Elliott Waves and Probability
Elliott waves are price cycles. The work by Ralph Nelson Elliott in the 1930s-50s identified a wave structure for the stock market the was heavily based on the fibonacci sequence, although his work most concentrated on the structure and, more specifically, market patterns.
The short of it is that the markets (currencies, stocks, futures, et al) move in a very predictable manner and are not affected to any great degree by events. Markets move based on the collective mood of the “herd” around the world who invest, or trade in them.
Expanding on that thought, you have to keep in mind that the direction of the market on a grand scale is determined by market participants on a worldwide basis. Many a time I wince at the suggestion that the market has had a major reaction to an event in any one country, while it’s rather obvious that the event in question has little significance beyond the borders of that country, or even within that country’s borders.
There are other times when I chuckle as the pundits one day align a market move with a major event, while the next day scramble to explain why the market has completely retraced that move on the following “no-news day.” Events simply have little, if anything, to do with the movement of the market.
On the other hand, what is very clear is that the market moves in identifiable patterns that correspond to specific fibonacci ratio measurements. In my time in the markets (over 20k hours), I have yet to find a wave sequence that did not have a fibonacci relationship with a larger pattern relating to the golden mean (1.618 or .618) or its reciprocal of .382. Fibonacci measurements are critical in determining the lengths of waves, and therefore the next turn in the opposite direction.
Fibonacci ratios run all through the markets. They’re found all through nature, as well. And of course, they originate with the planets in our solar system. The ratio of the distance between the planets in our solar system averages out to 1.618.
If you look at the chart on the left (click to expand), it shows a wave pattern on the left that’s a bull market trend. You can see that the first wave up moves in 5 “trending” subwaves (not numbered). The second wave then retraces in 3 waves (a countertrend move) 62% of the distance of travel of the first wave.
The third wave follows and it will typically rise 1.618 times (the golden mean) the distance of the first wave. At the top of that third wave, a countertrend wave will develop (a fourth wave) that will retrace 38% of the combined distance of waves 1, 2, and 3. Finally a fifth wave will trace out a length of 1.618 times the length of the original first wave.
Elliott wave impulsive sequences are fractal, and so what happens next is that the market will then retrace 62% of the entire distance of that combined sequence (which now becomes the first wave of a larger impulsive sequence). The wave that retraces 62% now becomes the second wave, and a new larger sequence develops that will rise to a “higher degree,” but with the same fibonacci relationships as that of all the waves within that first wave up. This pattern regenerates again and again until it has developed a full 5 waves as this higher degree.
The key to being able to predict the market is knowing where you are in either a trend or countertrend pattern. Knowing where you are (what pattern you’re in) produces a high probability trade, because these sequences and patterns happen over and over again within the larger market—in fact, throughout all markets. It doesn’t matter if it’s bonds, currencies, futures, commodities or what-have-you. The market moves in the same manner worldwide, every single day of the year.
A motive (impulsive), trending sequence has one basic form. It’s a five wave move and conforms to a specific set of rules that cannot be broken. If any of these rules are broken, the resulting sequence must be re-classified as a corrective (countertrend wave). These corrective waves have far fewer rules and there are many more corrective patterns than there are motive patterns. They are therefore, more difficult to predict. The secret to success is being able to identify a pattern early on, and trade them as the pattern continues to unfold and risk gradually reduces.
It’s the identification of these patterns that’s the key to unlocking the power of the Elliott wave sequence. If you spend the time the learn the system, which requires a knack for pattern recognition, the secrets of the market will morph before your eyes into a very readable map and lead to a very lucrative future.
Elliott wave price cycles work very well with time cycles, although I have found time cycles to be far less accurate and predictive. However, using time cycles to support EW price cycles gives you a much higher ability to predict and time any market. It reduces risk and heightens confidence.
Here’s a very recent interview with Bob Prechter, in which he reiterates his prediction of the trajectory for the not too distant future. Good reading if you’re interested in Elliott wave or the movement of the market.
Until you buy into this concept that the market moves in a very predictable manner based on the mood of the herd, you’ll never have a chance of beating the casino, because you’re playing against it. Period.
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The Market This Week
Above is the daily chart of ES (click to enlarge).
We appear to be in the second pattern of an ABC 4th wave correction. The second pattern is almost certainly tracing out a triangle. A triangle is always a final pattern in a combination sequence. If this is the case, I don't expect a wave below the previous low of about 2316.
As I describe above, technically a triangle is not confirmed until the D wave is in place. However, it's been a high probability prediction of mine from rather early on in its formation. An E wave down will follow the D wave.
I predicted the triangle very early on, because of the knowledge of Elliott wave patterns. Once we'd traced out a flat down (the first pattern in this fourth wave), the options (after a subsequent three wave move up) reduced to either a zigzag or a triangle. Once the zigzag option was eliminated, the triangle became the much higher probability pattern.
After completing the current fourth wave, we'll have one more wave to go, which could be an ending diagonal as a fifth wave. The long awaited bear market is getting closer.
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