Elliot Wave Theory

Elliot Wave Theory

Elliot Wave Theory

Thesis statement

How we can successfully apply the Elliot Wave Theory in Predicting the future behavior of stocks.

Introduction

The Elliot Wave Principle is a theory about mass psychology applied to financial markets. The EW principle suggests that mass psychology swings from pessimism to optimism in a predictable and cyclical wave pattern and that this pattern can be seen in price movements in financial markets.

Elliot Wave analysis is a form of technical analysis that attempts to forecast financial markets by identifying the beginning, middle and end of a predictable wave sequence. The theory was developed by Ralph Nelson Elliot, an accountant in the 1930s. (Myles, 2006)

The Elliot Wave principle posits that human collective behavior shifts between optimism and pessimism in a predictable natural sequence and that this sequence can be seen in market price movements. Due to the predictable nature of the wave sequence, when one has accurately identified the beginning one can forecast behavior by the natural sequence of action and response that waves represent. This ability to predict the actions of the market allows one to profitably buy and sell financial products. (Glenn, 2001)

According to Elliot, all natural processes repeat themselves in constantly reoccurring waves in a definite pattern and number. His model, in Nature's Law: The Secret of the Universe argues that market prices alternate between five waves and three waves at all degrees within a trend. The dominant waves 1, 3, and 5 are called "motive" waves, and each motive wave itself subdivides into five waves. Waves 2 and 4 are known as "corrective" waves, and subdivide into three waves. Motive waves can be either pessimistic or optimistic depending on whether the market is bullish or bearish. (Robert, (2001)

Elliott believed each wave had a "personality." The "personality" is an expression of the collective psychology at that moment in time. To apply the wave principal effectively an investor must understand how and why the wave developed. One must understand the initial catalyst.

This paper intends to first explain the Elliot Wave Theory, its background, principles and characteristics and then the applicability of Elliot Wave theory. The work is structured in four chapters.

Chapter I: Preliminary Considerations.

It will be a quick overview of historical context in which there is the theory and elements involved in the formation of the same. Proceed to mention who was Elliot and on what basis to formulate his Theory of Wave.

Chapter II: Theoretical development of the Wave Theory.

It will explain the aspects shape wave theory, and the main elements to take into account to practical use.

Chapter III: The Wave Theory in practice.

It will discuss the applicability of Elliot Wave theory.

Chapter IV: Conclusions.

It will summarize the main points.

Discussion and analysis

Preliminary Considerations

Ralph Nelson Elliott (1871-1948) had been an accountant by profession, specializing in restaurants and rail. The development of the latter activity led to several companies rail in Mexico and Central America. He retired in 1927 after contracting a serious disease in Guatemala, and spent several ...