Why do we choose the Wave Principle? (en)

Below is a brief introduction to the Elliott Wave Principle, where it comes from and why it is interesting. Enjoy!

How did Wave theory come about?

Ralph Nelson Elliott is the father of Wave theory, commonly referred to as the Elliott Wave Principle and more accurately described. Born July 28, 1871, in Marysville, Kansas, Elliott reached his goals late in life in a roundabout way.

After a long career in various accounting and business practices, R. N. Elliott was forced to retire at the age of 58 because of an illness he contracted while living in Central America. Needing something to occupy himself with during his recovery, he concentrated entirely on studying the stock market.

After a long career in various accounting and business practices, R. N. Elliott was forced to retire at the age of 58 because of an illness he contracted while living in Central America. Needing something to occupy himself with during his recovery, he concentrated entirely on studying the stock market.

Collins had traditionally put off the numerous correspondents who offered him systems for beating the market. Not surprisingly, the vast majority of these systems proved to be dismal failures. Elliott's Wave Theory, however, was another story.

The Dow Jones averages had declined throughout early 1935, and advisors were turning negative with the memories of the 1929-32 crash fresh in their minds. On Wednesday, March 13, 1935, just after the close of trading — with the Dow Jones averages finishing near the lows for the day — Elliott, citing his Wave Theory analysis, sent a telegram to Collins and flatly stated:

"NOTWITHSTANDING BEARISH (DOW) IMPLICATIONS ALL AVERAGES ARE MAKING FINAL BOTTOM."

The next day, Thursday, March 14, 1935, was the day of the closing low for the Dow Industrials that year. The 13-month "correction" was over, and the market immediately turned to the upside. Two months later, as the market continued its upward climb, Collins agreed to collaborate on a book on the Wave Theory. The Wave Principle was published on August 31, 1938.

During the early 1940s, the Wave Theory continued to develop. Elliott tied the patterns of collective human behavior to the Fibonacci, or "golden" ratio, a mathematical phenomenon known for millennia as one of nature's ubiquitous laws of form and progress.

Elliott then put together what he considered his definitive work, Nature's Law -- The Secret of the Universe. This volume includes almost every thought he had concerning his Wave Theory.

As a result of Elliott's pioneering research, today, thousands of institutional portfolio managers, traders and private investors use the Wave Theory in their investment decision-making.

What is the Elliott Wave Principle?

The Elliott Wave Principle is a detailed description of how groups of people behave. It shows that mass psychology oscillates from pessimism to optimism and back again in a natural sequence, creating concrete and measurable patterns.

One of the easiest places to see the Elliott Wave Principle in action is in the financial markets, where changes in investor psychology are captured in the form of price movements. If you can find recurring price patterns and figure out where we are today in those recurring patterns, you can predict where we are going.

The Elliott Wave Principle is named after its discoverer Ralph Nelson Elliott.

The Elliott Wave Principle measures investor psychology, which is the real driver of stock markets. When people are optimistic about the future of an issue, they drive the price up.

Two observations make this clear: First, investors have noticed for hundreds of years that events external to the stock markets do not seem to have a permanent effect on their development. The same news that seems to push the markets up today is just as likely to push them down tomorrow. The only reasonable conclusion is that markets just aren't reacting consistently to external events. Second, when you study historical charts, you see that markets are constantly developing in waves.

Using the Elliott Wave Principle is an exercise in probability. By understanding wave patterns, you will know what is likely to happen to the markets and (sometimes most importantly) what will not happen. Using the Elliott Wave Principle, you identify the most likely moves with the least risk.

How to apply Elliott Wave Principle?

When investors first discover Elliott Wave Principle, they are often most impressed by its ability to predict where the market will go next.

And that's impressive. But the benefits don't end there. The Elliott Wave Principle also gives you a method of determining at which points the market is likely to reverse. And that, in turn, gives you an idea of where you can enter and exit positions with the highest probability of success.

So, how to start applying the Elliott Wave Principle?
Starting at the most basic level. The Elliott Wave Principle works by identifying patterns in market prices. In other words, we start by analyzing the waves on the chart.

The Elliott pattern consists of "impulse waves" and "corrective waves". An impulse wave consists of five sub-waves . It moves in the same direction as the next larger trend. A corrective wave is divided into three sub-waves . It moves against the trend of the next larger size.

As shown in the figure below, these basic patterns form five- and three-wave structures of increasing size (more "degree," as Elliott said).

In the figure above, waves 1, 2, 3, 4, and 5 together make up a larger impulsive sequence, labeled wave (1). The impulsive structure of wave (1) tells us that the movement in the next larger degree of the trend is also ascending. This warns us to expect a three-wave correction - in this case a downtrend.

This correction, wave (2), is followed by waves (3), (4), and (5) to complete the next larger degree impulse sequence labeled wave 1. At that point, again a three-wave correction of the same degree, designated wave 2.

Thus, when applying the Elliott Wave Principle, our first task is to look at the price charts and identify any completed five-wave and three-wave structures. Only then can we understand where the market is and where it can go.

