Elliott wave principle

The Elliott wave principle (1871–1948), a professional , or wave principle, is a form of technical analysis that investors use to forecast trends in the financial markets and other collective activities. Ralph Nelson Elliottaccountant, developed the concept in the 1930s, proposing that market prices unfold in specific patterns, which practitioners today call Elliott waves, or simply waves. He published his views of market behavior in the book The Wave Principle (1938), in a series of articles in Financial World magazine in 1939, and most fully in his final major work, Nature’s Laws – The Secret of the Universe (1946). Elliott said that "because man is subject to rhythmical procedure, calculations having to do with his activities can be projected far into the future with a justification and certainty heretofore unattainable."

lliott Wave analysts (or "Elliotticians") say that they may not even need to look at a price chart to determine where a market lies in its wave pattern. Each wave has its own "signature," which often reflects the psychology of the moment. Understanding how and why the waves develop is the key to applying the Wave Principle; that understanding includes recognizing the characteristics described below.
These wave characteristics assume a bull market in equities. The characteristics apply in reverse in bear markets.

Wave 1: First waves are rarely recognized at their inception. When the first wave of a new bull market begins, the fundamental news is just about universally negative. The previous trend is considered still strongly in force. Fundamental analysts continue to revise their earnings estimates lower; most likely, the economy does not look strong either. Sentiment surveys are decidedly bearish, put options are in vogue, and implied volatility in the options market is high. Volume might increase a bit as prices rise, but not by enough to alert many technical analysts.

Wave 2: Wave two corrects wave one, but can never extend beyond the starting point of wave one. Typically, the news is still bad. As the markets retest the prior low, bearish sentiment quickly builds, and "the crowd" haughtily reminds all that the bear market is still deeply ensconced. Still, some positive signs appear for those who are looking: volume should be lower during wave two than during wave one, prices usually do not retrace more than 61.8% (see Fibonacci section below) of the wave one gains, and prices should fall in a three wave pattern.

Wave 3: Wave three is usually the largest and most powerful wave in a trend (although some research suggests that in commodity markets, wave five is the largest). The news is now positive and fundamental analysts start to raise earnings estimates. Prices rise quickly, and corrects are short-lived and shallow. Anybody looking to "get in on a pull-back" is likely going to miss the boat. As wave three starts, news is probably still bearish, and most market players remain negative. But, by the midpoint of wave three, "the crowd" will often now be on board with the new bullish trend. Wave three often extends wave one by a ratio of 1.618 : 1.

Wave 4: Fourth waves are typically clearly corrective. Prices may meander in a sideways pattern for an extended period, with wave four typically retracing less than 38.2% of wave three. Volume is well below than that of wave three. This is a good place to buy a pull back, if you understand the potential for wave 5 ahead. However, possibly the single most distinguishing feature of fourth waves is that they are often very difficult to count.

Wave 5: The fifth wave is the final leg of a five wave move. The news is now almost universally positive and everybody is bullish. Unfortunately, this is the point when many "average investors" finally buy in, right before the top. Volume is lower in wave five than in wave three, and many technical momentum indicators will start showing divergences (prices reach a new high, the indicator does not reach a new peak). At the end of a major bull market, bears may very well be ridiculed (recall how those calling for a top in the stock market during 2000 were received).

Wave A: Corrections are typically harder to identify than impulse moves. During wave A of a bear market, the fundamental news is usually still positive. Most analysts see the drop as a correction in a still-active bull market. Some technical indicators that suggest a wave A include increased volume, rising implied volatility in the options markets and possibly a turn higher in open interest in related futures markets.

Wave B: Prices move back higher, and is seen as a resumption of the now long gone bull market by many. For those familiar with classical technical analysis, the peak would be the right shoulder of a head and shoulders reversal pattern. Volume during a wave B should be lower than seen in wave A. By this point, fundamentals are probably no longer improving, but they most likely have not yet turned negative.

Wave C: Prices move impulsively lower in five waves. Volume picks up, and by the third leg of wave C, almost everybody realizes that a bear market is firmly entrenched. Wave C is typically at least as large as wave A and often extends to 1.618 times wave A or larger.