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Home Elliott Waves

Elliott Waves; Elliott wave principle
Elliott wave principle is widely used but poorly understood philosophical approach to financial markets. In 1930s Ralph Nelson Elliott made a unique discovery, which says: the average market movement rises in the form of "five waves" and declines in the form of "three waves". This allowed Elliott to forecast price movements with great precision. The theory was published in 1938 entitled "The Wave Principle”. According to this theory, prices generally follow the wave principle /sequence/ of movement, which can be used to determine future levels and reverse of the trend. Waves that follow the trend are called impulse waves, while waves that develop in the direction opposite to the main trend are called corrective.

Elliott theory further divided impulse and correction waves into five major and three lower movements. Eight consecutive movements /waves/ build a complete wave cycle, and the time limits for their development can vary from 15 minutes to decades.вълни на елиът The biggest challenge in Elliott wave principle is that the wave pulses themselves can be divided into sub /inferior/ pulses with the same wave structure, therefore it is crucial to properly define the relationship between waves of different structures.
 Basic wave model.
The fundamental Elliott’s argument is that all bull markets consist of five waves, and all bear – of three waves. In each bull phase there are three impulse waves and in between them there are two corrective ones.  Bear phase consists of two impulse waves and a corrective one lying between them. An important feature of Elliott wave principle is its applicability at all levels of a movement. Each pulse wave consists of five waves of a different degree and any corrective wave consists of three waves of a different degree.

According to some analysts, Elliott wave theory is not just a model or any blind pursuit of graphics, but a way of thinking and vision of the market. Any market movement /formation of wave/ is caused by the actions of the majority /the mass/ investors who are guided solely by their desire to gain profit from changes in price. It is this regular people’s motive that makes them think and act always in one and the same way. This applies to absolutely all markets: ranging from stock, currency, commodities, and even the market in the neighborhood. People become predictable exactly because of this single purpose for which they trade. Their psychology is always one and the same and it does not matter whether it is 1800, 1900 or 2003 year.

Ideal wave model:
Blindly following the wave structure is completely wrong approach. This mistake is made by almost all beginners and even by the advanced followers of this theory. There are few people who know what lies behind each of these individual waves. Why do the prices follow this structure? At what point of the movement we are and what to expect in the future? The charges towards Elliott Wave Theory that it only points past movements and has no predictive nature are made by people who are not familiar (and even if they are acquainted, they do not understand). There is a greater damage for people who partially know the wave theory and try to apply it incorrectly than for those who do not use it at all.

вълни на елиът

Psychology that lies in the terms ‘bottom’ and ‘top’ is the following:
The highest level /long period of time/: bottom – arises the question of survival, revival, depression, war; top – boom, peace, overoptimism, extreme satisfaction; These are the turning points of the major trends.
Middle level /medium term/: bottom – a decline, recession, panic, limited wars; top – positive emotions, economic improvement;
Low level /short term/: bottom – it is most often formed in bed news; top – often accompanied by good news. Note that the bottoms are formed in the presence of negative data and the tops in positive ones! Here we should note that the level at which we are reflects on the degree of force of the changing trend.

Psychology of traders in market position on the wave 1: It is formed after established turning point – bottom or top. It is defined with the term Rebound. People have attitude for the next correction of the current trend. They use any increase of sales. Very often the volumes of trade are not as large as it is normal for a change in the trend. Only the best enter in the right direction.

Wave 2: It is defined as Test of Lows. The question whether the worst is already past or is still forthcoming arises in the development of this wave. Aren’t we going to a new bottom? The conditions at which it is developed are sometimes even worse than those at the bottom. The majority wait for new bottom. Some of them already are short or have already been thrown out of the market. In a formed bottom most people have withdrawn. There are sellers but very few. Those who have failed to recognize the wave 1 still have the opportunity to take long and good (even better) levels. Good traders recognize the new good trend and begin to accumulate long positions. The volume gradually rises and the prices reasonably increase.

