Greetings traders and welcome back to another In-Depth
with Chris episode. In today's discussion,
we will be talking about the Elliott Wave theory.
This is one of those discussions that's based around the
psychological nature that humans have, and the repetitiveness
that we tend to cling to for that sense of familiarity.
Some of this repetitiveness, traders believe, they have
found a way to find and exploit some of these repeating patterns.
That's where the Elliott Wave theory falls into.
It's one of those patterns that, traders feel, continuously repeats
itself in a fractal manner, over and over again.
With the ability to masterfully identify ,as well as understand
what you're seeing with the Elliott Wave theory, it can become a very crucial
aspect to doing things like passing the Gauntlet Mini.
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But without further ado, let's dive on into the Elliott Wave theory
and learn a thing or two about this repetitive pattern.
There are numerous theories behind why the financial markets
work the way they do, but a substantial portion of those theories
does include the fact that traders are psychological creatures
that have patterns, and these patterns can be exploited in present themselves,
even on a historical price chart of an asset, because what's
moving that historical price chart is general supply and
demand based around psychological factors in the brain of
the trader who is buying and selling.
What is the Elliott Wave theory? The Elliott Wave theory is based on the
idea that the markets and the prices of the instruments just
simply move in a repetitive pattern, like we were saying.
These patterns are correlated with those psychological moves of the masses themselves,
and the way that investors also perceive some exterior factors.
All of these things are things that repeat themselves or,
have a tendency to display a certain outcome, if they displayed
this outcome for a similar circumstance in the past.
The Elliott Wave principle is used by traders to analyze market cycles
and to potentially time entry and exit points, as well as find potential extremes,
as far as a pipe price movement. The Elliott Wave theory opposes
the idea that the financial markets are just purely chaotic
and dominated by randomness, and anomalous moves. In fact,
it assumes that everything is some degree of a rational explanation
and can be explained by the behavior of those market participants
that are currently acting. The Elliott Wave theory was shaped
in the 1930's by Ralph Nelson Elliott.
The concept was first introduced in the book "Wave Principle."
This was published in 1938, and was a summarized series of
the articles in the Financial World magazine that were released
in 1939 that revolved around this Wave principle.
It was also covered extensively in Elliott's major work called "Natural
Laws: The Secret of the Universe", that was later published in 1946.
To sum it all up, the Elliott Wave theory shares key similarities
with the Dow theory in the sense that it is analyzing price
movements, and looking for those movements to repeat themselves
based around that psychological draw that humans have.
The herd mentality is something of a cornerstone of the Elliott
Wave theory. The concept suggests that the large groups of
individuals usually are affecting the way each other thinks
on a personal level. A typical characteristic of a herd mentality
is that individuals rarely take responsibility, and instead of making their
own decisions, are more willing to look for the way the group
acts and continue to act in that way. In other words, an individual may be more willing to follow
than to lead. The truth is the herd mentality isn't a new phenomenon.
It has been around for decades, and it is something that is
generally considered to be a true phenomenon in the trading world.
According to many studies out there, herd mentality
can be found in all aspects of life that involve any large
group of individuals including fashion, family, financial markets,
and just so much more. Generally speaking, where ever there
is a herd mentality style of thought in process,
usually this is perceived as an easier place to predict repetitive patterns.
The Elliott Wave theory is based around the concept
of what is called, impulse and corrective waves.
The impulse wave is going to be a wave that is going in the
direction of the trend, and the corrective wave is going to
be something that is going against the trend, essentially a wave correction.
The idea is that each price movement that goes in the direction
of the trend consists of five smaller waves.
The smaller waves are also referred to as impulse waves.
The same goes for corrections, with the
main difference that each price correction consists of three waves.
We have this five-three pattern, where five impulse
three corrective waves. Each impulse or corrective wave contains
five-three smaller ones within its pattern.
If we look here as the top wave goes, we have a 1, 2, 3, 4 and 5.
