Elliot Wave Theory - Amibroker AFL

The Elliot wave theory was presented to the trading community by Ralph Nelson Elliot in the years 1968 and 1969. In this remarkable work he has emphasized that the market movement is based on a pattern of five impulsive upward waves and three corrective downward waves. the stock market is largely driven by investor sentiments and related news. The stock price reflects the investor behavior. Stock price may witness newer highs and steep corrections. All these are part of share trading. Elliot has taken into consideration almost all the actions of the trading activity before formulating his theory.  He strongly believed that by studying the wave pattern one can anticipate the next price movement.

 

These Elliot waves of impulsive and corrective waves are governed by a set of rules. Each wave should strictly confirm to these rules. The wave 1 (W1) is the beginner; W1 can be of any length and an impulse wave pattern. The wave 2 (W2) is a corrective pattern and the length of the W2 cannot retrace more than of W1, This means W2 has to remain within W1. The retracement of W2 should be around 20%. When the trend continues the formation of wave 3 (W3) occurs. W3 is an impulsive wave. The W3 has to be greater than the W2 and should be greater than W1 by 1/3^rd. The wave 4 (W4) can be a corrective wave pattern. The retracement of W4 can be 15% of W2. After this the final formation of wave 5 (W5) can take place. W5 is an impulsive wave pattern. The W5 will usually extend beyond W3, longer than W1 and W3. Another important point to note is we can arrive at a target price movement for W5. There are four probabilities. It can be 1. 61.8% of W1. 2. 100% of W1. 3. 161.8% of W1. 4. 161.8% of W1and W3.  There is also a belief that the maximum movement of Wave 5 is six times Wave 3 in both price and time.

This five wave pattern is called impulsive phase of the Elliot Wave, regardless of the W2 and W4 corrective wave patterns. From the end of W5 begins the Corrective phase with three wave patterns.

 In the corrective phase we come across three waves which have been named W a, W b, and W c.. This corrective phase should be considered as a counter trend as opposed to the five wave trend. The W a is an impulsive wave pattern and beginner of the corrective phase W b is a corrective pattern and wave W c is again an impulsive and ending pattern. W b must be shorter than W a by price W b must be at least 20% of a by price. Wave b should retrace at least 30% of Wave a wave b is most likely to retrace wave a by 38.2% or 50% or 64.8% or 100%

W c can be similar to the length of W a. The retracing probability of W c is 61.38% or 161% of W a. Wave C is most likely to have a similar price length to W a.

Together with these five (W1-W5) and corrective three (Wa-Wc) make up one complete cycle. Now this cycle forms part of another Elliot Wave pattern. In the new pattern W1 to W5 becomes the new W1 (Marked 1 in the fig-2). Wa-Wc becomes the new W2 (Marked 2 in the fig-2). From here onwards another set of five upward and three downward forms the second cycle of wave pattern. in this pattern W1 to W5 forms the new W3(Marked 3 in the fig-2) The corrective phase of three wave pattern forms here completing a a fourth wave ((Marked 4 in the fig-2) From the end of this correction phase begin the last fifth cycle which completes the total upper wave pattern.(three upper waves).From here onwards the corrective phase begins. 

In the correction phase also we see a five wave pattern. At the end of the first correction cycle (Marked a in the fig-2), starts the second correction waves. At the end of second correction wave (Marked b in the fig-2) the last correction waves begins to set in. the last point of this waves is marked c in the fig-These two correction patterns completes the entire Elliot Wave formation, (1), (2), (3), (4),(5), [Impulsive phase] and (a), (b), (c) [corrective phase].

The rules governing the Elliot wave pattern and Fibonacci numbers are interrelated. For traders who are familiar with Fibonacci numbers, the Elliot wave patterns are not too difficult to understand. But for other investors The Elliot wave patterns takes time to understand. This is because the formation of Elliot waves can get truncated at many intervals. This is a common occurrence which can confuse a person who is new to chart reading. The most important thing about Elliot wave is identifying the trend at an early stage. Catching it before it happens is another way of saying it. This is not a Holy Grail hunting exercise, but careful observation can reveal some hidden opportunity.

 

The Amibroker AFL that I have posted along with this article does incorporate Fibonacci levels too. This Amibroker AFL also gives us projected Lows and Highs with Pivot level. The chart pattern can be of good use if used on a weekly mode rather than daily mode. This Amibroker AFL also includes a standard deviation code. This is useful in studying a stocks retracement patterns. Like many Amibroker AFL this is also customizable according to the user’s convenience. In the properties window many settings have been provided to vary the background color, title selection which turns off the Fibonacci levels plotted on the screen, price style that can be adjusted to show candles, bar or dots. The period for which the standard deviation can also be altered, and many more.

I request the users to copy this Amibroker AFL to the Custom formula folder of Amibroker and observe it with your favorite stocks. Try to gain maximum exposure. Please do not be in a hurry to master this Elliot Wave theory overnight. I am sure many of you may get interested in Elliot wave theory. What I have posted here is a simple way of understanding Elliot wave patterns. Once you get the hang of it you can do more research on Elliot wave to master it.    

The AFL can be downloaded from here

Best of luck and happy trading