Elliot Wave Analysis and How it Can Predict Market Movement

Elliot Wave Analysis (also referred to as the Elliot Wave Principle) is a specialized form of technical analysis that utilizes crowd psychology, investor sentiment, and price action to shed light on financial market cycles. Isaac Gilinski, the owner of Miami-based Brickell Analytics which provides customized macro-based research on global markets claims that the reason this approach is referred to as a wave, is because of the belief that market peaks and troughs are expressions of an underlying, natural rhythm referred to as impulsive phases and corrective phases.

In its simplest form, Elliot Wave Analysis is based on the view that impulsive phases have a sequence of five waves, and corrective phases have sequence of three waves. Each wave has its own nomenclature and characteristics, with impulsive waves numbered 1 through 5, and corrective waves designated with the letters A, B and C.

Impulsive Waves 1–5

· Wave 1: Wave 1 can appear when prevailing market activity is significantly depressed, and sentiment is strongly bearish. Even as competent Ellioticians (the name given to proponents of Elliot Wave Theory) start to enter the market and establish themselves on the ground floor, the overall activity is not enough to generate widespread participation. According to Isaac Gilinski, the bear market and most recent corrective trend is still fresh in the mind of investors, and most news and media headlines are still spotlighting the financial carnage such as job losses, consumer and business bankruptcies, and so on.

· Wave 2: Wave 2 is characterized by a pull back from the upward price movement characterized in wave one. Typically, this retrace is 50%, 61.8%, 76.4% or 85.4%, and cannot be more than 100%. Wave 2 is when many investors get irked and believe that the bear market has not ended.

· Wave 3: Wave 3 is when upward price movement triggers a surge in investor confidence and activity. This is usually the longest wave in the cycle and may include extensions with exaggerated sub-divisions. This dynamic can mislead some investors into believing that wave 4 has started, when in fact wave 3 is continuing.

· Wave 4: Wave 4 retraces some of the gains from wave 3 (but can not overlap wave 1), and often trends sideways to create a foundation for the fifth and final impulsive wave to come. Many Ellioticians eagerly anticipate and cheer the retrace in wave 4, because if they time things correctly they can “buy the dip” position themselves to generate a significant return when wave 5 emerges.

· Wave 5: Wave 5 is when sentiment is clearly bullish and is typically when average retail investors take notice and enter the market. Per Fibonacci Ratio, wave 5 is usually 61.8%, 100%, or 123.6% of wave 1.

Corrective Waves A, B and C

· Wave A: Similar to impulsive wave 1, corrective wave A is difficult to detect; especially for average retail investors who are buoyed by ongoing reports of bullish markets. However, competent Elliotticians notice tell-tale signs of a downturn, such as increasing volatility measures. Wave A can be in a zig-zag shape if there are five sub-waves, or a flat or triangle shape if there are three sub-waves.

· Wave B: In wave B, market fundamentals typically stop improving, but have not yet become clearly negative. Wave B is notorious for bear and bull traps, which ensnare investors who believe that the market is on the way up, when in fact the opposite is really happening.”

· Wave C: Wave C is formed by five separate downward sub-waves, which combined are typically as large as the correction in Wave A, but per the Fibonacci number can be 168.1% or more. It is usually by the third sub-wave that investors realize that a bear market has replaced a bull market.

The Bottom Line

Elliot Wave Analysis may look simple in theory, but it is highly complex — as evidenced by the number of self-described Elliotticians who either miss or misinterpret critically important clues and signs. Isaac Gilinski states that Elliot Wave Analysis is one of many important pieces of the picture. At his firm, they combine short-term sentiment analysis, which is contrarian in nature, with long-term wave theory — comprised of qualitative global macro analysis, wave analysis, and quantitative analysis — in an effort to try and generate early and accurate predictions, including the degree and size of the turns at particular junctures. One example of wave theory coming to life is when Brickell Analytics successfully predicted the decline of the Australian dollar. To read more about that story, click here.

Author Disclaimer: The views, thoughts, and opinions in this article belong solely to the author, and do not necessarily reflect those of Isaac Gilinski or Brickell Analytics. Furthermore, the prediction made by Brickell Analytics was one of many predictions made by Brickell Analytics; not all predictions are accurate. Brickell Analytics does not provide any personalized investment advice, nor does it engage in trading of securities. This article should not be considered investment advice or an offer to sell or the solicitation of an offer to buy any securities. All profits are for illustrative purposes and are not a suggestion that similar or future profits may occur. Past results are not necessarily indicative of future results. All investments involve risk and potential loss of principal. It should not be assumed that future investors will experience returns comparable to those of the research discussed herein.