Intro to the Elliott Wave Principle

November 9th, 2012

The Elliott Wave principle describes the psychology of crowds. Social mood (mass psychology) drives social action and has structure and form.

It reveals that mass psychology swings from pessimism to optimism and back in a natural sequence, creating specific and measurable patterns.

One of the easiest places to see the Elliott Wave Principle at work is in the financial markets, where changing investor psychology is recorded in the form of price movements. If you can identify repeating patterns in prices, and figure out where we are in those repeating patterns today, you can predict where we are going.

The Elliott Wave Principle is named for its discoverer Ralph Nelson Elliott (1871-1948) and developed during the 1930’s.

Elliott Wave Principle measures investor psychology, which is the real driver behind the stock markets. When people are optimistic about the future of a given issue, they bid the price up.

Using the Elliott Wave Principle is an exercise in probability. An Elliottician is someone who is able to identify the markets structure and anticipate the most likely next move based on our position within those structures. By knowing the wave patterns, you’ll know what the markets are likely to do next and sometimes most importantly what they will not do next.

 

Wave Structure Rules:

Here is the list of Rules for Impulse waves:
• An impulse always subdivides into five waves.
• Wave 1 always subdivides into an impulse or (rarely) a diagonal.
• Wave 3 always subdivides into an impulse.
• Wave 5 always subdivides into an impulse or a diagonal.
• Wave 2 always subdivides into a zigzag, flat or combination.
• Wave 4 always subdivides into a zigzag, flat, triangle or combination.
• Wave 2 never moves beyond the start of wave 1.
• Wave 3 always moves beyond the end of wave 1.
• Wave 3 is never the shortest wave.
• Wave 4 never moves beyond the end of wave 1.
• Never are waves 1, 3 and 5 all extended.

 

Logarithmic or arithmetic chart – What is best for analyzing Elliott Wave structure ?

 For long term analysis, log scale is the preferred scale, but arithmetic scale shows nearly the same picture at small degrees (Intermediate and lower). Often  both are confirming the “arithmetic” support and resistance, and if they produce different results, watch both levels to see how the market behaves.

There are two reasons to employ arithmetic scale charts from time to time: (1) They show percentage retracements properly; (2) They reflect the experience of futures traders, who make money per point, not by percentage moves.

Fibonacci levels, however they are calculated, are useful only in anticipating potentially significant support and resistance levels. The wave structure is more important. The best way to know when a rally or decline is finished is to see the completion of a five wave or a three wave pattern. And if a wave structure happens to end near a Fibonacci level that give confidence.

Fibonacci is secondary to the Elliott Wave structure and a confirmatory indicator. Fibonacci can be used as a guide about areas where the market may turn, but keep focus on the developing waves.

When judging a wave formation. A guideline is that wave 3 should be at least equal to wave 1. When 3 is approaching 1, if wave structure looks immature, assume 3 will reach 1.618 times 1. When 3 is approaching that level, if wave structure still looks immature, assume 3 will reach 2.618 times 1. This way, Fibonacci become a “guide,” not a definitive rule.

 

The purpose of learning the Wave Principle (psychology of the masses) is to understand and position yourself for the major trends in societies and the financial markets.

 

Elliott Wave Technician is a forecasting & research service based on the Elliott Wave Principle, economical cycles and demographics.
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