as follows. Section 2 describes the
principle of Elliott wave and time series dimensionality reduction
methods. Section 3 describes the proposed method of time series
dimensionality reduction. Section 4 the experimental results are
presented. Finally, section 5 concludes the paper and outlines
some direction for future works.
2. RELATED WORKS
In this section, the reviews of existing works and related theories
are described.
2.1 Elliott Wave Principle
The Elliott Wave Theory is introduced by Ralph Nelson
Elliott[19] which is inspired by the Dow Theory[20] 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. In fact, Elliott believed that all of man's activities, not just
the stock market, were influenced by these identifiable series of
waves. 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 market action. Thus 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 he had identified. The Elliott
Wave Theory describes the stock market’s behavior as a series of
waves up and another series of waves down to complete a market
cycle. Those cycles are grouped into eight waves, with five of
those following the main trend, and three being corrective trends.
After the eight moves are made, the cycle is complete. The
graphical view of Elliott Wave is depicted in figure 1.
Figure 1. Elliott wave cycle
Elliott Wave Theory interprets market actions in terms of
recurrent price structures. Basically, Market cycles are composed
of two major types of Wave : Impulse Wave and Corrective Wave
For every impulse wave, it can be sub-divided into 5 – wave
structure (1-2-3-4-5), while for corrective wave, it can be sub-
divided into 3 – wave structures (a-b-c).
The whole theory of Elliott Wave can be classified into two parts:
impulse patterns and corrective patterns.
2.1.1 Impulse patterns
The impulse pattern consists of five waves. The five waves
can be in either direction, up or down. As can be seen in figure 1,
the first wave is usually a weak rally with only a small percentage
of the traders participating. Once Wave 1 is over, they sell the
market on Wave 2. The sell-off in Wave 2 is very vicious. Wave 2
will finally end without making new lows and the market will
start to turn around for another rally. The initial stages of the
Wave 3 rally are slow, and it finally makes it to the top of the
previous rally (the top of Wave 1). At this time, there are a lot of
stops above the top of Wave 1. Traders are not convinced of the
upward trend and are using this rally to add more shorts. For their
analysis to be correct, the market should not take the top of the
previous rally. Therefore, many stops are placed above the top of
Wave 1. The Wave 3 rally picks up steam and takes the top of
Wave 1. As soon as the Wave 1 high is exceeded, the stops are
taken out. Depending on the number of stops, gaps are left open.
Gaps are a good indication of a Wave 3 in progress. After taking
the stops out, the Wave 3 rally has caught the attention of traders.
The next sequence of events are as follows: Traders who were
initially long from the bottom finally have something to cheer
about. They might even decide to add positions. The traders who
were stopped out (after being upset for a while) decide the trend is
up, and they decide to buy into the rally. All this sudden interest
fuels the Wave 3 rally. This is the time when the majority of the
traders have decided that the trend is up. Finally, all the buying
frenzy dies down; Wave 3 comes to a halt. Profit taking now
begins to set in. Traders who were long from the lows decide to
take profits. They have a good trade and start to protect profits.
This causes a pullback in the prices that is called Wave 4. Wave 2
was a vicious sell-off; Wave 4 is an orderly profit-taking decline.
While profit-taking is in progress, the majority of traders are still
convinced the trend is up. They were either late in getting in on
this rally, or they have been on the sideline. They consider this
profit-taking decline an excellent place to buy in and get even.
On the end of Wave 4, more buying sets in and the prices start to
rally again.
The Wave 5 rally lacks the huge enthusiasm and strength
found in the Wave 3 rally. The Wave 5 advance is caused by a
small group of traders. Although the prices make a new high
above the top of Wave 3, the rate of power, or strength, inside the
Wave 5 advance is very small when compared to the Wave 3
advance. Finally, when this lackluster buying interest dies out, the
market tops out and enters a new phase.
2.1.2 Corrective patterns
Corrections are very hard to master. Most Elliott traders
make money during an impulse pattern and then lose it back
during the corrective phase. An impulse pattern consists of five
waves. With the exception of the triangle, corrective patterns
consist of 3 waves. An impulse pattern is always followed by a
corrective pattern. Corrective patterns can be grouped into two
different categories: simple correction (zigzag) and complex
corrections (flat, irregular, triangle).
Simple Correction (Zigzag). There is only one pattern in a
simple correction. This pattern is called a Zigzag correction. A
Zigzag correction is a three-wave pattern where the Wave B does
not retrace more than 75 percent of Wave A. Wave C will make
new lows below the end of Wave A. The Wave A of a zigzag
correction always has a five-wave pattern. In the other two types
of corrections (Flat and Irregular), Wave A has a three-wave
pattern. Thus, if you can identify a five-wave pattern inside Wave
A of any correction, you can then expect the correction to turn out
as a zigzag formation.
Complex Corrections (Flat, Irregular, Triangle). In a Flat
correction, the length of each wave is identical. After a five-wave
impulse pattern, the market drops in Wave A. It then rallies
in a Wave B to the previous high. Finally, the market drops one
last time in Wave C to the previous Wave A low. Irregular
Correction. In this type of correction, Wave B makes a new high.
The final Wave C may drop to the beginning of Wave A, or below
it. Triangle Correction In addition to the three-wave correction
patterns, there is another pattern that appears time and time again.