But applying the Elliott Wave Principle to any chart, we must remember one important point. The Elliott Wave Principle does not give you confidence in any market outcome. Instead, it gives you an objective means of determining the probability of future market direction. There are usually two or more credible interpretations of waves. Therefore, it is important for any investor or trader to carefully evaluate the probability of each scenario.
"Alternate scenarios" are simply side roads that sometimes turn out to be the best path. Consider the Elliott Wave Principle as your road map to the market and your investment idea as a journey.

Specific Elliott rules minimize the number of permissible interpretations (or "alternative scenarios"). The analyst usually considers "priority" the one that satisfies the greatest number of coincidences. The top "alternative" is the one that satisfies the next highest number of matches, and so on. Alternatives are an integral part of using the Elliott Wave Principle.

Another key to the application of the Elliott Wave Principle is the Fibonacci Ratios. Few investors realize that the analysis of Fibonacci markets was first performed by R. N. Elliott. The use of Fibonacci ratios requires a correct interpretation of the Elliott Waves as a starting point. Elliott had two major discoveries regarding Fibonacci ratios within waves:
1. Corrective waves tend to repeat the previous impulse waves of the same degree in the Fibonacci proportions - common wave ratios include 38%, 50% and 62%.
2. impulse waves of the same level in a larger impulse sequence tend to correlate with each other in the Fibonacci proportion.

The rules of interpretation of waves and Fibonacci ratios together are powerful tools for developing investment strategies and reducing risk. The application of the Elliott Wave Principle helps investors to decide where to enter, where to exit, and at what point to abandon a strategy. Thus, the Elliott Wave Principle helps to determine the most probable direction of market movement.

The basics of the wave principle remain as Elliott formulated them. These basics are fully described in the standard textbook of wave analysis, "The Elliott Wave Principle - The Key to Market Behavior," written by A. J. Frost and Robert R. Prekter, Jr. This book saved the Elliott Wave Principle from oblivion and made it universally recognized as perhaps the most sophisticated form of technical analysis.

🔹 Remember: applying Elliott Wave Principle is easy, but it takes years of practice and hard work to master. Nevertheless, it is worth taking the time and learning how to count correctly. There are several Elliott wave software applications that claim to do all the calculations for you, but with all the variables on the market, it is much better to do the calculation yourself.

What is an Elliott Wave and what does it look like?

The wave principle is Ralph Nelson Elliott's discovery that social behavior, or crowding, changes trends and changes according to recognizable patterns. Elliott discovered that the constantly changing trajectory of stock market prices is indicative of a structural arrangement, which in turn reflects the basic harmony that exists in nature. Based on this discovery, he developed a rational system of market analysis. Elliott identified 13 movement patterns, or "waves," that recur in market price data and are repetitive in form, but not necessarily repetitive in time or amplitude. He named, identified and illustrated the patterns. These patterns represent Elliott waves.

These Elliott waves connect together to form larger versions of the same patterns. They, in turn, connect, forming similar structures of the next larger size, and so on:

In the markets, the movement ultimately takes the form of five Elliott waves of a particular structure. As you can see below, in the simplest Elliott wave structure, waves (1), (3) and (5) actually affect directional movement. Waves (2) and (4) represent pullback movements.

These two corrective movements are a prerequisite for an overall directional movement. And while there are several variations of Elliott waves, they all fit into the basic structure you see above. The stock market is always somewhere in the basic five-wave pattern at the greatest degree of trending. Since the five-wave pattern is the basic form of market movement, all other patterns are subordinate to it.

How does Elliott Wave Analysis work?

Wave analysis is based on the Elliott Wave Principle, which states that investor psychology drives stock markets.

Robert Prekter explains:

"The Wave Principle is a catalog of the ways that the crowd goes from the extreme point of pessimism at the bottom to the extreme point of optimism at the top. It is a description of the steps human beings go through when they are part of the investment crowd, in order to change their psychological orientation from bullish to bearish. Since people don't change much, the path they follow in moving from extreme pessimism to extreme optimism and back again tends to be the same over and over, regardless of news and extraneous events."

The Elliott Wave Principle allows you to correctly decipher the wave patterns unfolding in the market and then make predictions as to which wave patterns are most likely to emerge next - this is the basis of Elliott Wave Analysis.

Each Elliott wave structure carries unique features and is followed by another specific and unique structure. The study of these structures ultimately allows analysts to predict what might happen in the next moment, and - perhaps more importantly - what will not happen in the next moment.

Advantages and disadvantages of Elliott Theory

👍 Advantages.

• Works in all markets/timeframes.
• Based on psychology, is reflected in natural processes
• Predicts the market, both by price movement direction and its duration. Forecasts can be made both for a short term and for a long term.
• It contains specialized tools that help to break down and calculate waves on the chart.
• How to structure infinite fluctuations into cycles and waves

👎 Disadvantages.

• Subjectivism. "Wavesetters" can mark up the same chart in different ways.
• Hardness in identifying waves, especially corrective waves
• The need for long training, preferably under the guidance of an experienced trader.

Why do we choose the Wave Principle?

The Wave principle is not only one of the best forecasting methods, it is above all a detailed description of the behavior of the markets. Such a description gives a huge amount of information about the position of the market in relation to the behavior of investors, and thus tells us about its likely future path.

In simple words, Wave analysis is a way to determine the current market situation (which stage a wave is in). After determining the location, the trader makes more accurate forecasts of the upcoming chart movement, which greatly increases the likelihood of profit.

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