# Weaving through market waves

| Updated on November 05, 2011

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Named after Ralph Nelson Elliott (1871-1948), the ‘Elliott Wave Theory' is that the movement of the stock market can be predicted by observing and identifying a repetitive pattern of waves. Based on rhythms found in nature, the theory suggests that the market moves up in a series of five waves and down in a series of three waves, explains www.investopedia.com. “The key difference between the Elliott Wave Principle and other cyclical theories is that this theory suggests no absolute time requirements for a cycle to complete.”

Acknowledging Elliott's work as a remarkable feat of observation and diligence, Ian Copsey proposes a modification of the ‘impulsive' wave structure, in ‘Harmonic Elliott Wave' (www.wiley.com). For starters, the intro chapter in the book informs that the Wave Principle can be loosely separated into two basic market characteristic types, viz. trends, and consolidation (or correction). “Elliott named the trending phase impulsive while the rest were classed as corrective.”

Bewildering questions

An instructive chapter on ‘corrective waves' opens by stating that the corrective wave structure is probably the biggest headache for any Elliottician. “How deep will the retracement be? How long will it last and how complex will it be?” This is a sample of questions arising from a bewildering range of potential outcomes that can push a new analyst attempting to learn the principle into finding a simpler method of forecasting, cautions the author. He suggests that with the use of Fibonacci and harmonic ratios, it is possible to piece together the developing clues as to what will happen next.

The advanced learners should be able to relate to the ‘modification' chapter where the author makes a reference to Robert Prechter's ‘Diagonal Triangle wave development,' and the Dow Theory which recognises a three-wave development in price. “In a simple five-wave rally in Elliott's structure there are three impulsive moves higher. In a single extended rally there are five impulsive moves higher, while in a double extended rally there are seven impulsive moves higher. In my modification there are a standard six impulsive moves higher.”

Hit-or-miss forecasting

The author alerts that many Elliotticians hail the natural Fibonacci element to the wave structure and how it is therefore a natural development of waves, but will rarely actually observe them, he frets that such an approach can make forecasting a hit-or-miss affair. “They detail how market retracements and extensions develop in line with Fibonacci ratios, implying that their analysis blends harmoniously with the ratios. However, when you see their analysis there appear to be few occasions where there are any relationships.”

Lest the avid followers of the ‘Wave' get miffed, Copsey repeatedly weaves in his reminder that Elliott did not have the benefit of modern spreadsheets which calculate a wide range of projection ratios that can be used for any time frame, from one minute to monthly. Elliott had to do all this in long hand, which limited his ability to fully analyse wave relationships in detail, he adds.

Valuable counsel in a ‘case study' chapter is that, for anyone attempting to forecast markets, there is absolutely no possibility of being right 100 per cent of the time. In some cases, as the author points out, the underlying larger degree forecast may be correct, but due to the sheer variety of developmental structures, especially in corrective patterns, there will always be errors of judgment, unseen alternatives, and just plain mistakes in the positioning of the lower wave degrees.

He notes that, quite often, once a forecast is made for an extension or retracement to a level or perhaps a series of possible targets, the fact that the call was wrong is quite obvious. “In many cases, since a forecast will always imply a particular wave development, in three waves or five, the error may be evident in the approach to the target and perhaps be anticipated with a particular retracement level providing a very obvious level where the structure completely breaks down…”

For the expert charter looking for ever-newer approaches to the world of technicals.

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Published on November 05, 2011