Introduction to Elliot & his Wave Theory.(part-2)

More and exhaustive studies have been made on Elliot wave theory by many experts to follow the markets and the studies are available in the links under Elliot wave Tutorials in this blog. With complex counting of waves and numerous rules and squabble among EW analysts about the correct labelling has scared away many from this simple tool. 

My sincere attempt is to illustrate here the way I self taught myself with the wave theory and the utility of it when combined with other methods in understanding market moves. The book that inspired me the most to follow EW is "Elliott wave Explained" by Robert beckman.
To me, EW is simply a spontaneous counting of "Fives and threes" and its combination to put the market moves in a predictable order.

Ralph Nelson Elliot observed after years of analysis that the market movement was quite orderly and followed a pattern of waves. It is a theory that reflects the law governing the form of the natural path of all human activities. This Nature's law, though predictable to the dedicated, still leaves much mystery to many.
The comparison with tide, wave and ripple has been used since the earliest days of Dow Theory.

What is a wave..?? There are no parameters to define what is a wave and hence it is left to the imagination of the follower. The example of the waves of the ocean illustrates this quite well..
1. A small wave starts initially.

2. And then it recedes for a while and gathers more strength.

3.On its next advance, the wave becomes stronger than the earlier one.

4.With a further consolidation, the final wave explodes with full strength.

What is a wave..?? There are no parameters to define what is a wave and hence it is left to the imagination of the follower. Years of my observations have helped me to arrive at a basic tool to identify a wave which is "Trendline". When a trendline is combined with the study of Technical indicator such as macd (How to combine EW with macd, you are well guided to put these price movements in an orderly fashion as defined by Elliot wave theory that prices move in 5 waves followed by a 3 wave correction. And this process continues..on and on.
The Elliot theory: Market moves in waves, each of which is interrelated to one another in time and price. A movement in a particular direction can be represented by "5" distinct waves of which three in the direction(called impulse wave-1,3,5) and two against the direction(called Corrective wave-2,4).
One such five-wave would become the first wave of the higher degree. Eg: 5 waves in hour would become one single wave in the Day.
Each corrective wave will subdivide into 3 waves of a lesser degree. And this process continues with variations in actual market place as per the Traders/Investors psychology & their resultant behaviour which moves the markets.

How to apply..? You simply start labeling them in fives and threes as you deem fit using, if necessary, other "Overbought & Oversold" indicators and other methods. There are some basic rules to be followed to help you in counting them correctly which will be discussed next week.

Here is a small illustration to count them and their immense utility in assessing the likely direction of the market which helps in proper entry and exit and above all to "sit tight" with the trades.

1. At the reversal point, the first wave is formed with a swift retracement of the last fall. The illustration here is of the onset of the bull run started in March 2009.(In the 5-minute or 30 minute chart, the faster retracement could have been spotted at 2630 after a positive divergences and highly oversold nature).

As the first set of "5"s is complete, it becomes the 1st or "A" wave (As the upmove from mar.09 low is construed as corrective)of a larger degree/ time cycle.
i.e- from hourly 5 waves, they become the 1st wave of the daily as shown below:
Also note that the last fall from 2798 to 2556 got retraced in shorter time to 2836, confirming a trend reversal.

Always book out at the count of 5, at least partially and re-enter at the count of "abc"-the corrective part. In most bullish cases, the correction ends at the 4th wave of the previous lower cycle. Never miss the "Third wave entry"-one of the most rewarding phase.There are many traders who simply wait for the 3rd wave set ups in various time cycles to make their safer & rich trades. Note in the hourly chart below the irregular correction in the second wave(marked in red) wherein the "b" moved above the "1st" wave suggesting of "Bullish undercurrent" that market is quite impatient to forge ahead.

Here below, you will note the completion of three sets of "fives" connected by two sets of "threes" to form one big "First or A"(Pink) wave to be followed by a correction which ended near the 4th wave of the previous cycle. Now Imagine, what the 3rd wave of this larger time scale can have in store for it after experiencing a small 3rd wave upmove earlier within the "three sets of Fives". We'll see soon.

The more noisy or countless sub-waves are enclosed within the daily waves in a neat fashion.Note also how the "first break of the trendline often gives away the end of a 4th wave and the onset of a powerful 5th wave" This is not a rule but a guideline worth remembering.

Yes..in the daily 3rd wave, the markets gave a Black Swan..a total upward freeze. This happens often to individual scrips.Note also, subsequent to the completion of the 5-waves in daily which make up the 1st or "A" wave of the weekly, a larger correction sets in. A break of the redrawn trendline confirms the "a" wave(first of the three waves of a correction) of that correction.

