Elliot Wave stock correction ..
Who is Robert Prechter, and why should investors
care that he is warning them to be on high alert for
a potential collapse in the stock market?
The president of Elliott Wave International, Prechter may not be a household name on Main Street, but he’s widely known on Wall Street as the foremost authority on the Elliott Wave principle, a forecasting methodology used by generations of technical analysts that is based on the belief that financial markets trend in five waves, and retrace in three waves.
5 charts to help unravel the Elliott Wave mystery
The Elliott Wave principle is based on Ralph Nelson Elliott’s conviction that social, or crowd, behavior tends to trend, and reverse, in identifiable patterns, or cycles.
Elliott used the stock market as his main source for research, because it was an easy way to chart the current and past behavior of a crowd with similar interests. He identified a number of patterns of movement, or waves, that recurred, in combination with larger, and/or smaller, versions of the same patterns.
Those who are well versed in the intricacies of these patterns can gauge where the market’s recent movements fit into them, and then predict where the market will move to complete the cycle.
Elliott’s “The Wave Principle,” was originally published in 1938. Robert Prechter has since become the foremost authority on Elliott Wave theory by applying and enhancing Elliott’s ideas. Prechter is the president of Elliott Wave International.
Under Elliott Wave theory, the most basic pattern of market progress is the motive wave, which is subdivided into five waves and usually labeled by technicians with numbers. Three of those waves (1, 3 and 5) move in the direction of the underlying trend, or impulse, while the two intervening waves (2 and 4) act as countertrend interruptions, or retracements, of the motive wave.
“At any time, the market may be identified as being somewhere in the basic five-wave pattern at the largest degree of a trend,” according to a tutorial provided by Elliott Wave International to its members (Club EWI). “Because the five wave pattern is the overriding form of market progress, all other patterns are subsumed by it.”
There are certain “rules” that govern the five-wave pattern:
• Wave 4 cannot enter the territory of Wave 1, according to EWI. If it does, the market’s latest move must be part of a larger motive wave, which could be progressing higher or lower.
• Wave 2 can’t retrace more than 100% of Wave 1, according to the Market Technicians Association. If it does, then Wave 2 might not be a corrective wave as originally thought, and could actually be moving in the direction of a motive wave to a larger degree.
• Wave 3, which often represents the strongest part of the market cycle, can’t be the shortest by price, compared with Wave 1 or Wave 5.
A complete cycle of wave development actually consists of eight waves, made up of two phases: 1) a wave subdivided into five waves and 2) a three-wave corrective wave.
The corrective wave, usually labeled by technicians by letters, consists of two waves (A and C) that move in the opposite direction of the motive wave, and an intervening retracement wave (
that moves in the same direction of the motive wave.
One key rule for the simple, zigzag corrective phase is that, in a bull market, Wave B ends noticeably lower than where Wave A starts. The opposite is true in a bear market.
“In summary, the essential underlying tendency of the Wave Principle is that action in the same direction as the one larger trend develops in five waves, while reaction against the one larger trend develops in three waves, at all degrees of a trend,” according to EWI.
One of the keys to interpreting wave counts is to determine what degree the wave in question represents.
As the above chart shows, each wave could be part of another wave of a higher degree, which in turn could be part of another wave of an even higher degree.
For example, a corrective Wave (A) could be the beginning of a countertrend Wave 4 pullback of a 5-wave uptrend to a larger degree.
“The Wave Principle, then, reflects the fact that waves of any degree in any series always subdivide and re-subdivide into waves of lesser degree and simultaneously are components of waves of higher degree,” EWI explains.
In Elliott’s original work, he identified nine degrees of waves, that could range from decades to intraday movements. His labels read a little like the classification of living things:
1) Grand Supercycle
2) Supercycle
3) Cycle
4) Primary
5) Intermediate
6) Minor
7) Minute
Minuette
9) Subminuette
Under Prechter’s view, the U.S. stock market’s rise from 1932 was the beginning of a Supercycle, with the rally to 1937 representing the first wave of a Cycle degree.
This spiral, which takes the form of a Nautilus sea shell, is commonly used to describe the mathematical ratio that Elliott Wave theorists lean on to explain why the stock market follows similar patterns to those found in natural systems, including living creatures on earth and galaxies in space.
