Elliott Wave Theory was developed by R.N. Elliott and popularized by Robert Prechter. This theory asserts that crowd behavior ebbs and flows in clear trends. Based on this ebb and flow, Elliott identified a certain structure to price movements in the financial markets. The article serves as a basic introduction to Elliott Wave Theory. A basic 5-wave impulse sequence and 3-wave corrective sequence are explained. While Elliott Wave Theory gets much more complicated than this 5-3 combination, this article will only focus on the very basics.
Elliott wave analysts (or Elliotticians) hold that each individual wave has its own signature or characteristic, which typically reflects the psychology of the moment.Understanding those personalities is key to the application of the Wave Principle; they are defined below. (Definitions assume a bull market in equities; the characteristics apply in reverse in bear markets.)
Theory:
Five wave pattern (dominant 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 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.
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).
http://i.investopedia.com/inv/articl...is/elliot1.gif
Three wave pattern (corrective trend)
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.
Three Guidelines
There are numerous guidelines, but this article will focus on three key guidelines. In contrast to rules, guidelines should hold true most of the time, not necessarily all of the time.
Guideline 1: When Wave 3 is the longest impulse wave, Wave 5 will approximately equal Wave 1.
Guideline 2: The forms for Wave 2 and Wave 4 will alternate. If Wave 2 is a sharp correction, Wave 4 will be a flat correction. If Wave 2 is flat, Wave 4 will be sharp.
Guideline 3: After a 5-wave impulse advance, corrections (abc) usually end in the area of prior Wave 4 low.
http://stockcharts.com/school/data/m...guidelines.png
The first guideline is useful for targeting the end of Wave 5. Even though Wave 5 could be longer than Wave 3 and Wave 3 could still be longer than Wave 1, chartists can make initial Wave 5 projections once Wave 4 ends. In a larger uptrend, chartists simply apply the length of Wave 1 (percentage change) to the low of Wave 4 for an upside target. The opposite is true for a 5-wave decline. The percentage decline in Wave 1 would be applied to the high of Wave 4 for a Wave 5 estimate.
The guideline of alternation (2) is useful for determining the time of correction for Wave 4. After a sharp decline for Wave 2, chartists can expect a relatively flat correction for Wave 4. If Wave 2 is relatively flat, then chartists can expect a relatively sharp Wave 4. In practice, Wave 2 tends to be a rather sharp wave that retraces a large portion of Wave 1. Wave 4 comes after an extended Wave 3. This Wave 4 marks more of a consolidation that lays the groundwork for a Wave 5 trend resumption.
The third guideline is useful for estimating the end of a Wave II correction after a Wave I advance. Waves I and II are the larger degree waves. Waves 1-2-3-4-5 are lesser degree waves within Wave I. Once the Wave II correction unfolds, chartists can estimate its end by looking at the end of the prior wave 4 (lesser degree wave 4). In a larger degree uptrend, Wave II would be expected to bottom near the low of lesser degree Wave 4. In a larger degree downtrend, Wave II would be expected to peak near the high of lesser degree Wave 4.
How MACD Indicator can Count Elliott Wave:
I will show you how I use MACD Indicator to count Elliott Wave, this method is very useful and easy to apply, especially when the price start moving in a new trend. And why I say it is useful and valuable ? Because when you can predict the price movement, you would know where the price will probably head and where it will potentially stop, this helps trader with many oppurtunities to be profitable.
The screenshot below is the EURAUD 4H I took just now , as of May 9th 2013, you can see price has breaked the downtrend.
http://2.bp.blogspot.com/-w3CDK3scV_...uraud+-+4h.png
Now I will zoom in a bit and explain the rules how I count the wave :
The peak of MACD wave is usually the 3rd wave of price in Elliott Wave Theory ( I assumed you already know the basic of Elliott Wave)
When MACD reachs near zero, it indicates the retracement waves (wave 2 and wave 4) are completed.
Divergence between the price and MACD in the last wave usually show wave 5 is running out of fuel and it is the end of wave 5.
Here is the chart how I count the Wave, by the time I post this, I have entered a Short sell, you may check the chart back in a few days to see if I am profitable
http://3.bp.blogspot.com/-R4Mn96bHA3...liott+Wave.png
MACD DIVERGENCE AND ELLIOT WAVE:
According to Jeffrey ( Author of book: " Elliott Wave Trading: Principles and Trading Strategies"), divergence relationships are easy to identify. Whenever prices make a new extreme, look for underlying indicators to move in the opposite direction. Specifically
The momentum relationship most often seen in waves 3 and 5 is divergence. Bullish divergence forms when prices make a new low while an accompanying indicator does not. Conversely, bearish divergence occurs when prices register a new high while an accompanying indicator does not. Bullish and bearish divergences are common to waves A and C, just as they are waves 3 and 5.
Notice the bearish divergence between waves 3 and 5 in the daily price chart of Halliburton Company (HAL) -- Prices reach a new high, yet the MACD indicator moves in the opposite direction:
http://www.elliottwave.com/images/fr...20dec%2027.jpg
Jeffrey notes that if you label an advance as a 5th wave move, and yet you do not see momentum divergence, that tends to argue for an extended 5th wave.
Next, at waves A and C, you can see an example of bullish divergence. Wave A bottomed at $32.90 in HAL and wave C ended much lower at $29.83. The histogram readings that correspond to waves A and C are -36.26 and -26.60, respectively.
Here's another example of divergence between waves A and C in Akamai Technologies (AKAM).
http://www.elliottwave.com/images/fr...Akami12-26.jpg
Notice that wave C is lower in price than wave A. However, if you look at the MACD histogram, you'll see that it registered a higher reading in wave C than it did in wave A, thus giving us a bullish divergence.