Once a larger correction in the form of an "abc" (We label the corrections as "abc" to avoid a confusion of labeling both upmoves and downmoves using numbers) is complete, the next big 3rd wave or "C" wave(as it is still considered to be corrective)start to unfold.

The most important factor in labeling the moves is to help identify the direction, its magnitude depending on its time cycle to stay in the direction for the correct amount of time. One should not, for eg.,enter into an hourly 3rd wave and sit tight for days.The hourly direction lasts for "Hours" only.
Remember there are waves within waves and various "Counts" are in force at any given time for different time cycles. EW works well for the larger time scale and requires high agility & proper stop loss & money management to play the shorter version.
My EW learning has come mostly from the shorter version as you will see most of the wave forms in a shorter version since one life time is not enough to see them in larger time scale which can run into centuries.
In the next week, we will learn some basic rules that govern this wave movements.
Have patience..Elliot took 10 years to arrive at his theory.
Get rich slowly.

Nifty ends the year on a high note .

Weekly channel support comes at 5050-5060.
Supply keeps coming at & above 5180.

Overbought Hourly charts may put pressure on the Overbought daily especially after a 5-wave completion. Correction will continue till 5225 is broken decisively. Trading below 5DMA @ 5175 can drag the index down to complete the correction.

The weekly pivot(5194) and the daily Pivot(5202) have come quite close to the highs of this upmove suggesting loss of momentum. "5180" will be a decisive Level.

Good Bye, the enriching "2009".

Thank you, all my readers...

You have truly enriched my life more than anyone can imagine
and more importantly brought out the best in me.
I am grateful for that.

Wishing you all a very very profitable and fulfilling "2010".

Nifty Intraday Update.

Weakness only if it closes below 5209 at 1.00PM.

Nifty PreMarket View

With a strong "Asia", the next big move up is likely to unfold, holding above 5176-5185.

Nifty entering the end of the month, settlement, Year & a long weekend..!!

Nifty Intraday Update

Res. @ 5190-5198+ ; Supp. @ 5165-5144.

Nifty PreMarket View

Another narrow trading day..?

Nifty in an upward pause post breakout.

Nifty Intra Update

Nifty Intraday Update.

Nifty PreMarket View

Expecting a sideways move after the sharp short term up move of last three days in an "abc" form. If it makes a new high in the first hour, then that could be counted as part of the "5". The negative divergence in 5-minute chart suggests of a short term correction. Positional Longs may be initiated during this correction to 5060 or 5040 or 5110. For aggressive traders, some trading range of 5100-5130 to 5190 to 5220.

An Invitation to enter the world of Elliott waves.(Part-1)

Success in the stock market is measured in terms of money earned. Luck is how the envious describe hard work and the successful use of skilled judgement.
Stock market offers no absolutes that it will do what it wants to do, when it wants to do it.
You need a guide to help define probabilities and the knowledge to weigh them, followed by the confidence to act on your own judgement and not be thrown off-balance by the arrival of the improbable.
The most rewarding aspect of the wave principle is that when only one option is offered, the probability of success is extraordinarily high. Markets are efficient but 90% driven by emotions and these emotions are reflected by the Nature's Law called "Elliott waves" named after Ralph.N.Elliott who discovered it and effectively applied to US markets on a larger time frame.
Most important intellectual quality for successful investment is the ability to keep an open mind. The biggest mistakes are made by those who do not know what they do not know. Genius is nothing but a great aptitude for patience.
The precise order of wave formation can often seem obscure, riddled with random noise, leaving you totally confused as to the position of the market within the framework of the overriding elliott trends. The forecasting error is not due to Elliott's wave principle but to our misuse of it. Markets and Elliott wave principle are like the Delphic Oracle; neither are ever right or wrong, they just are.
Be realistic - that is the best way to make money from the wave principle. When in doubt, Stay out. Even a slight acquaintance with the wave principle will reinforce your performance.
Markets are technically strongest after a sharp decline and technically at their weakest after a sharp upmove and EW suggests to sell into the strength and buy into the weakness quite contrary to the crowd behaviour.
Before you'd have been petrified by the falling markets. Now you can place them in context - a mere corrective wave, possibly time to buy in with both hands.
Before you were tempted to get wildly enthusiastic about bull markets getting yourself right at the top of the market every time. Now you see that the prices are rising in the fifth wave and you sell the market when there is euphoria all around.
Market's movement is a psychological phenomenon. The stock market is a creation of man and therefore reflects human idiosyncrasy. Wave principle represents this rhythm of man's response to external stimuli which shows itself in price fluctuation.

