It was Ralph Nelson Elliot who first proposed a theory in 1920s widely known today as “Elliot Wave Theory” which states that stock market as thought to be completely incoherent in manner actually is not. It is actually a form of technical analysis which is used to analyse financial market cycles and predict market trends by identifying extremes in investor psychology, high and low prices.
He made this theory as an extension of Dow’s work stating that the patterns or waves(as he used to call them) which appear in the price charts are actually repetitive and not completely random.
As of today, no one(not even the world’s best super computers) have been able to recognize a pattern in the decimal digits of the Pi value i.e. 22/7. It is said that it is a unique number for which no specific repetitive pattern exists and is always calculated by approximation. Unlike in stock markets(according to him), there exits a specific pattern in the trends occurring on the price charts. The price moves up and down due to the optimism and pessimism of millions of people and their sentiments. This creates a swing in the price known as upward and downward swings which then creates a pattern which can be predicted.
According to Elliot Wave theory, the price action of the market can be accurately predicted.
In this model,the points 1,2,3,4,5 are in an uptrend and this wave is made up of impulses. These are making up a trend which is moving in the up direction and the corrections are noted by A,B,C.
If we draw an upward trendline joining the points 2,4 and extend it diagonally in the North east direction as well as by drawing an upward trendline joining the points 1,3,5 and extending it diagonally in the North east direction we can predict that whenever the trendline is breached downwards indicates that the market is making a correction.
He states that the waves generally has three distinct price movements. Two in the direction of the trend and one opposite to it. The one opposing is known as corrective wave. An impulse-wave formation, followed by a corrective wave, form an Elliott wave degree consisting of trends and counter trends.
Although the Elliot wave shown in the picture is bullish, the same applies for a bearish trend.
The empirical validity of the Elliott Wave Principle remains the subject of debate.
BY ABHIRAM DAPKE
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