Understanding that Elliott waves demonstrate unique momentum relationships as well as price structure allows you to label waves more accurately and with greater confidence.
SOUCRCE: Elliott Wave Theory
Elliott wave analysts (or Elliotticians) hold that each individual wave has its own signature or characteristic, which typically reflects the psychology of the moment.Understanding those personalities is key to the application of the Wave Principle; they are defined below. (Definitions assume a bull market in equities; the characteristics apply in reverse in bear markets.)
Theory:
Five wave pattern (dominant 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 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.
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).
http://i.investopedia.com/inv/articl...is/elliot1.gif
Three wave pattern (corrective trend)
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.
Three Guidelines
There are numerous guidelines, but this article will focus on three key guidelines. In contrast to rules, guidelines should hold true most of the time, not necessarily all of the time.
Guideline 1: When Wave 3 is the longest impulse wave, Wave 5 will approximately equal Wave 1.
Guideline 2: The forms for Wave 2 and Wave 4 will alternate. If Wave 2 is a sharp correction, Wave 4 will be a flat correction. If Wave 2 is flat, Wave 4 will be sharp.
Guideline 3: After a 5-wave impulse advance, corrections (abc) usually end in the area of prior Wave 4 low.
http://stockcharts.com/school/data/m...guidelines.png
The first guideline is useful for targeting the end of Wave 5. Even though Wave 5 could be longer than Wave 3 and Wave 3 could still be longer than Wave 1, chartists can make initial Wave 5 projections once Wave 4 ends. In a larger uptrend, chartists simply apply the length of Wave 1 (percentage change) to the low of Wave 4 for an upside target. The opposite is true for a 5-wave decline. The percentage decline in Wave 1 would be applied to the high of Wave 4 for a Wave 5 estimate.
The guideline of alternation (2) is useful for determining the time of correction for Wave 4. After a sharp decline for Wave 2, chartists can expect a relatively flat correction for Wave 4. If Wave 2 is relatively flat, then chartists can expect a relatively sharp Wave 4. In practice, Wave 2 tends to be a rather sharp wave that retraces a large portion of Wave 1. Wave 4 comes after an extended Wave 3. This Wave 4 marks more of a consolidation that lays the groundwork for a Wave 5 trend resumption.
The third guideline is useful for estimating the end of a Wave II correction after a Wave I advance. Waves I and II are the larger degree waves. Waves 1-2-3-4-5 are lesser degree waves within Wave I. Once the Wave II correction unfolds, chartists can estimate its end by looking at the end of the prior wave 4 (lesser degree wave 4). In a larger degree uptrend, Wave II would be expected to bottom near the low of lesser degree Wave 4. In a larger degree downtrend, Wave II would be expected to peak near the high of lesser degree Wave 4.
How MACD Indicator can Count Elliott Wave:
I will show you how I use MACD Indicator to count Elliott Wave, this method is very useful and easy to apply, especially when the price start moving in a new trend. And why I say it is useful and valuable ? Because when you can predict the price movement, you would know where the price will probably head and where it will potentially stop, this helps trader with many oppurtunities to be profitable.
The screenshot below is the EURAUD 4H I took just now , as of May 9th 2013, you can see price has breaked the downtrend.
http://2.bp.blogspot.com/-w3CDK3scV_...uraud+-+4h.png
Now I will zoom in a bit and explain the rules how I count the wave :
The peak of MACD wave is usually the 3rd wave of price in Elliott Wave Theory ( I assumed you already know the basic of Elliott Wave)
When MACD reachs near zero, it indicates the retracement waves (wave 2 and wave 4) are completed.
Divergence between the price and MACD in the last wave usually show wave 5 is running out of fuel and it is the end of wave 5.
Here is the chart how I count the Wave, by the time I post this, I have entered a Short sell, you may check the chart back in a few days to see if I am profitable
http://3.bp.blogspot.com/-R4Mn96bHA3...liott+Wave.png
MACD DIVERGENCE AND ELLIOT WAVE:
According to Jeffrey ( Author of book: " Elliott Wave Trading: Principles and Trading Strategies"), divergence relationships are easy to identify. Whenever prices make a new extreme, look for underlying indicators to move in the opposite direction. Specifically
The momentum relationship most often seen in waves 3 and 5 is divergence. Bullish divergence forms when prices make a new low while an accompanying indicator does not. Conversely, bearish divergence occurs when prices register a new high while an accompanying indicator does not. Bullish and bearish divergences are common to waves A and C, just as they are waves 3 and 5.
Notice the bearish divergence between waves 3 and 5 in the daily price chart of Halliburton Company (HAL) -- Prices reach a new high, yet the MACD indicator moves in the opposite direction:
http://www.elliottwave.com/images/fr...20dec%2027.jpg
Jeffrey notes that if you label an advance as a 5th wave move, and yet you do not see momentum divergence, that tends to argue for an extended 5th wave.
Next, at waves A and C, you can see an example of bullish divergence. Wave A bottomed at $32.90 in HAL and wave C ended much lower at $29.83. The histogram readings that correspond to waves A and C are -36.26 and -26.60, respectively.
Here's another example of divergence between waves A and C in Akamai Technologies (AKAM).
http://www.elliottwave.com/images/fr...Akami12-26.jpg
Notice that wave C is lower in price than wave A. However, if you look at the MACD histogram, you'll see that it registered a higher reading in wave C than it did in wave A, thus giving us a bullish divergence.
Understanding that Elliott waves demonstrate unique momentum relationships as well as price structure allows you to label waves more accurately and with greater confidence.
SOUCRCE: Elliott Wave Theory