I feel no opportunity should be lost to help you understand this extremely valuable and potentially highly profitable investment tool. I want you to think, live and breathe Elliott and his wave principle.

I have put up a Elliott wave Tutorial Link in the blog. Go through them which are quite simple and lucid to understand. Spend your valuable time on them and allow it to take you through the whole teaching....and do not struggle to understand. If necessary go over again. From next week, we will start discussing various application of the Wave principles to our trading strategies.

Leading Technical Indicator - the Stochastics

Technical analysis is practiced in two main categories namely chart patterns and indicators. Indicators are calculations based on the price of a stock/ Index and indicates trends, volatility and momentum. Indicators are often compared to "pulse, pressure check" of a patient by the doctor to assess the extent of the illness. Indicators help you assess the market for its momentum, direction, etc.

Indicators are used as a tool to gain further insight into the supply and demand of securities. Indicators are used to confirm price movement and the probability that the given move will continue. Along with using indicators as secondary confirmation tools, they can also be used as a basis for trading as they can form buy-and-sell signals.

Indicators are of two main types - leading and lagging - both differing in what they show users.

Leading Indicators are those created to precede the price movements of a security giving predictive qualities. Two of the most well-known leading indicators are the Relative Strength Index (RSI) and the Stochastics Oscillator. I have often identified the reversal with the additional help from Stochastics.

Lagging indicator is one that follows price movements and has less predictive qualities. The most well-known lagging indicator is the MACD. The usefulness of this indicator tends to be lower during non-trending periods.

A leading indicator is thought to be the strongest during periods of sideways trading ranges, while the lagging indicators are regarded as highly useful during trending periods and produce fewer buy-and-sell signals which allow the trader to capture more of the trend instead of being forced out of their position.

The stochastic oscillator is calculated as a percentage of a security's closing price to its price range over a given time period. For eg: If a 5 day range of an index is 100 points and the index has closed to day 80 points up from that 5 day low, the stochastic will be 80, near overbought. Similarly if the index closes quite close to the 5 day lows, a mere 20 point away from it, the stochastic is 20, near oversold. The oscillator's sensitivity to market movements can be reduced by adjusting the time period or by taking a moving average of the result. In an upward trend the price should be closing near the highs of the trading range and in a downward trend the price should be closing near the lows of the trading range. When this occurs it signals continued momentum and strength in the direction of the prevailing trend.

This leading indicator will create many buy and sell signals that make it better for choppy non-trending(Sideways) markets instead of trending markets where it is better to have less entry and exit points.

The stochastic oscillator is plotted within a range of 0 and 100 and signals overbought conditions above 80 and oversold conditions below 20. The stochastic oscillator contains two lines. The first line is the %K which is essentially the raw measure used to formulate the idea of momentum behind the oscillator. The second line is the %D which is simply a moving average of the %K. The %D line is considered to be the more important of the two lines as it produces better signals.

There are two main ways this indicator is used to form buy and sell signals are through crossovers and divergence.

Crossovers occur when Stochastic moves up from below 20 or 30 to generate a buy signal or moves down from above 70 or 80 to create a sell set up. It signals that the trend in the indicator is shifting and that this trend shift will lead to a certain movement in the price of the underlying security.

Divergence occurs when the direction of the price trend and the direction of the indicator trend are moving in the opposite direction. This signals that the direction of the price trend may be weakening as the underlying momentum is changing.

There are two types of divergence - positive and negative. Positive divergence occurs when the indicator is trending upward while the security is trending downward. This bullish signal suggests that the underlying momentum is starting to reverse and that traders may soon start to see the result of the change in the price of the security. Negative divergence gives a bearish signal as the underlying momentum is weakening during an uptrend.

When it is combined with EW, the effectiveness increases as during 3rd waves, it tends to remain in the "Overbought" or "Oversold" for longer than usual. During such a 3rd wave, the lagging indicator,Macd, works well.

We, now, have trendlines & Channels, Pivots with supports & Resistances, leading(Stochastics) and lagging(Macd) indicators combination in a Trading system that forms the basis of our "Tech.Table". Note that we are not obsessed by any indicator or any method but each one contributing its worth as in a "Cohesive TEAM" that can lead you into any challenging trading day. What is the one most important team member missing.? The strategist who can peek into the opponents (Market's) next move. We will cover next the Strategist, Elliott wave.