The Elliott wave
principle is a form of technical analysis that investors use
to forecast trends in the financial markets and other
collective activities. Ralph Nelson Elliott (1871–1948), a
professional accountant, developed the concept in the 1930s:
he proposed that market prices unfold in specific patterns,
which practitioners today call Elliott waves, or simply waves.
Elliott published his views of market behaviour in the book
The Wave Principle (1938), in a series of articles in
Financial World magazine in 1939, and most fully in his final
major work, Nature’s Laws – The Secret of the Universe (1946).
Elliott said that "because man is subject to rhythmical
procedure, calculations having to do with his activities can
be projected far into the future with a justification and
certainty heretofore unattainable."
The wave principle posits that collective investor psychology
(or crowd psychology) moves from optimism to pessimism and
back again. These swings create patterns, as evidenced in the
price movements of a market at every degree of trend.
From R.N. Elliott's essay, "The Basis of the Wave Principle,"
October 1940. Elliott's model says that market prices
alternate between five waves and three waves at all degrees of
trend, as the illustration shows. As these waves develop, the
larger price patterns unfold in a self-similar fractal
geometry. Within the dominant trend, waves 1, 3, and 5 are
"motive" waves, and each motive wave itself subdivides in five
waves. Waves 2 and 4 are "corrective" waves, and subdivide in
three waves. In a bear market the dominant trend is downward,
so the pattern is reversed—five waves down and three up.
Motive waves always move with the trend, while corrective
waves move against it.
Elliott's market model relies heavily on looking at price
charts. Practitioners study developing price moves to
distinguish the waves and wave structures, and discern what
prices may do next; thus the application of the wave principle
is a form of pattern recognition.
The structures Elliott described also meet the common
definition of a fractal (self-similar patterns appearing at
every degree of trend). Elliott wave practitioners say that
just as naturally-occurring fractals often expand and grow
more complex over time, the model shows that collective human
psychology develops in natural patterns, via buying and
selling decisions reflected in market prices: "It's as though
we are somehow programmed by mathematics. Seashell, galaxy,
snowflake or human: we're all bound by the same order." |