The Fibonacci ratio of 0.618, made famous by a 13th-century mathematician named Leonardo Fibonacci of Pisa, is based on a number sequence, in which the sum of two adjacent numbers forms the next higher number (1, 1, 2, 3, 5, 8, 13 ...).
It is often referred to as the golden, or divine ratio, because it has been found throughout nature, such as in the breeding pattern of rabbits, the DNA double helix, how petals on a flower are arranged, proportions of the human body, a galaxy spiral, and so on ad infinitum.
In Elliott Wave, the five waves of a motive of phase have a Fibonacci relationship with the eight waves of a complete cycle. And each wave or phase tends to have a Fibonacci relationship with other waves or phases; thus a retracement phase is often close to 0.382 (1 minus 0.618), or up to 0.618, the length of the motive phase.
Walter Zimmerman, chief technical analyst at energy research firm United-ICAP, who studied chaos theory and complex systems in graduate school, said the process of price discovery follows a similar fractal structure: “The next price is always a function of the previous price, in any market, even at the open.”
In simple terms,
a complete bull-market cycle consists of a 5-wave advance
and a 3-wave retracement
In the simplest form, a weekly chart of Apple Inc.’s stock could represent an example of a five-wave pattern.
That doesn’t necessarily mean the start of a new corrective phase is imminent. If Wave 5 develops into a “fifth-wave extension” that is 1.618 times the length of the first three waves, Apple’s stock AAPL, +0.04% would climb to above $209.
But given that Wave 3 is more than 1.618 times the length of Wave 1, and Wave 3 is longer than the length of Wave 1, the pullback from the May 28 record intraday high of $134.54 could already be the start of a corrective phase.
And again, in the simplest terms, a 61.8% retracement of the uptrend from the April 2013 low of $55.01 to the record high comes in at $85.39, which is 35% below current levels.
The textbook definitions of wave counts and degrees are always open to interpretation, something a simple slide show of charts can’t completely explain.
United-ICAP’s Zimmerman said it took years to cultivate his understanding of Elliott Wave theory. Then all off a sudden, it became clear to him, like one of those “Magic Eye” pictures that if you blur your eyes just right becomes a detailed 3-D image.
“It was wonderful,” Zimmerman said. “Something that was fuzzy and out of focus, suddenly came into focus.”
Who is Robert Prechter, and why should investors
care that he is warning them to be on high alert for
a potential collapse in the stock market?
The president of Elliott Wave International, Prechter may not be a household name on Main Street, but he’s widely known on Wall Street as the foremost authority on the Elliott Wave principle, a forecasting methodology used by generations of technical analysts that is based on the belief that financial markets trend in five waves, and retrace in three waves.
5 charts to help unravel the Elliott Wave mystery
The Elliott Wave principle is based on Ralph Nelson Elliott’s conviction that social, or crowd, behavior tends to trend, and reverse, in identifiable patterns, or cycles.
Elliott used the stock market as his main source for research, because it was an easy way to chart the current and past behavior of a crowd with similar interests. He identified a number of patterns of movement, or waves, that recurred, in combination with larger, and/or smaller, versions of the same patterns.
Those who are well versed in the intricacies of these patterns can gauge where the market’s recent movements fit into them, and then predict where the market will move to complete the cycle.
Elliott’s “The Wave Principle,” was originally published in 1938. Robert Prechter has since become the foremost authority on Elliott Wave theory by applying and enhancing Elliott’s ideas. Prechter is the president of Elliott Wave International.
Under Elliott Wave theory, the most basic pattern of market progress is the motive wave, which is subdivided into five waves and usually labeled by technicians with numbers. Three of those waves (1, 3 and 5) move in the direction of the underlying trend, or impulse, while the two intervening waves (2 and 4) act as countertrend interruptions, or retracements, of the motive wave.
“At any time, the market may be identified as being somewhere in the basic five-wave pattern at the largest degree of a trend,” according to a tutorial provided by Elliott Wave International to its members (Club EWI). “Because the five wave pattern is the overriding form of market progress, all other patterns are subsumed by it.”
There are certain “rules” that govern the five-wave pattern:
• Wave 4 cannot enter the territory of Wave 1, according to EWI. If it does, the market’s latest move must be part of a larger motive wave, which could be progressing higher or lower.
• Wave 2 can’t retrace more than 100% of Wave 1, according to the Market Technicians Association. If it does, then Wave 2 might not be a corrective wave as originally thought, and could actually be moving in the direction of a motive wave to a larger degree.