This would be wave 1, wave 2, wave 3, wave 4, wave 5,
followed by a corrective wave in the opposite direction against the the trend,
where we have an A, a B, and a C. This is then broken
down inside each of these waves with more waves completing
this pattern over, and over, and over again. It continues on as you
continue to zoom in the microscope. As you can see with this bottom line,
we have an awful lot going on.
This is that fractal nature, but it is a continuation of
exactly what we're seeing with the same exact patterns.
To put it simply, the movements in the direction of the
trend just take place in five waves, while the corrections against it, unfold in three waves.
As we can see, the movement in the trend's direction would be that 1, 2, 3, 4, 5, while the
moves against it will be the A, B and C. The five wave sequence
with the 1, 2, 3, 4, 5, are our impulse waves, with the A, B, and C being our corrective waves.
As far as the terminology goes, the bullish Elliott Wave theory
in practice is going to exhibit a five-wave rise, followed
by a three-wave fall. During the down trend,
it is going to be a five-wave fall, followed by a three-wave
rise. The waves do differ from each other in terms of their degree.
Meaning, what time frame they're associating themselves with.
Here, we have all of the different degrees, as they're called, to understand
the time frames that they are referencing. The first is called
the subminuette. The subminuette references a move
or a wave that is occurring in minutes.
Then, we have the minuette, which is going to be a wave that is occurring in hours.
Then, we have the minute degree, which is going to be in days.
Then, we have the minor, which is going to be weeks.
Then, we have the intermediate wave, which is going to be weeks to months.
Then finally, we have a primary wave, which is a few months to a couple years.
This is usually where it ends for most traders, but
it does get even larger than that.
Down here we have a cycle, which is going to be a several year long wave,
followed by a super cycle, which is going to be several
decades, usually in the range of 40 to 70 years,
followed by the grand supercycle, which is where it just flat-out
ends, because most of us are going to live that long anyway, and
that is going to be a multi-century wave.
These are the terms, that way you know how to properly
degree what you are looking at, or provide a degree to what
you're looking at, and then you can apply the correct trading
knowledge to what you're looking to gain from that information.
Understanding the degrees is important because it allows
us to better place the time frame of the trade that we are attempting to find.
Let's go back to the graph to analyze the impulse patterns themselves.
The impulse, or motive waves, as they're called.
This is going to be the waves that are occurring within the
dominant trend. We start off with wave 1, and as with most
indicators or strategies out there, the first
portion in this wave 1 is going to be the hardest to find because it's by itself.
It's usually the most difficult to interpret.
During the first wave, if we were to attribute it to a stock formation,
to make this relatively simple to understand in
economic perspectives, if we were to say the first wave occurred,
it was going to occur usually during a time with low earnings
reports, estimations, or just an overall bearish sentiment,
or bearish surveys in general, that caused that temporary downturn.
Wave 2 is the corrective wave that reminds us of
the recently dominant bullish trend overall.
However, it is worth noting that the second wave cannot surpass
the starting point of the first wave.
Otherwise, the pattern will break. During wave 2, the
news regarding economic performance is still bad and prices
retest the previous lows in a lot of scenarios.
There is buildup of negative sentiments. and usually a prevalence of
investors with bearish news, however, things are slowly starting to look better.
Wave 3 is a very decisive wave, and in most cases, it is the biggest
and most powerful in the whole trend, except usually in the
commodities markets, where the largest wave usually comes
at number 5. That is just the pattern, and it's worth noting.
During wave 3, during the midpoint at least, the news usually
starts coming out positively, and the effect of this usually
has some type of powerful wash over that is washing away
that bearish pullback in general.
This stage is usually accompanied by rising prices, positive
earnings reports, and just general bullish projections.
Then we have wave 4, and wave 4 is the second corrective wave in the sequence.
The prices here can move sideways at times, and a lot of times
we should expect the wave to retrace somewhere less than
38.2% of the previous wave. Wave 4 is usually associated
with a lower volume than wave 3, but we don't need to get
nervous if things seem to be lacking during the progress
of wave 4, this is typical for wave 4.
