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Sri Lanka Equity Forum » Stock Market Charts & Graphs » Elliott Wave Theory

Elliott Wave Theory

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1 Elliott Wave Theory on Sun Jun 19, 2011 10:06 am

gann

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Senior Manager - Equity Analytics
Senior Manager - Equity Analytics
I think our community is becoming more interested in technical aspect of trading and mature enough to grasp the concept of wave patterns.
I strongly recommend learning Elliot Wave Principal.

Here is the basic Idea.

NOTE:
In a freely traded and liquid market the price should follow the Elliot patterns. If the price action does not confirm to elliot patterns, implies the price is manipulated or external interferences by way of news etc.


Elliott Wave Theory interprets market actions in terms of recurrent price structures obedient to the Fibonacci sequence. Basically, Market cycles are composed of two major types of Wave : Impulse Wave and Corrective Wave. For every impulse wave, it can be sub-divided into 5 - wave structure (1-2-3-4-5), while for corrective wave, it can be sub-divided into 3 - wave structures (a-b-c).

[You must be registered and logged in to see this image.]

Surfer's Waves within Wave

An important feature of Elliott Wave is that they are fractal in nature. 'Fractal' means market structure are built from similar patterns on a larger or smaller scales. Therefore, we can count the wave on a long-term yearly market chart as well as short-term hourly market chart.
See waves within wave:
[You must be registered and logged in to see this image.]

Rules for Wave Count

Based on the market pattern, we can identify ' where we are' in term of wave count. Nevertheless, as the market pattern is relatively simplistic, there are several rules for valid counts:
Wave 2 should not break below the beginning of Wave 1;
Wave 3 should not be the shortest wave among Wave 1, 3 and 5;
Wave 4 should not overlap with Wave 1, except for wave 1, 5, a or c of a higher degree.
Rule of Alternation : Wave 2 and 4 should unfold in two different wave forms.
Wave forms in Impulse Wave

There are three major types of wave form in Impulse Wave:
(a) Extended Wave

Among Wave 1, 3 and 5, only one should unfolded into extended wave. 'Extension' means the wave is elongated in nature and sub-waves are conspicuous in relation to waves of higher degree.
See extension pattern:
[You must be registered and logged in to see this image.]

(b) Diagonal Triangle at Wave 5

Sometimes, the momentum at Wave 5 is so weak that the 2nd and 4th sub-waves overlap with each other and evolved into diagonal triangle.
(c) 5th Wave Failure

In some other circumstances, the Wave 5 is so weak than it even cannot surpass the top of the wave 3, causing a double top at the end of the trend.
See diagonal triangle and failure fifth pattern:

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Wave Forms in Corrective Wave

Corrective Wave forms are rather complicated, but basically we can categorize them into six major wave forms:

Zig-Zag : abc pattern composed of 5-3-5 sub-wave structure.
Flat : abc pattern composed of 3-3-5 sub-wave structure, with b equals a.
Irregular : abc pattern composed of 3-3-5 sub-wave structure, with b longer than a.
Horizontal Triangle : 5-wave triangular pattern composed of 3-3-3-3-3 sub-wave structure.
Double Three : abcxabc pattern composed of any two from above, linked by x wave.
Triple Three : abcxabcxabc pattern composed of any three from above, linked by two x waves.

See Six Corrective patterns:

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Conclusion

The attractiveness of Elliott Wave Analysis is : Three impulse wave forms and six corrective wave forms are conclusive. All we have to do is to identify which wave form is going to unfold in order to predict future market actions. This is a bold statement, needless to say, knowledge of market historical wave patterns and experiences in wave count are of paramount importance.

The subject is vast. Takes time to understand. Good luck.

2 Re: Elliott Wave Theory on Sun Jun 19, 2011 11:06 am

xhora

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Senior Manager - Equity Analytics
Senior Manager - Equity Analytics
hey gann can u give us a practical example from CSE that support this pattern?

3 Re: Elliott Wave Theory on Sun Jun 19, 2011 11:27 am

smallville

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Associate Director - Equity Analytics
Associate Director - Equity Analytics
@xhora wrote:hey gann can u give us a practical example from CSE that support this pattern?

Yes as much as this theory goes as theory, it wouldn't be fruitful till we see a practical example of it.. Its really useful if gann can support with the same.
In the mean time, thanks for educating the forum Wink

4 Re: Elliott Wave Theory on Sun Jun 19, 2011 12:49 pm

Slstock

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Director - Equity Analytics
Director - Equity Analytics


Good work Gann. But yes if you can, please illustrate with couple of actual examples as the concepts will strike more then.

5 Re: Elliott Wave Theory on Sun Jun 19, 2011 3:11 pm

Intrinsic


Manager - Equity Analytics
Manager - Equity Analytics
Dear Gann,

Great ! It would be greater if you can demonstrate few cases with the help of DirectFN TWS charting, pl.

+ rep from me.