Wave 3: It is also called Powerful Wave. Typical for its development is its strength, increasing volume, positive fundamental data coming out, and economy prosperity at a rapid pace. It is very often divided into fives of a smaller magnitude. This wave is never the shortest one. Almost all market participants are made sure for the start of a new trend. Masses (the ordinary investors) “catch the train”. Just when everybody is convinced of the rally has started, and the waves are long, buyers are missing because the waves are all long. Good traders coming from wave 1 and 2 start cashing their profits. Correction, the next wave 3, is rather the result of covering long positions than short sales.

Wave 4: The easiest for prediction wave which is called Surprising Disappointment. It differs from wave 2. Most often it takes more time for its development than for wave 2; it does not penetrate deeply in wave 3 and never becomes a part of wave 1. The reduction of the optimism in wave 3 gives rise to disappointment for part of the participants. Volumes are low. The first signal of a recent top is present. The development of the last 5th wave depends on the development of this one. General investors add to their long positions, hoping to revive the strength of the trend, but professionals come into with the clear idea for a recent turning.

Wave 5: Final Advance. The name is significant. Good news for the economy and companies in particular continue to come up but they are not as positive as within wave 3. The volume of trade starts declining (unless we have a case of extended 5th wave). Optimism grows tremendously, and starts getting close to obsession. The most eager and unprofessional traders rush to buy something with their last capital. And inevitably there comes a time in which there is no one to buy. The top is formed. Professionals come up first and take short positions. The majority continues to think that this is not a long-term top and continues to hold long positions which are devaluated with every passing day. This process of non-recognition of the turned trend is typical for the most inexperienced (which are about 90% of the total). The mass continues to hope for an increase, but it still does not come....
 
А, В, С formation /correction waves/.
Wave А /Technical Breakdown/- it crosses the channel where the pulse movement is developed. It suggests a completion of the impulsive motion. During the development of this wave most of the traders hope for a recent recovery of the main trend and hurry to find long positions. This again is typical for the masses and less experienced people who think that markets move "straight" and any short-term correction should be used for new positions along the main trend. Depending on the mode of development of this wave we can predict the nature of whole A-B-C correction. If it is in five waves (impulsive, but of a different degree) then we know that a ZigZag (5-3-5) will follow. If A is in 3 waves then either FLAT, or Triangle flows.

Wave В /Narrow, Emotional Advance/ - this wave is the most deceptive one. Not for nothing it is known as a trap for bulls and speculators paradise. This is a wave in which most people are confused and ill-considered entry along the trend is most painful, because the development of C removes many stops and a little while after you have been thrown out of the market it goes in your direction. This wave is usually very weak technically (low volume and slope). There is non-confirmation here. If you cannot determine at what point of the counting at the time of correction you are, then you are in wave B. This wave can be between a minimum of 61.8% and up to 261.8 percent from A.

Wave С /Worst of bear market/ - because it appears as a third wave in the correction it is normal to have many properties of the third waves. It is characterized by strength, volume and a greater slope. Sometimes this wave is devastating. All hopes for a trend recovery during the A and B vanish now. The majority begin to lose hope that soon we will see upward movement. The strength and 5-wave structure is often confused with the start of a new trend which is absolutely wrong.
On the contrary, for the top analysts, this is the most appropriate for entering wave and the most easily predictable one. Because it is end of a movement of a greater magnitude (in the case of a correction that may be in position 2, 4 or B) it is easy to be foreseen. There are many options for its development, but after A and B have passed, and knowing the dependencies between these 3 parts (A-B-C) of the corrective movement, the possibilities for C are limited to 1-2 with a very high accuracy. The fact that its recognition is easy and the forthcoming resumption of the trend make it a pretty good chance of winning with a relatively low risk.

