VISITING ELLIOT WAVE THEORY
July 14th 2008 00:00
Value Investing is a strategy believed to be responsible in making today’s world’s richest man. If you follow that strategy, a lot of people say, you can forget about charts, and timing the market and all those other stuffs. But if you consider that the man who is supposed to have “invented” charting is the guy who founded the Dow Jones Industrial Averages, can you dismiss the use of charts lightly?
If we judge by the number of people who depend on stock market charts daily, I would say you cannot. And so, I thought, we should revisit the Elliot Wave Theory today. At least, for the sake of those who have no idea what in the world that theory means.
As usual, before we start, let me emphasize that this author is not an expert. Thus, if anybody ever notices a mistake in my interpretation they are welcome to make a comment and I will not even squeak.
The Elliot Wave Theory was invented by Ralph Nelson Elliot. It suggests that in a Bull Market the stock market moves in Eight-step rhythmic pattern which is divided into two parts. In the first part, the first step is an (1.) ascending line followed by (2.) a shorter descending (correction) line, the third line (3.) is an ascending line longer than the first, the fourth (4.) is another short descending line (correction) and the fifth which completes the push upwards is (5.) another ascending line.
What follows the fifth step (the beginning of the second part, actually) in our ascending pattern is the first of the three step descending moves represented here by the letters A, B and C. If the market is still bullish, the rhythmic pattern will start all over again at the end of letter C.
What this pattern represents according to the theory is the general psychology of the market. The way the investors think in general. And one is supposed to see this cyclical pattern regardless of the time frame one is studying. That means, that you will see that completed pattern (from number 1 to letter C) shown above whether you are looking at a trading activity in terms of a minute, an hour, a day, a week, a month, a year, 5 years, 10 years, etc.
To further explain, let’s call those portions of the pattern labeled 1 to C as legs (as in from point 1 to point 2 is one leg. Point 2 to point 3 is one leg, etc.). If you look closer, in a real chart, you will see a complete pattern of 1 to C in each of those legs. It will be shown in reverse in the case of a bearish market but it will still be the same pattern. Reverse in this case means: if bullish is five up three down – bearish is three up, five down.
An investor is supposed to benefit from the use of this theory by making a right guess on which part the pattern he is trading in at any given moment. If, for example, he guessed rightly that he is at that point near the end of number 2 then he can go in confidently knowing that the prices are about to go up again.
If his play is to short the market, then his entry point will be somewhere near the corrective phase. The most obvious point is where the number “5” meets letter “A.”
Entering at those exact points (or near them) is what is referred to by many as ‘timing” the market. Newbies like me are not recommended to do that. It requires some sophistication we still have not acquired. And not very few are saying that this kind of strategy is what brings investing closer to gambling.
But let the experts argue that point.
My only concern here is to introduce the theory to market beginners like me, if only to erase from their minds the impression that an ascending market will keep climbing forever and a descending market will keep falling forever.
If we judge by the number of people who depend on stock market charts daily, I would say you cannot. And so, I thought, we should revisit the Elliot Wave Theory today. At least, for the sake of those who have no idea what in the world that theory means.
As usual, before we start, let me emphasize that this author is not an expert. Thus, if anybody ever notices a mistake in my interpretation they are welcome to make a comment and I will not even squeak.
The Elliot Wave Theory was invented by Ralph Nelson Elliot. It suggests that in a Bull Market the stock market moves in Eight-step rhythmic pattern which is divided into two parts. In the first part, the first step is an (1.) ascending line followed by (2.) a shorter descending (correction) line, the third line (3.) is an ascending line longer than the first, the fourth (4.) is another short descending line (correction) and the fifth which completes the push upwards is (5.) another ascending line.
What follows the fifth step (the beginning of the second part, actually) in our ascending pattern is the first of the three step descending moves represented here by the letters A, B and C. If the market is still bullish, the rhythmic pattern will start all over again at the end of letter C.
Elliot Wave pattern
See that portion (1) there to the left? That straight ascending line is composed of several of those 1 to C patterns
To further explain, let’s call those portions of the pattern labeled 1 to C as legs (as in from point 1 to point 2 is one leg. Point 2 to point 3 is one leg, etc.). If you look closer, in a real chart, you will see a complete pattern of 1 to C in each of those legs. It will be shown in reverse in the case of a bearish market but it will still be the same pattern. Reverse in this case means: if bullish is five up three down – bearish is three up, five down.
Hey, why complain about the labels (1 to C)? I did say reversed, didn't I?
An investor is supposed to benefit from the use of this theory by making a right guess on which part the pattern he is trading in at any given moment. If, for example, he guessed rightly that he is at that point near the end of number 2 then he can go in confidently knowing that the prices are about to go up again.
If his play is to short the market, then his entry point will be somewhere near the corrective phase. The most obvious point is where the number “5” meets letter “A.”
Entering at those exact points (or near them) is what is referred to by many as ‘timing” the market. Newbies like me are not recommended to do that. It requires some sophistication we still have not acquired. And not very few are saying that this kind of strategy is what brings investing closer to gambling.
But let the experts argue that point.
My only concern here is to introduce the theory to market beginners like me, if only to erase from their minds the impression that an ascending market will keep climbing forever and a descending market will keep falling forever.
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Comment by Fobzy
Fobz
Ask your boss for a raise in salary.
Comment by Market Newbie
Gizmo Peek
Stock Market Punk
A raise? Hmmm... only a guy who can grow everything in his farm doesn't need it.
But with the way the prices of oil and everything else are rising around here, he might need to give me the company and I still won't accept it because of those prices