It is called the Triangle pattern. Unlike other triangle studies, the
Elliott Wave Triangle approach designates five sub-waves of a
triangle as A, B, C, D and E in sequence. Triangles, by far, most
commonly occur as fourth waves. One can sometimes see a
triangle as the Wave B of a three-wave correction. Triangles are
very tricky and confusing. One must study the pattern very
carefully prior to taking action. Prices tend to shoot out of the
triangle formation in a swift thrust. When triangles occur in the
fourth wave, the market thrusts out of the triangle in the same
direction as Wave 3. When triangles occur in Wave Bs, the
market thrusts out of the triangle in the same direction as the
Wave A.
3. THE PROPOSED MODEL
Our model comprises of two parts; part 1, the time series
dimensionality reduction, and the part 2, the identification of
Elliott wave.
3.1 Time Series Dimensionality Reduction
A stock market time series consists of several fluctuant price
movements of up and down directions. These movements always
form wave-like structure. However, most of minor fluctuated
movements usually become noise in many analysis methods.
Reducing the dimensions or minor fluctuated movements of stock
market time series can provide a higher degree of analysis results.
Due to Elliott wave analysis, the early identifying the forming of
the waves is very important for traders to gain their profit taking.
Modeling of stock market time series dimensionality
reduction can be determined by reducing the minor fluctuated
movements and retaining the major fluctuated movement. The
major fluctuated movement points can be known as Perceptually
Important Points(PIPs). Algorithm of identification of PIPs was
first introduced by Chung et al. (2001)[15], and, with the similar
idea, it is independently introduced by Douglas and Peucker
(1973)[21]. Chung et al [15] describe the concept of data point
importance as the influence of a data point on the shape of the
time series. A data point that has a greater influence to the overall
shape of the time series is considered as more important. The
implementation of PIPs identification can be found in
[15][16][22].
In a time series, PIPs identification is performed recursively
until all points are considered. With the method introduced by Fu
et al.(2007)[15], importance-ordered PIPs are used for
constructing the SB-Tree data structure and dimensionality
reduction can be done by accessing number of PIPs from the tree.
Nevertheless, by considering number of PIPs, in some case, the
reconstructed time series may be constructed in distorted-wave
shape because of the connecting line between the bottom
important points or between the peak important points. This is
shown in figure 2.
To eliminate these effects, we introduce the method of
time series dimensionality reduction by considering point-
importance order of wave-like shape preservation(PWP). The
PWP method is very important to preserve the reconstructed
shape of time series in the wave-like form. The idea of PWP is
come from the number of retrieved PIPs cannot preserve the
wave-like shape of the dimension reduced time series
2.
0.5
peak-peak connecting
0.4
0.3
0.2
bottom-bottom connecting
0.1
0
0 50 100 150 200 250 300 350 400 450
Figure 2. Distorted-wave shape dimensionality reduction.
.
The algorithm of PWP can be sequentially presented as follow.
(1) For the time series S ={s1, s2, …, sm}, consider the first
PIP on the first iteration including retrieval of the first
and the last point of S.
Let sp1 is the first PIP, thus the time series is divided
into 2 segments; s1sp1 and sp1sm ,then PIPs are recorded
into PIPList.
(2) For each sub-segment from step 1, the next iteration of
PIP retrieval is considered. When PIPs are retrieved
from all sub-segments, at this point, the peak-to-peak
connecting and bottom-to-bottom connecting are
determined.
(3) If the peak-to-peak connecting or bottom-to-bottom
connecting exists, retrieval the next PIP of the segment
is determined. Otherwise, remove PIPs which are the
end points of the segment. Finally, all PIPs are recorded
to the PIPList.
(4) Follow step 1-4 until the threshold is reached.
The threshold used for considering in step 4 is determined by
the period of trading. If a stock trader trades once a week(5
business days) the threshold is set to be 5.
The result from this algorithm is the list of PIPs series in different
levels.
3.2 Identification of Elliott Waves
To identify the existing of Elliott waves, the point-to-point
matching is provided. This method matches the time series and
the pattern templates. However, since the varieties of amplitude of
waves and points distances the matching point-to-point directly is
not proper.
By the method of pattern based matching proposed by Fu et
al.(2007)[22], the amplitude distance and temporal distance
measures are applied in this research.
Suppose P and Q are lists of points in the time series and
templates, thus the amplitude distance can be determined as
follow.
, ∑ (1)
Here, SP and spk denote the PIPs found in P. However, the
measure in Eq. (1) has not yet taken the horizontal scale (time
dimension) into considerations. Therefore, it is preferred to
consider the horizontal distortion of the pattern against the pattern
templates. The temporal distance (TD) between P and Q is
defined as:
∑ [5] J. T. Yao, C. L. Tan and H.-L. Poh, "Neural Networks for
, (2)
where and denote the time coordinate of the sequence
points and , respectively. To take both horizontal and
vertical distortion into consideration in the similarity measure, the
distance (or similarity) measure could be modified as:
, , 1 , (3)
where w1 denotes the weighing among the AD and TD and can be
specified by the users. In this paper w1=0.5 is applied[22].
4. EXPERIMENTAL RESULTS
5. CONCLUSION
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