lecture 10: Elliott Wave Theory, Fibonacci, and Gann

Question 1

who discovered the Fibonacci Sequence

Answer 1

Leonardo Pisano a.k.a “Fibonacci” of Pisa, Italy

Question 2

what is the fibonnaci sequence

Answer 2

1,1,2,3,5,8,13,21,34,55,89,144 gives us the Fibonacci sequence

Question 3

who developped the EWT (Elliott Wave Theory)

Answer 3

Ralph N. Elliott

popularized by Robert Prechter

Question 4

EWT (Elliott Wave Theory)

Answer 4

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”

Question 5

3 types of corrective waves

Answer 5

Zig zags

Flats

Triangles

Question 6

Zig zags correciton

Answer 6

A-B-C

A & C impulse, B corrective

Question 7

Flat correction

Answer 7

A-B-C moves sideways with overlapping sub waves

Question 8

triangles correction

Answer 8

Like triangle patterns with five waves A-B-C-D-E

Question 9

EWT Basic rules (that cannot be broken and must always hold)

Answer 9

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

Question 10

EWT Guidelines (not always expected)

Answer 10

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.”

Question 11

Using EWT

Answer 11

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

Question 12

Five wave pattern (dominant trend)

Wave 1

Answer 12

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.

Question 13

Five wave pattern (dominant trend)

Wave 2

Answer 13

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.

Question 14

Five wave pattern (dominant trend)

Wave 3

Answer 14

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

Question 15

Five wave pattern (dominant trend)

Wave 4

Answer 15

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

Question 16

Five wave pattern (dominant trend)

Wave 5

Answer 16

Wave five is the final leg in the direction of the dominant trend.

The news is almost universally positive and everyone is bullish.

Unfortunately, this is when many average investors finally buy in, right before the top.

Volume is lower in wave five than in wave three, and many momentum indicators start to show divergences (prices reach a new high, the indicator does not reach a new peak).

At the end of a major bull market, bears may very well be ridiculed (recall how forecasts for a top in the stock market

Question 17

Three wave pattern (corrective trend)

Wave A

Answer 17

Corrections are typically harder to identify than impulse moves.

In wave A of a bear market, the fundamental news is usually still positive.

Most analysts see the drop as a correction in a still-active bull market.

Some technical indicators that accompany wave A include increased volume, rising implied volatility in the options markets and possibly a turn higher in open interest in related futures markets.

Question 18

Three wave pattern (corrective trend)

Wave B

Answer 18

Prices reverse higher, which many see as a resumption of the now long-gone bull market.

Those familiar with classical technical analysis may see the peak as the right shoulder of a head and shoulders reversal pattern.

The volume during wave B should be lower than in wave A.

By this point, fundamentals are probably no longer improving, but they most likely have not yet turned negative.

Question 19

Three wave pattern (corrective trend)

Wave C

Answer 19

Prices move impulsively lower in five waves.

Volume picks up, and by the third leg of wave C, almost everyone realizes that a bear market is firmly entrenched.

Wave C is typically at least as large as wave A and often extends to 1.618 times wave A or beyond.