Chaos, Solitons and Fractals 92 (2016) 137–141

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Chaos, Solitons and Fractals

Nonlinear Science, and Nonequilibrium and Complex Phenomena
journal homepage: www.elsevier.com/locate/chaos

Elliott wave principle and the corresponding fractional Brownian

motion in stock markets: Evidence from Nikkei 225 index
Deniz Ilalan∗
Cankaya University, Department of Banking and Finance, Eskisehir Yolu 29.km, 06530 Ankara, Turkey

a r t i c l e i n f o a b s t r a c t

Article history: This paper examines one of the vital technical analysis indicators known as the Elliott wave principle.
Received 20 July 2016 Since these waves have a fractal nature with patterns that are not exact, we first determine the dimension
Revised 10 September 2016
of them. Our second aim is to find a linkage between Elliott wave principle and fractional Brownian
Accepted 20 September 2016
motion via comparing their Hausdorff dimensions. Thirdly, we consider the Nikkei 225 index during Japan
asset price bubble, which is a perfect example of an Elliott wave.
Keywords: © 2016 Elsevier Ltd. All rights reserved.
Elliott wave
Hausdorff dimension
Fractional Brownian motion

1. Introduction Most investors regard the down movement as a retracement as

Human mind tends to perceive movements in a rhythmical
fashion. This phenomenon became a yardstick for R. N. Elliott [4] in
the sense that investors become bullish and bearish according to
certain cycles. According to this model, once stock prices are on
an increasing trend, they are followed by some corrective patterns
called retracements. Moreover, after a peak, investors become pes-
simistic and the trend is reversed. This is the beginning a down-
ward movement with some upward corrections.
These waves have special rules and restrictions as described be-
low and shown in Fig. 1. (for details see [2,5,13])
• First wave is the beginning of the upward trend which usually
hard to observe at its early stages. The news are negative ev-
erywhere. Economy looks bad and analysts are bearish.
• Second wave is the retracement of wave 1. However, prices do
not retrace more than 61,8% which comes from a Fibonacci re-
lation.
• Wave 3 is the most powerful and largest wave and usually goes
beyond wave 1 by a ratio of 1,618: 1.
• Wave 4 is another corrective move where the level of retrace-
ment is lower than 38,2%.
• Wave 5 is the final piece of the bull market. News are almost
universally positive. This wave ends with a climax.
• Wave A is the beginning of downward trend. As in the case
of wave 1 its inception is not obvious since news are positive.
in wave 2 or wave 4.
• Wave B is the retracement of wave A, which is regarded as the
continuation of the upward trend in a wrong manner.
• Wave C is the realization of the bear market.
Another important characteristic of Elliott wave is its self-
similar patterns. Elliott waves have fractal nature; however, sim-
ilarity patterns are not identical like Koch snowflake. The rest of
the study is as follows: In Section 2 the Hausdorff dimension of El-
liott wave is computed. Section 3 gives the linkage between Elliott
wave and fractional Brownian motion. Section 4 is the application
of Elliott waves and the corresponding fractional Brownian motion
to Japan Nikkei 225 index together with some simulation results.
Finally, Section 5 concludes.
2. Hausdorff dimension of Elliott waves
Definition 2.1. Let X be a metric space. If S ⊆ X and d ∈ [0, ∞),
the d dimensional Hausdorff content of S is defined by


CHd (S ) : = in f rid : there is a cover of S by balls with
i

radii ri > 0

Definition 2.2. The Hausdorff dimension of X’s defined by

∗
Fax: +90 312 233 10 27.  
E-mail address: denizilalan@cankaya.edu.tr dimH (X ) := in f d ≥ 0 : CHd (X ) = 0

http://dx.doi.org/10.1016/j.chaos.2016.09.018
0960-0779/© 2016 Elsevier Ltd. All rights reserved.
138 D. Ilalan / Chaos, Solitons and Fractals 92 (2016) 137–141

Fig. 1. Elliott wave patterns and their fractal nature.

Source: Adapted from Ref [4].

Fig. 3. Elliott wave of type 2.

