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Over the past 13 years, we have used and developed the
predictive theory of Elliott Waves as applied to markets. In our opinion,
this theory was truly inspired, and, despite being developed before some
of the theories discussed earlier, it includes them all in an integrated
model.
Our analysis of markets is based on observations of group
behaviour that manifests in price movements. In studying the emotional
state of a market, we are able to predict certain future price moves independently
of fundamental information.
Our principal method of trade idea generation is through
the analysis of the price actions of markets as described by R. N. Elliott
in his book, "The Wave Principle". He observed that markets
unfold according to a basic rhythm or pattern of five waves in the primary
direction and three waves that act as a correction. The primary waves
are known as impulse waves and are numbered 1, 2, 3, 4, 5, while the corrective
waves are lettered a, b, c. For this sequence, wave 1 is corrected by
wave 2, wave 3 is corrected by wave 4, and the entire sequence is corrected
by the sequence a, b, c.
If this sounds simplistic, it is worth noting that wave
counting involves hundreds of rules and guidelines, all of which are exact
in nature. A major movement unfolds according to the patterns of five
waves, after which the entire pattern is corrected by a pattern of 3 waves
in the opposite direction.
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Numbered phases
are cardinal waves
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Lettered phases
are corrective waves
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In the language of modern physics, this is the basic fractal
unit that is then built up to form a bigger picture. Thus, 1, 2, 3, 4,
5, a, b, c become waves 1 and 2 respectively of the next larger degree
pattern. The Wave Principle is interesting in that it recognizes the fractal
nature of price structures before the theory was observed in physics.
In the Macro time frame waves 1 – 5 complete a wave of higher degree (1,
3 or 5).
The Wave Principle embodies an important concept known as
alternation, which recognizes the market as a biological entity rather
than a mechanical one. This is best demonstrated by the way in which the
wave 2 and wave 4 corrections take different structural forms, in a process
known as alternation. This occurs as the market's short-term memory produces
a feedback loop in which, if the wave 2 was a deep price drop, the fear
of a repeat performance in wave 4 actually results in a shallow price
correction with a longer time component.
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