• Wave 3, which often represents the strongest part of the market cycle, can’t be the shortest by price, compared with Wave 1 or Wave 5.
A complete cycle of wave development actually consists of eight waves, made up of two phases: 1) a wave subdivided into five waves and 2) a three-wave corrective wave.
The corrective wave, usually labeled by technicians by letters, consists of two waves (A and C) that move in the opposite direction of the motive wave, and an intervening retracement wave (
that moves in the same direction of the motive wave. One key rule for the simple, zigzag corrective phase is that, in a bull market, Wave B ends noticeably lower than where Wave A starts. The opposite is true in a bear market.
“In summary, the essential underlying tendency of the Wave Principle is that action in the same direction as the one larger trend develops in five waves, while reaction against the one larger trend develops in three waves, at all degrees of a trend,” according to EWI.
One of the keys to interpreting wave counts is to determine what degree the wave in question represents.
As the above chart shows, each wave could be part of another wave of a higher degree, which in turn could be part of another wave of an even higher degree.
For example, a corrective Wave (A) could be the beginning of a countertrend Wave 4 pullback of a 5-wave uptrend to a larger degree.
“The Wave Principle, then, reflects the fact that waves of any degree in any series always subdivide and re-subdivide into waves of lesser degree and simultaneously are components of waves of higher degree,” EWI explains.
In Elliott’s original work, he identified nine degrees of waves, that could range from decades to intraday movements. His labels read a little like the classification of living things:
1) Grand Supercycle
2) Supercycle
3) Cycle
4) Primary
5) Intermediate
6) Minor
7) Minute
Minuette 9) Subminuette
Under Prechter’s view, the U.S. stock market’s rise from 1932 was the beginning of a Supercycle, with the rally to 1937 representing the first wave of a Cycle degree.
This spiral, which takes the form of a Nautilus sea shell, is commonly used to describe the mathematical ratio that Elliott Wave theorists lean on to explain why the stock market follows similar patterns to those found in natural systems, including living creatures on earth and galaxies in space.
The Fibonacci ratio of 0.618, made famous by a 13th-century mathematician named Leonardo Fibonacci of Pisa, is based on a number sequence, in which the sum of two adjacent numbers forms the next higher number (1, 1, 2, 3, 5, 8, 13 ...).
It is often referred to as the golden, or divine ratio, because it has been found throughout nature, such as in the breeding pattern of rabbits, the DNA double helix, how petals on a flower are arranged, proportions of the human body, a galaxy spiral, and so on ad infinitum.
In Elliott Wave, the five waves of a motive of phase have a Fibonacci relationship with the eight waves of a complete cycle. And each wave or phase tends to have a Fibonacci relationship with other waves or phases; thus a retracement phase is often close to 0.382 (1 minus 0.618), or up to 0.618, the length of the motive phase.
Walter Zimmerman, chief technical analyst at energy research firm United-ICAP, who studied chaos theory and complex systems in graduate school, said the process of price discovery follows a similar fractal structure: “The next price is always a function of the previous price, in any market, even at the open.”
In simple terms,
a complete bull-market cycle consists of a 5-wave advance
and a 3-wave retracement
In the simplest form, a weekly chart of Apple Inc.’s stock could represent an example of a five-wave pattern.
That doesn’t necessarily mean the start of a new corrective phase is imminent. If Wave 5 develops into a “fifth-wave extension” that is 1.618 times the length of the first three waves, Apple’s stock AAPL, +0.04% would climb to above $209.
But given that Wave 3 is more than 1.618 times the length of Wave 1, and Wave 3 is longer than the length of Wave 1, the pullback from the May 28 record intraday high of $134.54 could already be the start of a corrective phase.
And again, in the simplest terms, a 61.8% retracement of the uptrend from the April 2013 low of $55.01 to the record high comes in at $85.39, which is 35% below current levels.
The textbook definitions of wave counts and degrees are always open to interpretation, something a simple slide show of charts can’t completely explain.
United-ICAP’s Zimmerman said it took years to cultivate his understanding of Elliott Wave theory. Then all off a sudden, it became clear to him, like one of those “Magic Eye” pictures that if you blur your eyes just right becomes a detailed 3-D image.
“It was wonderful,” Zimmerman said. “Something that was fuzzy and out of focus, suddenly came into focus.”
