Ralph Nelson Elliott was regarded as one of the greatest technical analysts of the 20th century. In the early-1930s, Elliott began working on a systematic study of fluctuations in the stock market. Based on his analysis, he concluded that fluctuations in the stock market were mainly based on collective human behavior.
Elliott believed that all speculative markets followed fairly predictable price movements based on investor psychology and underlying social principles. In 1938, he combined all of his research into a book called The Wave Principal.
Elliott’s book was very well received within the investment community, particularly among traders who relied on technical analysis.
The Elliot Wave Principle
Elliott passed away in 1948, leaving behind a treasure trove of historical data and research based on his Wave Principal. Elliott’s original work in the field of human behavior actually became more popular in the years following his death.
Several technical analysts expanded on his research, particularly in the area of investor psychology. This additional research also looked at crowd psychology and the herd mentality of crowds. Today, Elliott Wave is one of the most popular forms of technical analysis used to forecast the stock market and other speculative markets.
The Elliott Wave Principal moves between optimism and pessimism in natural sequences. These mood swings create various patterns or waves. Based on Elliott’s model, all market prices fluctuate between impulse and corrective phases. These fluctuations occur regardless of the time frame. In other words, Elliott Wave can be successfully applied to long-term studies or short-term studies.
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Impulse Phases and Corrective Phases
Impulse phases are subdivided into five smaller waves. Corrective phases are subdivided into three smaller waves. In a bull market, waves #1, #3, and #5 of the impulse phase are bullish. Waves #2 and #4 are retracements of the primary bullish trend.
In a bear market, waves #1, #3, and #5 are bearish. Waves #2 and #4 are retracements of the primary bearish trend. The big move always occurs in wave #3.
Waves #1, #3, and #5 are also known as motive waves. These waves always move with the underlying trend. Waves #2 and #4 are also known as corrective waves. They move against the underlying trend. Please review Chart #15.
Each motive wave and corrective wave has its own sub-cycle. Each sub-cycle is divided into mini waves. An entire Elliott Wave motive pattern consists of 89 waves, followed by a completed corrective pattern of 55 waves.
During his initial research, Elliott subscribed to the idea that each completed wave pattern represented a degree of movement based on a specific time frame. Each degree of movement was given a name.
Elliott labeled nine different degrees of movement.
- Grand Supercycle – multi-century
- Supercycle – multi-decade
- Cycle – multi-year
- Primary – months
- Intermediate – weeks to months
- Minor – weeks
- Minute – days
- Minuette – hours
- Sub-minuette – minutes
A grand supercycle is the longest degree of movement based on Elliott’s research. The reversal of a grand supercycle is incredibly rare. Most traders and investors will never see a grand supercycle reversal in their lifetime.
Although Elliott Wave has been extremely popular over the past several decades, the main criticism of this trading approach is based on the fact that the entry and exit levels are too subjective.
Additionally, the wave counts are open to interpretation. In an attempt to remedy this problem, many traders who use Elliott Wave on a daily basis prefer to combine the wave counts with Fibonacci ratios. Adding Fibonacci ratios to the mix provides specific entry and exit signals.
Elliott Wave is not perfect. It continues to remain one of the most widely followed trading techniques in the history of technical analysis.
Brief Summary of Elliott Wave
- Ralph N Elliott is regarded as one of the greatest technical analysts of all time.
- In the early-1930s, Elliott began to study fluctuations in the stock market.
- He observed that fluctuations in the stock market were based on human behavior.
- Throughout the 1930s, Elliott developed a systematic investment approach.
- The investment approach was based on his observations concerning human behavior.
- Following his death in 1948, traders continued to study Elliott’s original work.
- Elliott’s methods actually became more popular during the years following his death.
- His methodology became known as the Elliott Wave Principle.
- Elliott Wave Principal moves between optimism and pessimism in natural sequences.
- These mood swings create various patterns or “waves.”
- All prices fluctuate between an impulse phase and a corrective phase.
- According to Elliott, these fluctuations will occur regardless of the time frame.
- Therefore, Elliott Wave can be applied to long-term studies or short-term studies.
- In a bull market, waves #1, #3, and #5 are bullish.
- Waves #2 and #4 are retracements of the primary bullish trend.
- In a bear market, waves #1, #3, and #5 are bearish.
- Waves #2 and #4 are retracements of the primary bearish trend.
- An entire Elliott Wave motive pattern consists of 89 waves.
- This is followed by a completed corrective pattern of 55 waves.
- Elliott believed that each completed wave pattern represented a degree of movement.
- Each degree of movement was based on a specific time frame.
- Elliott labeled nine different degrees of movement.
- Elliott Wave continues to remain extremely popular among technical analysts.