Technical Analysis

A Beginner’s Guide to Elliot Wave Theory & Application

Elliot Wave theory was initiated in the 1930s by Ralph Nelson Elliot.  His basic theory was that crowd behaviour, the basis for market activity, tends to operate in recognisable phases, and as such, price movements can be anticipated to some degree.

During his early studies, using Stock Market data for his analysis, Elliot isolated thirteen examples of patterns ? or waves ? that are repetitive in their form only, and that the time and amplitude of the waves need not necessarily be repetitive. To demonstrate what he learned, Elliot named, defined and illustrated each pattern, showing how several small patterns could be brought together to create one larger example of the same form, which would in turn merge into another, larger version of the ?wave?.

Elliot Wave Theory is a collection of these patterns, and a set of guidelines regarding as to where and when the patterns may occur in the financial markets. These patterns allow the Elliot Wave trader to understand market action, and possibly predict future trends. These patterns are now known throughout the industry as ?The Elliot Wave Principle?.

It is somewhat easier to grasp the concept of Elliot Wave if we demonstrate the theory in pictures, rather than words. The basic format is shown in Figure 1 below.

There are two distinct parts to each wave: the Numbered Phase, and the Lettered Phase.

In the Numbered Phase, Waves 1, 3 and 5 are called ?impulse? waves – minor upwards moves in an otherwise bullish trend. Waves 2 and 4 are the smaller, less powerful ?corrective? waves.

In the Lettered Phase, Waves A and C are the stronger impulse waves down, with Wave B ? the bull wave ? now the weaker move.

Waves within Waves

Elliot theorised
that the wave in Figure 1 was a small wave, embedded within an overall larger
wave, and that each larger wave was in turn simply part of an even larger wave. This can be difficult to imagine, but if we look at the example in Figure 2 below, we can see exactly what he meant.

In Figure 2, we can see that Waves 1 through 5, and Waves A through C – as shown in Figure 1 –  form part of an overall  impulse Wave 3, as shown in Figure 2.

Elliot believed that there were many cycles of both impulse and corrective waves, and he named each cycle to fit in with his theory that the waves were based around the Fibonacci series of numbers ? 1, 2, 3, 5, 8, 13 etc. The names are:

  1. Grand Supercycle
  2. Supercycle
  3. Cycle
  4. Primary
  5. Intermediate
  6. Minor
  7. Minute
  8. Minuette
  9. Sub-Minuette

Elliot provided several varieties of the main wave, and placed particular relevance on the Fibonacci value of 0.618, as the most common level for a retracement to occur.
Of course, the examples shown in Figures 1 and 2 are perfect definitions of Elliot Wave Theory. In the real world, things tend not to be quite so clear. The price action shown in Figure 3 below is taken from the NASDAQ Composite Index, during the later part of 2003. The waves are still there, but somewhat harder to spot to the untrained eye.


 
In theory, to trade using Elliot is simple. You identify the main wave, enter long, and cover or sell short as a reversal occurs.

In practice, things can be rather different; many wave patterns are identified only with hindsight, and disagreements often arise between followers of Elliot as to which cycle the market is actually in at any given time.

This article has been merely a basic overview.  Elliot Wave Theory can be explored in much more detail by those with an interest.  A hot button topic among market participants, it tends to be something one either believes in or thinks is useless.  The fact that Robert Prechter – probably the biggest name in Elliott Wave practice – was woefully incorrect in his public stock market predictions during the 1990s was a hit to the technique’s credibility as well.  It’s like any other trading tool, though, in that each individual trader must determine it’s value on their own.  Some will find it useful.  Others will not.

References:
www.elliotwave.com
www.wavechart.com
www.stockcharts.com/education  Scott McCormick

Matt began Spread Betting in late 2002, and moved into trading e-mini Dow Jones and S&P500 Futures during 2003. He has also traded Forex during 2004. He is totally self taught, taking his education from a variety of media and websites, along with the inevitable compulsory lessons dealt out by the markets.Currently, he works part time for T2W running our Sales and Marketing activities, is studying for his degree in IT & Computing with the Open University, and also runs a computer repair and website design business at Aardvark Technology

Matt began Spread Betting in late 2002, and moved into trading e-mini Dow Jones and S&P500 Futures during 2003. He has also traded Forex during 20...