Indications of waves: waves are divided into two types – impulsive and corrective. Impulsive waves are in the same direction with the main trend and corrective ones are at the opposite direction. The main difference between the types of movements is the difference in their structure.  Impulsive are always 5 waves and the corrective are 3. Essential for the wave analysis is identifying and defining the different Wave Degree.
For example, not each five is a part of the impulsive motion. Although you have seen five waves, this does not mean that there is a change in the trend. There are fives in wave A and C of the correction.

Waves indiciations:
There are three main types of corrective movements:
FLAT (3-3-5) – It is indicated as А-В-С and A is in 3 waves, B is in 3 waves, and C is in 5 waves.
ZigZag (5-3-5) – It is indicated as А-В-С, and А is in 5 waves, В in 3, and С in 5 waves.
Triangle (3-3-3-3-3) - It is indicated as А-B-C-D-E and each wave is in triad. 

Elliot rules, corrections:
The emergence of five-wave impulse pattern indicates the direction of the long-term trend. For example, rising 5-3 model after a sharp drop in the market will bring further price increases, while falling 5-3 model after a sharp jump will lead to price decreases.
1. Wave 4 will not reach a level below the top of wave 2.
2. Wave 3 is often the longest, but never the shortest of the 5 impulse waves in the movement.
3. Two of the impulse waves will have approximately the same length.
4. None correction /three-wave/ formation will completely repeat the position of its predecessor formation.
5. The duration and the amplitude of the correction will be larger than those of a lower level correction.
There are deviations in the 5-3 model of Elliott that must be taken into account. Break-down or extension can appear in the fifth wave. Diagonal triangles /wedges/ appear. Prices go in a direction opposite to the slope of the triangle. Elliott attaches great importance to the shrinking and expanding triangles. The direction of movement after leaving the triangle is the same as that in wave 2 of the triangle.
      
Problems in Elliott Wave Principle.
Many analysts find Elliott Wave Principle as imperfect.
Reasons:
1. There is no acceptable explanation for the 5-3 formation. The model does not exist as regular phenomenon nowhere else in the nature. It is difficult to accept that something so fundamental is inexplicable and has no other manifestations.
2. The complexity of the wave means that sometimes it is impossible to predict price movements, alternatives and probabilities can only be established.
3. The principle is most difficult to be applied in some markets than in others; for example, commodity markets and Forex.
4. In Forex currency pairs are traded, i.e. graphics can be mirrored, for example USD/EUR, which can not happen to shares.
5. It is often difficult to determine the proper bottom from which to start counting the waves, and thus undermines the 5-3 structure. See more in Courses
 
Credit Ratings

The need for internationally recognized credit rating occurs with the globalization of financial flows and the growth of speculative trading. Investors do not care about the nationality of the bonds and the financial instruments. Concepts such as patriotism or personal sympathies have lost their meaning.

The rating agencies saddled themselves with the noble task to unify criteria for assessing credit risk; among the most authoritative of them are - Moody's, Standard & Poors, and Fitch, Inc. No matter whether comes to issuance of government securities of the United States, Bulgaria or Cameroon, the Tokyo or Bucharest municipal bonds, corporate debt or shares in different countries the principles and methods for evaluation are the same.
 
Classification
Credit ratings of Investment Type.

AAA – The highest credit rating; it indicates the lowest credit risk. This rating is assigned when extremely strong capacity for timely repayment of financial obligations is proved. The likelihood of deterioration as a result of external adverse factors is minimal.
Аа, АА – Very high credit quality; they indicate very low credit risk. This rating indicates very high potential for timely repayment of financial obligations. The organization to which such rating is assigned is not particularly susceptible to adverse external emerging trends.

А – High credit quality; the rating indicates low credit risk. This rating indicates high potential for timely repayment of financial obligations, although the organization is susceptible to cnanges in circumstances or in economic condictions.

Ваа, ВВВ – Good credit quality – The rating indicates low credit risk. The potential for repayment of obligations is considered as satisfactory; however, there is a risk of deterioration of the state of the organization as a result of worsening the situation in the external environment and changing economic conditions.