Table 1
Hurst parameter and corresponding displacements.
1
H= 2
Regular Brownian motion
1
H< 2
Negative correlation (the displacements tend to decrease)
1
H> 2
Positive correlation (the displacements tend to increase)

according to Theorem 2.1

√
√

3r1D1 + 5r2D1 = 1 → 3 2/8 D1

+5 10/8 D1
= 1 → D1 ∼
= 1, 867.
√
In Fig. 3 short lines are of r1∗ = 2
and long lines are of
 √
10
2 2
r2∗ = ( 1 ) + ( 10
3
) = 10
length which gives us the dimension
√ 10 √ 10
as 4( 2/10 ) 2 + 6( 10/10 ) D2 = 1 → D2 ∼
D
= 1, 693. Finally, the di-
3D +D
mension of the entire wavelet is D = 14 2 ∼
Fig. 2. Elliott wave of type 1.
= 1, 824.
Here we considered the retracements to be 1/3 of the previous
Definition 2.3. A finite collection of real numbers (r1 , …, rn ) is wave. Results can be generalized for arbitrary amount of retrace-
called a contracting ratio list if ments with more complex but solvable analytical expressions.

0 < ri < 1, ∀i = 1, 2, …, n. 3. Fractional Brownian motion

The generalization of Brownian motion, called fractional Brow-

nian motion (fBm, [9]) allows the increments to be dependent
Theorem 2.1. Let (r1 , …, rn ) be a contracting ratio list. Then there
 among each other. fBm is a Gaussian process BH (t) on [0, T] with
exists a unique non negative real number D such that ni=1 riD = 1.
zero mean and which has the covariance function
D = 0 if and only if n = 1.
1 2H

E [BH (t )BH (s )] = |t | + |s|2H − |t − s|2H .

Proof. If n = 1 then D = 0 is the only solution. If n > 1, de-

fine the function f on [0, +∞) by f (t ) = ni=1 rit . Hence, f(0) = n
and lim f (t ) = 0 < 1. Since f is continuous a positive solution
n→∞
n D
for D exists for the equation. i=1 ri = 1. The derivative of f is
n D
i=1 ri logri < 0 is monotone decreasing which assures the unique-
ness of the solution. D corresponds to the Hausdorff dimension.
For a detailed of Hausdorff dimension discussion see [1,9,11].
Now our aim is to determine the Hausdorff dimension for El-
liott waves. We will treat the pattern between wave 4 and wave
A separately from the other 3 patterns with identical similarity
namely wave 1–2, wave 2–3 and wave A-B-C. Not let us focus on
these 3 patterns called type 1. Without loss of generality we ex-
amine wave 1–2 (Fig. 2):
In order to determine the Hausdorff dimension of a type 1
wave, we see that there are two different generators. If we con- √
sider the initiator to be [0, 1] short lines are of length r1 = 82
 √
2 2
where long lines have a length of r2 = ( 18 ) + ( 83 )
2
H ∈ (0, 1) is called the Hurst [6,7,10] parameter.
Table 1 shows the characteristics of the displacements accord-
ing to the Hurst parameter.
The graph of regular Brownian motion has a dimension of
DB = 2 − H = 1,5. When H < 12 the curve is rougher and for values
close to zero it becomes a space filling curve. For values H > 12 the
curve is smoother.
In Section 2, the Hausdorff dimension of the Elliott wave was
computed as D∼ =1,824. Thus, compared to the trajectories of regular
Brownian motion it is more space filling. Hence we can deduce
that Elliott waves could be generated as the trajectories of a fBm
with a Hurst parameter of 0,176.
4. Nikkei 225 index
From the beginning of 1914 till the end of 1989 (around 77
years), Nikkei 225 index showed a persistent stability. On Decem-
= 10
8 . Now
ber 29, 1989 however, something totally unpredictable happened.
 D. Ilalan / Chaos, Solitons and Fractals 92 (2016) 137–141 139

10.6

10.4

10.2

10

9.8

9.6

9.4
12/31/85
4/30/86
8/31/86
12/31/86
4/30/87
8/31/87
12/31/87
4/30/88
8/31/88

4/30/89
8/31/89
12/31/89
4/30/90
8/31/90
12/31/90
4/30/91
8/31/91
12/31/91
12/31/88
Fig. 4. Logarithm of Nikkei 225 index.

