Let Elliott Waves Signal the Market Direction for You : If you are the only bull in the herd running, your survival instincts will tell you to follow the herd, regardless of the direction. The same applies to the maneuver of a successful trader or investor in the financial group called the Stock Market. As trader psychology changes, so does the Market.
The Elliott Wave principle captures the essence of trader psychology. It is an effective visual representation of the trader’s human nature to follow extreme optimism ‘on a busy road’ followed by extreme pessimism, and then repeat the process again and again. The Elliott Wave pattern captures the persistent disclosure of the extremes described as Stock Market sentiment.
Traders cannot rely on news and events to move the Stock Market. History has shown that news and events related to the Market do not have a consistent effect on its direction due to the continued influence of Market sentiment. For example, the Market’s reaction to the same news can be very positive at one time, but then very negative at another time.
The Elliott Wave pattern displays traders the most likely future direction of the Market based on the pattern’s current structure. By understanding the characteristics of the Elliott Wave pattern, a trader can identify possible higher returns from possible lower returns thereby reducing investment risk.
The classic Elliott Wave pattern consists of both impulsive and corrective waves. The impulse wave is moving in the same direction as the current trend and consists of five sub-waves. The corrective wave moves against the current trend and consists of three sub-waves.
The formation of sub-waves can vary greatly. However, the general trends to watch for for trading purposes are as follows:
The first sub-wave in either an impulsive or corrective wave can be difficult for traders to accept as it is the first wave that goes against the current direction;
The second sub-wave in either the impulsive or corrective wave can create an opportunity for the trader to respond if he misses the first sub-wave as it is a partial retracement of the first sub-wave;
The third sub-wave of the impulsive wave can be the most predictable and strongest sub-wave as momentum has been established;
The fourth sub-wave of the impulsive wave may show more volatility in its retracement than the second sub-wave; and The fifth sub-wave of the impulsive wave and the third sub-wave of the corrective wave may be less predictable and more volatile than the other sub-waves because they determine the end of the larger wave.
In addition, traders can increase their chances of success by placing entry and exit points near levels that support a change in the direction of the Market. For example, placing an entry for a long position near the start of an upward impulse wave has a higher success rate than placing an entry for a long position near the end of an upward impulse wave.
Forecasting the market direction of the Elliott Wave pattern does not provide certainty, but rather the probability of the market direction. There may be more than one valid interpretation of the wave pattern, each of which carries the possibility of an accurate picture of the direction of the Market.
Traders should keep in mind that Elliott Wave patterns are usually constantly revalued and changed as Market sentiment unfolds to provide a higher probability of Market forecast. Changes in wave patterns should be seen not as a weakness, but as a strength. To be sure, the Market is quite dynamic; therefore, any tool used to help forecast the Market must also be dynamic.
It is important to note that the principles and uses of Elliott Waves have endured for more than 70 years, when in 1938, in collaboration with C. J. Collins, R.N. Elliott introduces the ‘Elliott Wave Principals’. Mr Elliott believes that while stock market prices may appear random and unpredictable, they actually follow predictable, natural laws that can be measured and estimated by applying wave patterns based on the analysis of Fibonacci numbers, also pioneered by Mr Elliott.
Mr Elliott theorizes that the general wave is characterized by Fibonacci proportions of 38%, 50%, and 62%. Impulsive waves relate to each other in Fibonacci proportions and corrective waves tend to retrace in Fibonacci proportions.
Mr. Elliott, greatly motivated by the response to his theory in the world of investing, developed it to be applied to all human behavior collectively. His last and most comprehensive work entitled ‘The Secret Laws of the Universe’ was published in 1946, two years before his death.