Credit ratings of Non-investment Type.

Ва, ВВ – Risky – The rating indicates the potential occurrence of credit risk in the event of changes in macro economic in the course of time. However, it is possible business or financial alternatives to occur which allow the organization to easily repay its obligations.
В – High risky – The rating indicates the presence of significant credit risk, but there is limited element of security for the organization. Currently the organization meets its obligations, but the potential for repayment of debt in the future is dependent on a sustainable and positive business development and economic macro environment.

Саа, ССС, Са, СС, С – High risk of bankruptcy – The bankrupt of the organization is absolutely possible. The potential for repayment of debt in the course of time depends only on the stability and favorable development of the macro environment.

Са, СС – The rating shows great possibility for future bankruptcy.
С – The rating signals for an inevitable bankruptcy.
 
DDD, DD, D (Moody's C) – Actual bankruptcy – This rating depends on the prospects for full or partial satisfaction of the creditors of the organization.

DDD – The highest potential for satisfaction of the creditors /about 90 – 100%/. Organizations with such credit ratings have the potential to resume their activities with or without a reorganization of their business.

DD – A potential for satisfaction of the creditors within 50 – 90%.

D – The lowest potential for repayment of debts to creditors – under 50%.
Ancillary indices to the main rating index

“+” or ”-” – In order to specify further the status of the organization  "+" or "-" sign can be added to the main index. Ancillary indices are not added to category ААА, Ааа and to categories below Саа, ССС.

“Withdrawn” – This ancillary index is assigned to securities for which the necessary information to determine the credit rating is missing as well as to securities, which have been withdrawn from trading.

“Rating Watch” – Placed under surveillance are those organizations for which there is sufficient likelihood for up or down change in the current rating. When the trend is to raise the credit rating index "Positive" index is placed and if the trend is for decrease in the credit rating "Negative" index is placed. When index "Evolving" is set, this means that it is possible to increase or decrease the credit rating or it remains unaltered. The surveillance lasts for a relatively short time.

“Rating Outlook” – shows the development prospects of the organization in a period of 1-2 years. The Rating Outlook can be “Positive”, “Negative” or “Stable”. Stable outlook means the probability of keeping the current rates for a period of 1-2 years, although it is possible to increase or decrease the rating.

Shares/Stocks of Companies

Shares are ordinary and privileged. Ordinary shares entitle to vote in the General Assembly of the company. On the contrary, holders of preferred shares may not vote at shareholder meetings, but on the other hand, are entitled to a higher dividend than that of ordinary shares. The shares are also divided into registered and bearer. Transfer /sale/ of registered shares shall be made by endorsement through which the new owner is indicated. The transfer of bearer shares is realized through their physical transfer from the seller to the buyer.

The shares are also available and dematerialized. The available ones are printed as typical security with the relevant attributes and protections. Dematerialized shares are registered in the form of nominal depository receipts. Their transfer is made by compulsory mediation of a specialized clearing institution /depository/ which in the event of sale cancels the currently existing depository receipt and issues a new receipt for the next owner.

Stocks classification according to their investment qualities.

Blue chips – shares of large companies with a long successful history having stable dividends over the years.

Growth stocks – shares of emerging companies, which normally do not pay dividends, investing profits in business development. The benefit in this type of shares is the increase of their market value.

Defensive stocks – shares of companies that are sustainable in times of crisis

Income stocks – shares of companies paying dividends above the average of the market.

Cyclical stocks – shares of companies, the value and profitability of which depend on the stage of the economic cycle, i.e. they are pro-cyclical.

Seasonal stocks – shares of companies whose performance is susceptible to seasonal fluctuations.

It should be noted that many financial analysts blame just the rating companies for the financial crisis and in particular for the high volatility of the Forex and stock and raw materials markets. See more in Courses

 

 
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