Then finally, comes wave 5. Wave 5 completes the pattern in the direction of the
dominant trend. All news and sentiments are firmly bullish.
Usually at this time, the volume is a little lower than wave
3, and prices start going for their new highs.
Usually, this isn't the best place to buy, because the trend
most likely is close to a reversal point.
Now, we're going to focus on the counter trend moves,
which are called the corrective moves. This is A, B, and C.
If we had a bullish 5 sequence going up, the counter trend
moves are going to be the three that come afterwards, and
they are going down. If the overall 5 sequence was actually
going down, then obviously, our counter trend moves in that
scenario, would be going up. It would be our three going up after that.
It's always going to be the opposite, hence the name, the counter trend move.
We should also be aware that
the corrective waves themselves are usually a bit harder
to identify than compared to the impulse waves, due to their
against the trend nature. During wave A, this guy here,
we're going to see an increase in trading volume, generally speaking,
and usually we have relatively stable prices.
By the time we get to wave B. At wave B, we can expect to see
the prices reverse to try to go to potentially a higher point,
which may fool you and confuse the idea of these counter-trend
moves in general, but during wave B, it should be lower than
during wave A, where wave A started, so this is very important.
We don't want to see wave B go above this point here.
As we continue, we generally expect to see that the news
is potentially positive, but decreasing at this point, causing
this nice little bullish pop. Then finally, when we get
to wave C. Wave C is usually the biggest confirmation in
the bear market. Wave C is usually a large wave, and usually
as large as wave A. Wave C is usually accompanied by an increase
in trading volume, and once again, wave C should not be climbing higher than the point of wave B.
Now that we understand the five-three formation,
as well as the Elliott Wave theory in terms of if it's going
upwards, we're going to have our five waves climbing with
our three waves declining. The next thing that we're waiting
for, if we want to actually execute an entry based upon our
read, is when we complete our C wave, we want the markets
begin rising in the bullish Elliott Wave variation.
Everything I'm saying can be completely inversed, if we are looking for
an Elliott Wave theory in a bearish market.
We want the market to climb here after we find C, and we're
hoping it's going to climb up here towards B, so let's see what that looks like.
Here we have ourself a green line ,marked off at the B.
The reason is, as the market climbs and moves above B, the
Elliott Wave theory is totally complete at
this point, the portion that we analyze, that is. As we climb above B,
this is an indication that the market is looking to push
potentially in the direction of that overall trend.
Once price climbs above the high point of B, we now are
looking for an entry to go long in this scenario. If we were
to inverse this, then we would be looking to short once we file
below the low point of B, if the the image was just completely upside down.
Now that we understand how to get into the market,
let's talk about how we can protect our earnings as the market
continues to climb, with the help of the Elliott Wave theory.
Say that our initial stop was down here.
Well, what we could do with our market after we find our
entry, which is going to be a long once we break B, which happened here.
As we form our second wave, and we begin working
towards the third wave, pushing these new highs that wave
3 generally does, we can set a stop loss at the highest point
of wave 1. By doing this, this is giving ourself a logical
locked in location where support and resistance most likely
was already found, historically. We can use wave 1 as
the location of the stop-loss, continue to ride the market
higher, as long as the pattern continues.
To sum it all up, the Elliott Wave theory is a very
powerful pattern, but it's not the easiest pattern in the world to
spot, especially not for new traders.
Despite this, there are many documented cases of professional investors, like
Paul Tudor Jones, who have made great, beautiful, powerful trades
with nothing more than the Elliott Wave theory.
It's a very, very powerful pattern, but can become very cumbersome
if you get lost in its fractal nature. If you have a keen
eye and you develop the ability to spot the pattern efficiently, as they're beginning,
it can be indescribably powerful to you.
I recommend at least being aware of it, and deciding how
you want to incorporate it into your trading repertoire, if you so decide.
Until next time folks, thank you for joining me
as always. Please make sure you click that like and
subscribe button down below, and I will see you all very soon. Cheers folks!