10.2

10.15

10.1

10.05

10

9.95
3/18/1987
3/23/1987
3/28/1987
4/2/1987
4/7/1987
4/12/1987
4/17/1987
4/22/1987
4/27/1987

5/7/1987
5/12/1987
5/17/1987
5/22/1987
5/27/1987
6/1/1987
6/6/1987
6/11/1987
6/16/1987
6/21/1987

7/1/1987
5/2/1987

6/26/1987

Fig. 5. Elliott wave formations in Nikkei 225 index between 3/18/1987–7/1/1987 (76 days).

Table 2 However, we know that the Elliott wave principle can be ob-
Elliott wave patterns of Nikkei 225 index
served by looking also at small scales. We therefore, zoom the
between Jan. 1986–Sep. 1990.
Nikkei 225 index further. The observations are given in Figs. 5 and
Wave Begins Ends 6.
1 Jan. 1986 Sep. 1986
If we zoom further and concentrate on the date 6/1/1987 and
2 Sep. 1986 Nov. 1986 the following 13 days we encounter another wave pattern.
3 Nov. 1986 Jul. 1987 These similar patterns demonstrate us the Elliott wave thus
4 Jul. 1987 Mar. 1988 fractal nature of Nikkei 225 index. Notice that our data includes
5 Mar. 1988 Jan. 1990
only closing day prices. One can zoom further whenever minute or
A Jan. 1990 Apr. 1990
B Apr. 1990 Jul. 1990 second based data is available.
C Jul. 1990 Oct. 1990 In Fig 7 we see possible trajectories for different Hurst param-
eters. Top left (H = 0,95) and top right (H = 0,75) are too smooth.
Although in the bottom left (H = 0,5, regular Brownian motion) fig-
ure we see an increase, peak and then a decrease in the begin-
ning but a fractal nature can not be observed. In the bottom right
In fact nothing unusual happened but the stocks begin to fall figure (H = 0,176) we can easily observe Elliott wave structure be-
dramatically. The decline continued till August 18, 1992, approxi- tween days 20 0–40 0 and 450–550. Moreover there are numerous
mately a decline 65%. (see [8,12] for details) other Elliott waves if the trajectory is observed in detail. Hence we
In Fig. 4. we see an Elliott wave formation between Jan. 1986– see that the fractal structure of Elliott wave is captured with a fBm
Sep. 1990. Wave patterns are given in Table 2. with a Hurst parameter of 0,176.
140 D. Ilalan / Chaos, Solitons and Fractals 92 (2016) 137–141

10.17
10.165
10.16
10.155
10.15
10.145
10.14
10.135
10.13
10.125
10.12
6/3/1987

6/5/1987
6/6/1987
6/7/1987
6/8/1987
6/9/1987
6/10/1987
6/11/1987
6/12/1987
6/13/1987
6/14/1987
6/15/1987
6/16/1987
6/17/1987
6/18/1987
6/19/1987
6/4/1987

Fig. 6. Elliott wave formations in Nikkei 225 index between 6/3/1987–6/19/1987 (14 days).

Fig. 7. Simulation of fractional Brownian motion for different values of Hurst parameters.

5. Conclusion Stock returns are assumed to be log-normally distributed as

Elliott waves are widely used technical indicators by practition-
ers. Although not identical, the fractal nature of these waves en-
able us to calculate their Hausdorff dimension. We see that El-
liott wave movements could be one of the trajectories of a frac-
tional Brownian motion. Due to their space filling character, we
demonstrated that the generator has a Hurst parameter close to
zero.
proclaimed by the Black Scholes option pricing formula [3]. How-
ever, it is also a well known fact that this assumption inherits
some major drawbacks like the volatility smile phenomenon.
In this study, we see that when there is an Elliott wave struc-
ture for a certain period, the normality assumption (regular Brow-
nian motion) is no longer at stage. During wavelets, generator must
be a fractional Brownian with a Hurst parameter of 0,176 (less than
0,5). Therefore it can be deduced that the Hurst parameter of the
 D. Ilalan / Chaos, Solitons and Fractals 92 (2016) 137–141
logarithm of a stock return process is not always 0,5. Hence, from
a fractal point of view, this paper demonstrates that the normal-
ity assumption of the logarithm of stock returns is quite restrictive
and unrealistic.
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