6 Re: Elliott Wave Theory on Sun Jun 19, 2011 8:30 pm

gann

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Senior Manager - Equity Analytics
Senior Manager - Equity Analytics
CSF chart
[You must be registered and logged in to see this image.]

Wave one is a minor rally taking the previous weekly high after the bear run.
Wave 2 corrected wave one but not entirely.
Which paid way for optimistic wave3.
Wave 3 was corrected by wave 4.
The the last ditch optimism in wave 5.
Then you got the correction of the entire sequence. usually retraces till wave 4.

Its also evident that beginning of wave 5 is manipulated in the chart.

Also note: you can take a horse to water but you can't make him drink Smile



Last edited by gann on Sun Jun 19, 2011 11:19 pm; edited 5 times in total

7 Re: Elliott Wave Theory on Sun Jun 19, 2011 8:34 pm

gann

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Senior Manager - Equity Analytics
Senior Manager - Equity Analytics
http://en.wikipedia.org/wiki/Elliott_Wave_Principle

Five wave pattern (dominant trend) Three wave pattern (corrective trend)
Wave 1: Wave one is rarely obvious at its inception. When the first wave of a new bull market begins, the fundamental news is almost universally negative. The previous trend is considered still strongly in force. Fundamental analysts continue to revise their earnings estimates lower; the economy probably does not look strong. Sentiment surveys are decidedly bearish, put options are in vogue, and implied volatility in the options market is high. Volume might increase a bit as prices rise, but not by enough to alert many technical analysts.

Wave 2: Wave two corrects wave one, but can never extend beyond the starting point of wave one. Typically, the news is still bad. As prices retest the prior low, bearish sentiment quickly builds, and "the crowd" haughtily reminds all that the bear market is still deeply ensconced. Still, some positive signs appear for those who are looking: volume should be lower during wave two than during wave one, prices usually do not retrace more than 61.8% (see Fibonacci section below) of the wave one gains, and prices should fall in a three wave pattern.

Wave 3: Wave three is usually the largest and most powerful wave in a trend (although some research suggests that in commodity markets, wave five is the largest). The news is now positive and fundamental analysts start to raise earnings estimates. Prices rise quickly, corrections are short-lived and shallow. Anyone looking to "get in on a pullback" will likely miss the boat. As wave three starts, the news is probably still bearish, and most market players remain negative; but by wave three's midpoint, "the crowd" will often join the new bullish trend. Wave three often extends wave one by a ratio of 1.618:1.

Wave 5: Wave five is the final leg in the direction of the dominant trend. The news is almost universally positive and everyone is bullish. Unfortunately, this is when many average investors finally buy in, right before the top. Volume is often lower in wave five than in wave three, and many momentum indicators start to show divergences (prices reach a new high but the indicators do not reach a new peak). At the end of a major bull market, bears may very well be ridiculed (recall how forecasts for a top in the stock market during 2000 were received).

Wave A: Corrections are typically harder to identify than impulse moves. In wave A of a bear market, the fundamental news is usually still positive. Most analysts see the drop as a correction in a still-active bull market. Some technical indicators that accompany wave A include increased volume, rising implied volatility in the options markets and possibly a turn higher in open interest in related futures markets.


Wave B: Prices reverse higher, which many see as a resumption of the now long-gone bull market. Those familiar with classical technical analysis may see the peak as the right shoulder of a head and shoulders reversal pattern. The volume during wave B should be lower than in wave A. By this point, fundamentals are probably no longer improving, but they most likely have not yet turned negative.

Wave C: Prices move impulsively lower in five waves. Volume picks up, and by the third leg of wave C, almost everyone realizes that a bear market is firmly entrenched. Wave C is typically at least as large as wave A and often extends to 1.618 times wave A or beyond.
Wave 4: Wave four is typically clearly corrective. Prices may meander sideways for an extended period, and wave four typically retraces less than 38.2% of wave three (see Fibonacci relationships below). Volume is well below than that of wave three. This is a good place to buy a pull back if you understand the potential ahead for wave 5. Still, fourth waves are often frustrating because of their lack of progress in the larger trend.


8 Re: Elliott Wave Theory on Sun Jun 19, 2011 9:08 pm

xhora

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Senior Manager - Equity Analytics
Senior Manager - Equity Analytics
Thanks again Gann, rep from me.
you must have a gifted eye to identify patterns. Smile

9 Re: Elliott Wave Theory on Sun Jun 19, 2011 10:25 pm

rijayasooriya

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Senior Vice President - Equity Analytics
Senior Vice President - Equity Analytics
It is good to know about this type of patterns...but I personally do not think these patterns will significantly work in practical world......otherwise there will be lot of multi billionairs.....

10 Re: Elliott Wave Theory on Sun Jun 19, 2011 11:07 pm

gann

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Senior Manager - Equity Analytics
Senior Manager - Equity Analytics
@rijayasooriya wrote:It is good to know about this type of patterns...but I personally do not think these patterns will significantly work in practical world......otherwise there will be lot of multi billionairs.....

I think there are even more who disregard these patterns thinking if they were true there would be more multi billionaires.

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