TECHNICAL ANALYSIS

FRANCO SHAO

The Elliott Wave Principle

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Like any system or structure found in nature, the closer you look at wave patterns, the more structured complexity you will see. Franco Shao leads a beginning discussion of the Elliott Wave Principle, a technique that can yield accurate market forecasts.
n the 1930s, Ralph Nelson Elliott, a corporate accountant by profession, studied price movements in the financial markets and observed that certain patterns repeated themselves. He offered proof of his discovery by making astonishingly accurate stock market forecasts. Things that appeared random and unrelated, Elliott said, would actually trace out a recognizable pattern once you learned what to look for. Elliott called his discovery The Elliott Wave Principle, and its implications were huge. He identified the common link that drives trends in human affairs, from financial markets to fashion, from politics to popular culture. Robert Prechter, Jr., president of Elliott Wave International, resurrected the Wave Principle from near obscurity in 1976 when he discovered the complete body of R.N. Elliotts work in the New York Library. Robert Prechter, Jr. and A.J. Frost published Elliott Wave Principles in 1978. The book received enthusiastic reviews and became a Wall Street bestseller. In Elliott Wave Principle, Prechter and Frosts forecast called for a roaring bull market in the 1980s, to be followed by a record bear market. Needless to say, knowledge of the Wave Principle among private and professional investors grew dramatically in the 1980s. When investors and traders first discover the Elliott Wave Principle, there are several reactions:

crystal ball to foretell the future And finally, the correct and useful response Wow, here is a valuable new tool I should learn to use.
Just like any system or structure found in nature, the closer you look at wave patterns, the more structured complexity you will see. It is structured, because natures patterns build on themselves, creating similar forms at progressively larger degrees. You can see these fractal patterns in botany, geography, physiology and things that humans create, like roads, residential subdivisions... and as recent discoveries have confirmed in market prices. Natural systems, including Elliott wave patterns in market charts, grow through time, and their forms are defined by interruptions to that growth. This statement means when your hands formed in the womb, they first looked like round paddles growing equally in all directions. Then, in the places between your fingers, cells ceased growing or died and growth was directed to the five digits. This structured progression and regression is essential to all forms of growth. That this punctuated growth appears in market data is only natural as Robert Prechter, Jr., the worlds foremost Elliott wave expert and president of Elliott Wave International, says, Everything that thrives must have setbacks. Basic Elliott Wave Pattern The first step in Elliott Wave analysis is identifying patterns in market prices. At their core, wave patterns are simple; there are only two of them
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Disbelief that markets are patterned and largely predictable by technical analysis alone Joyous irrational exuberance at having found a

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TECHNICAL ANALYSIS

Figure 1

impulse waves and corrective waves. Impulse waves are composed of five sub-waves and move in the same direction as the trend of the next larger size (labeled as 1, 2, 3, 4, 5). Impulse waves are called this because they powerfully impel the market. A corrective wave follows, composed of three sub-waves, and it moves against the trend of the next larger size (labeled as a, b, c). Corrective waves accomplish only a partial retracement, or correction, of the progress achieved by any preceding impulse wave. As Figure 1 shows, one complete Elliott wave consists of eight waves and two phases. There is the five-wave impulse phase, whose sub-waves are denoted by numbers, and the three-wave corrective phase, whose sub-waves are denoted by letters. What R.N. Elliott set out to describe using the Elliott Wave Principle was how the market actually behaves. There are a number of specific variations on the underlying theme, which Elliott meticulously described and illustrated. He also noted that each pattern has identifiable requirements as well as tendencies. From these observations, he was able

to formulate numerous rules and guidelines for proper wave identification. A thorough knowledge of such details is necessary to understand what the markets can do, and at least as important, what it does not do.

Forex Trading with Elliott Wave

Elliott Wave Counts may be summed up as follows: Wave 1 is normally the most weak of the impulse waves. It is typically based on short covering by the bears from a previous move. The next Wave is created at the end of the first Wave and after the currency pair is sold off. Wave 2 comes to an end when the market fails to make new lows. Wave 3 is the most lengthy and strong of the impulse waves. This Wave leads to strong currency buying or selling in the direction of the trend and usually starts slowly, but tends to accelerate as the market breaks to new highs above the top of Wave 1. A correction occurs, especially after a strongly trending

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market. Then, traders start making profits, paving the way for Wave 4. After the Wave 4 correction, the currency pair will rally ushering in Wave 5. This Wave is usually supported by retail traders and not institutional buyers and tends to lack the momentum generated in the third Wave. In a nutshell, Elliott Wave analysis can be deployed to enhance a traders Forex swing trade opportunities. A closer look into the Elliott Wave theory and other strategies could be useful for traders enabling them to use these as tools for increasing their Forex opportunities. When evaluating the Forex market for swing trade opportunities, the focus should be placed on forecasting directional changes for a currency pair with technical analysis. In this analysis, there are different indicators. The most reliable tool used to predict Forex market swings is Elliott Wave analysis because it can be used to identify trends and countertrends. It can also be used to identify continuation and exhaustion of trends and evaluate the potential of trend pricing targets. Elliott strongly believed that the markets movement was a direct result of the mass psychology of the time. He also believed that the stock market is a fractal or an object similar in shape, but at a different scale. An apt example of a natural fractal is a stalk of broccoli. The stalk and individu-

al branches look strikingly similar because the branches are the same except smaller in scale. According to Elliott, this mass psychological move resembles the herding tendency in human beings. Summing up, market action is not the cause of economic growth or slow down, but a reflection of the mass psychology of investors. If the mood of the investing public is upbeat, then a bull market ensues. This is counter to what most individuals perceive that is to say because there is a bull market the mood of the investing public is upbeat.

Franco Shao is founder of ForexCycle.com - a website that focuses on market trends and data analysis of the financial markets, especially for foreign exchange trading. It was established in year 2005. Franco has rich experience in the industry. As a trader, Franco has been engaged in the financial markets for over 10 years. Recently, he has been paying more attention to his website management and foreign exchange trading. Franco has enjoyed writing articles presenting his opinions talking about trends, the estimation and analysis of the financial market especially for the business of Foreign Exchange trading. He also has a keen interest in the world of Forex trading. Franco can be reached at forexcycle@gmail.com

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