module 9 - elliott waves and cycles of time

The Responsible Trader Lessons


The Responsible Trader’s - POVModule 9 – Elliott Waves and Cycles of Time



The Responsible Trader’s - POV• The Responsible Trader's POV (Point of View).

• These are my notes, my own additional research and studies on the Topic that I posted, and my personal observations and opinions that I am sharing to further enhance our knowledge and understanding.

• Some of these were previously posted on “The Responsible Trader” thread, Stock Market Pilipinas (www.stockmarketpilipinas.com). This is the latest version of previous posts I made.

• Some of these plus further explanations and discussions will be appearing in my forthcoming book “The Responsible Trader.”

http://www.stockmarketpilipinas.com/



1. Size – the larger and more solid the candles, the higher the sentiment.

Increasing size of green candles show bullish sentiment.

Increasing size of red candles show bearish sentiment.

Charts courtesy of Amibroker Charting Software



2. Shape – The shape of the candlestick or pattern determines the type of pattern generated, the possible trading signal and the potential direction of the trend.

Bullish engulfing – a large green candle engulfing a small red candle in a downtrend

Bearish engulfing – a large red candle engulfing a small green candle in an uptrend




Single Candle Patterns – the Hammer and the Hanging Man – both have the same shape but their names vary depending on their location.

Hammer in a Downtrend, a Reversal Signal A Hanging Man in an Uptrend, a Reversal Signal

3. Location – determines what the Pattern is called




Ideally, in an uptrend prices should move along a straight line in an upward direction through time.

The stock market does not work in ideal conditions. I call deviations from the straight line movements, distortions. For every distortion there is always an equal and opposite correction. In trading, we also call corrections as Retracements.



Correction in the Stock Market comes in two Forms. The First is Correction in Price. The deviation from the straight line shown by the price movement upward is immediately corrected by a movement back towards the straight line.



The Second is Correction in Time. The deviation from the straight line shown by the price movement upward is slowly corrected by a sideways movement back towards the straight line.



If we continue this pattern of upward price movements and correction, we are going to have the figure below. Do you recognize the pattern?

You are right. This is the basic Elliott Wave Pattern and I have color coded them here.This called the 5-3 Patttern.



The first 5-wave pattern (1,2,3,4,5) are called impulse waves. The last 3-wave pattern (a,b,c) are called corrective waves.

The first 5 wave Patterns (1,2,3,4, and 5) are Trend Waves. Waves 2 and 4 are corrections within the Trend.

The corrective Waves a,b, and c are Counter-Trend Waves.



Whenever I discuss Elliott Waves, there are always two names that come to my mind. The first is Ralph Nelson Elliott.

Ralph Nelson Elliott - American accountant and author who developed the Wave Principle a form of technical analysis that identifies trends in the financial markets.



Wave 1 – Initial Take Off – Mostly professionals, No amateurs

Wave 2 – Profit Taking After Initial Take Off – Mostly professionals, No amateurs

Wave 3 – The Strong Rally – Mostly professionals and some amateurs



Wave 4 – Profit Taking and Buying on Dips. Professionals taking profit and amateurs buying on dips

Wave 5 - Irrational Exuberance. Few professionals and mostly amateurs

Wave a,b,c – Professionals shorting the market, Mostly amateurs cutting losses.



As Elliott observed, wave patterns form larger and smaller versions of themselves.

This repetition in form means that price activity is fractal.



A Grand Supercycle is made up of Supercycle waves which is made up of Cycle waves which is made up Primary waves, which is made up of Intermediate waves which is made up of Minor waves which is made up of Minute waves which is made up of Minuette waves which is made up of Sub-Minuette waves.



The second name that comes to my mind is Leonardo Pisano for the Fibonacci Retracements

Leonardo Pisano, better known by his nickname Fibonacci, was a great Italian mathematician who first observed certain ratios of a number series that are regarded as describing the natural proportions of things in the universe, including price data.



The ratios arise from the followingnumber series: 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144 ……This series of numbers is derived by starting with 1 followed by 2 and then adding 1 + 2 to get 3, the third number. Then, adding 2 + 3 to get 5, the fourth number, and so on.

The Fibonacci ratios are derived by dividing any number in the series by the next higher number, after 3 the ratio is always 0.625. After 89, it is always 0.618. If you divide any Fibonacci number by the preceding number, after 2 the number is always 1.6 and after 144 the number is always 1.618. These ratios are referred to as the “golden mean.” Additional ratios were then derived to create ratio sets as follows:



When R.N. Elliott wrote about the Wave Principle, he stated that the Fibonacci sequence was its mathematical basis. Elliott waves both impulsive and corrective adhere to specific Fibonacci proportions.Common objective for Wave 3 is 1.618. Wave 5 is equal to Wave 1, Wave 2 is .618 of Wave 1 and Wave 4 is .382 of Wave 3.



3 Cardinal Rules of the Elliott Wave TheoryRule Number 1: Wave 2 can never retrace more than 100% of Wave 1.Rule Number 2: Wave 4 may never end in the price territory of Wave 1Rule Number 3: Out of the three impulse waves 1,3 and 5, wave 3 can never be the shortest.

A violation of one or more of these rules implies that the operative wave count is incorrect.



Summary: 1. Elliott Waves are fractals. Each wave can be split into parts, each of which is a very

similar copy of the whole. Mathematicians like to call this property "self-similarity".

2. A trending market moves in a 5-3 wave pattern. The first 5-wave pattern are calledimpulse waves. These are also called Trend Waves.The second 3-wave pattern are called corrective waves. Letters are used instead ofnumbers to track the correction. These are also called Counter Trend Waves.

3. There are 3 Rules to be observed when using the Elliott Wave theoryRule Number 1: Wave 2 can never retrace more than 100% of Wave 1.Rule Number 2: Wave 4 may never end in the price territory of Wave 1Rule Number 3: Out of the three impulse waves 1,3 and 5, wave 3 can never be the shortest.



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module 9 - elliott waves and cycles of time

Education

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straight line movements

type of pattern

large green candle

small green candle

large red candle

small red candle

basic elliott wave pattern