lecture 10: Elliott Wave Theory, Fibonacci, and Gann Flashcards
who discovered the Fibonacci Sequence
Leonardo Pisano a.k.a “Fibonacci” of Pisa, Italy
what is the fibonnaci sequence
1,1,2,3,5,8,13,21,34,55,89,144 gives us the Fibonacci sequence
who developped the EWT (Elliott Wave Theory)
Ralph N. Elliott
popularized by Robert Prechter
EWT (Elliott Wave Theory)
states that stock prices are governed by irregular cycles founded upon the Fibonacci series (1-2-3-5-8-13-21…).
Impulse waves (move with trend) with corrective (counter trend) waves against trend
5 motive waves, (waves 1,2,3,4,5), 3 impulse waves (waves 1, 3, 5)
3 corrective waves: A, B, C
The market moves with “three steps forward and two steps back”
3 types of corrective waves
Zig zags
Flats
Triangles
Zig zags correciton
A-B-C
A & C impulse, B corrective
Flat correction
A-B-C moves sideways with overlapping sub waves
triangles correction
Like triangle patterns with five waves A-B-C-D-E
EWT Basic rules (that cannot be broken and must always hold)
Wave 2 may not break below the origin of wave 1
Wave 3 is never shorter than wave 1 and 5, but it does not necessarily have to be the longest wave
Wave 4 cannot overlap the termination of wave 1
All other suggestions are guidelines
EWT Guidelines (not always expected)
Alternation: Types of corrective waves in wave 2 and 4 alternate (a flat is followed by a zig-zag, or triangle)
Equality: At least 2 of the 3 impulse sub waves in a 5 sub wave sequence are often equal in length (i.e. waves 1 and 5 usually are equal in length)
Truncation : Occasionally the fifth wave fails to exceed the third wave, and gets “truncated.”
Using EWT
Difficult to interpret, especially corrective waves
Much debate as to “which wave we are in?” Where the heck is that wave?
Tendency to over analyze
Waves are fractal
Waves known after the fact
Wave movements are related to the Fibonacci ratio
Five wave pattern (dominant trend)
Wave 1
rarely obvious at its inception
When the first wave of a new bull market begins, the fundamental news is almost universally negative
The previous trend is considered still strongly in force.
Fundamental analysts continue to revise their earnings estimates lower; the economy probably does not look strong.
Sentiment surveys are decidedly bearish, put options are in vogue, and implied volatility in the options market is high.
Volume might increase a bit as prices rise, but not by enough to alert many technical analysts.
Five wave pattern (dominant trend)
Wave 2
Wave two corrects wave one, but can never extend beyond the starting point of wave one.
Typically, the news is still bad.
As prices retest the prior low, bearish sentiment quickly builds, and “the crowd” haughtily reminds all that the bear market is still deeply ensconced.
Still, some positive signs appear for those who are looking: volume should be lower during wave two than during wave one, prices usually do not retrace more than 61.8% (see Fibonacci section below) of the wave one gains, and prices should fall in a three wave pattern.
Five wave pattern (dominant trend)
Wave 3
Wave three is usually the largest and most powerful wave in a trend (although some research suggests that in commodity markets, wave five is the largest).
The news is now positive and fundamental analysts start to raise earnings estimates.
Prices rise quickly, corrections are short-lived and shallow.
Anyone looking to “get in on a pullback” will likely miss the boat.
As wave three starts, the news is probably still bearish, and most market players remain negative; but by wave three’s midpoint, “the crowd” will often join the new bullish trend.
Wave three often extends wave one by a ratio of 1.618:1
Five wave pattern (dominant trend)
Wave 4
Wave four is typically clearly corrective.
Prices may meander sideways for an extended period, and wave four typically retraces less than 38.2% of wave three.
Volume is well below than that of wave three.
This is a good place to buy a pull back if you understand the potential ahead for wave 5.
Still, the most distinguishing feature of fourth waves is that they often prove very difficult to count