Rhody Trader

Senior member
2,620 264
Matt's article is a brief overview of Elliott Wave Theory for those unfamiliar with the method. It certainly isn't a comprehensive study, which would be (and is) the subject of full books. Discussion is encouraged.
 

bakula

Junior member
40 0
I wish Matt discussed more about the elliot wave! In depth analysis/chat is welcomed-novice myself and this theory is very interesting..Thanks!
 

FetteredChinos

Veteren member
3,897 40
hmm, good beginner's guide..BUT:-

would have been nice to discuss fib extentions and expected ratios of the wave lengths.

eg isnt a wave 3 expected to be 1.618 or 2.618 x wave 1 length?

wave 4 cant overlap into wave 2?

wave 4 is usually identified by a sloping triangle in price, and if using indicators a return of the MACD to the zero line. (this is a fairly low risk long setup)

also, the time duration of the waves can also be looked into.. counting bars... fibs?

or is this getting too close to being a commercially available system?

FC
 

rossored

Senior member
2,088 49
FetteredChinos said:
or is this getting too close to being a commercially available system?
Yes :)

I wrote this a while ago, and it was intended just to be a very basic introduction - nothing more than that.
 

FetteredChinos

Veteren member
3,897 40
thats matt. it does serve a purpose..

couldnt trade off it directly, but more as Skim used to:- ie , look for 5 legs up, then if you have a reversal signal as per another method, then it is a fairly safe trade..

as for an elliot/fib/cycle based system.. watch this space.

im gonna launch the Market Map, as developed with Mofo, all for the princely sum of £69,000 for an hours tuition.

roll up, roll up...
 

etypejag

Newbie
8 0
I have been watching Elliot waves for a number of years now.
They are great after the event!!
When you are actually in the middle of a so-called wave, they have a nasty habit of changing
The experts then very conveniently re-label everything!!!
 

nine

Senior member
2,038 506
Joules,

Once upon a time I followed Robert Prechter's organizations calls on the market top. They didn't come close to getting it right --- kept changing to alternatives and alternatives on alternatives --- but a couple of years later they were claiming success. They'd nailed it - LMAO. Friends mentioned that they had been told that RP's lot wrote good books but were not very good at calling it having repeatedly called "THE TOP" all the way up. Apparently my experience of their minor top calling excellence was also normal.

So, if the GURU himself doesnt call it correctly (or even close) then who are the "accurate" practicitioners and newsletter sellers?
 

nine

Senior member
2,038 506
Darned if I understand much of that Julian.

I happily admit my losing trades and my losing days (I had one on Monday) . I believe that integrity is key to trading ... both with oneself and with others ... and I would stop using my GP if I found that she was mismanaging her patients.

The Elliott boys not only failed to admit any lack of clear vision but after the fact they claimed it as a success. In their advertising a year later they were claiming to have correctly called the top, crowing about it. That deserves a little bagging given I was paying for the material and I am sure others have done so since based on their claims.

Good luck in your trading :)
 

sulong

Active member
249 15
Kiwi said:
The Elliott boys not only failed to admit any lack of clear vision but after the fact they claimed it as a success. In their advertising a year later they were claiming to have correctly called the top, crowing about it. That deserves a little bagging given I was paying for the material and I am sure others have done so since based on their claims.

Good luck in your trading :)
You bought Elliott wave stuff from GWB? whoa, that's weird.
 

Verno

Member
77 3
I read somewhere that the impulse wave needs to be between 8-13 periods long or something like that. Can anyone enlighten me?
 

b_chris

Newbie
1 0
Interesting thread, I use Elliot Wave for EOD on markets that it works well on quite sucessfully, thats the other thing, like all trading styles it works best on some markets and not others.

The way I use it is not to predict the market out come, but as a set of trading rules.

Good Trading.
 

robrr

Newbie
6 0
I heard some people made tons of money using RP's calls. They just took the opposite trade of what he put out in his hotline.

Does anybody remember it?
 

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