Wednesday, January 23, 2013

An Elliott Wave Analysis of the Markets

Some of my readers, sure, would be waiting for this post. I can say this because I had done an Elliott Wave Analysis of the markets once before and that post was a massive hit with my readers. A similar attempt is being made now on the current chart of Nifty. But a disclaimer goes with this post and that is that I'm not an expert on the Elliott Wave Principle. I have a little knowledge about it and I'm taking a risk of trying and numbering the waves with this little knowledge, a process which can even prove the best in the field wrong (at times). I would also advise my readers not to give too much of weightage to this post as the market may prove me wrong. But it still might turn out to be useful to read, in case my numbering turns out to be correct.


But before I actually begin the analysis, I must share with you what the Elliott Wave Principle says. A method developed by Mr. RN Elliott, it says that the market moves in waves, 5 waves in the direction of the trend (called impulse waves) and in 3 waves against the trend (called corrective waves). The impulse waves are numbered (1, 2, 3, 4 and 5) and the corrective waves are lettered (A, B and C). The rules of the waves are as follows:
  1. Wave 2 never retraces more than 100% of wave 1. In other words, the end of wave 2 will never breach the beginning of wave 1.
  2. Wave 3 can never be the shortest of the 5 impulse waves. It is usually the longest, but never the shortest.
  3. Wave 4 will never enter the price territory of wave 1. 
The other guidelines of the Elliott Wave Principle are as follows:
  1. Waves are formed in all time frames and different time frames are given different names and are called degrees. 
  2. Corrective waves can turn out to be complex in their formation and could take the form of zigzags, flats and triangles.
  3. Waves 2 and 4 tend to alternate in their formation i.e. if one wave is a zigzag the other will tend to be a sharp move.
  4. Out of the three waves, 1, 3 and 5, can be an extended wave.
  5. Wave 5 can turn out to be truncated too. This means that the end of wave 5 may not cross the end of wave 3, at times.
  6. Sometimes the end of wave B may cross the end of wave 5, in which case, the low or high formed by the end of wave 5 is called the orthodox bottom or orthodox top.
  7. Corrective waves of corrective waves can be very complex.

    Keeping these rules and guidelines in mind, let us start with the numbering. 




Attached above is the monthly chart of Nifty. According to the above chart, wave I of the cycle degree started from 800 and ended at 1818, a move of 1018 points. Wave II made a low of 850 and respected the rule that the end of wave II never breaches the beginning of wave I. Wave III, as can be seen is an extended wave. Within wave III, the 5 impulse waves of the primary degree have also been marked as 1, 2, 3, 4 and 5. Wave 3 of the primary degree also seems to be an extended wave and within that, waves of the intermediate degree have been marked as i, ii, iii, iv and v. As can be seen from this chart wave iii of 3 of III is also an extended wave. Wave IV has corrected a major portion of wave III and has made a low of 2252 but has respected the rule that it will not enter the price territory of wave I, the high of which was 1818. As can be seen waves IV, 4 and iv have all respected that rule. Wave IV normally retraces about 38.2% of wave III but in this case, it has retraced almost 75% of wave III. And in cases where wave IV corrects a major portion of wave III, wave V usually turns out to be truncated. And that's what has happened in this case. Wave V ended at a high of 6338, just short of the high of wave III (6357). Then start the corrective waves of the cycle degrees, A, B and C. Wave A retraced from the top of wave V (6338) to 4531. And we currently seem to be in wave B of the cycle degree. 




Let's look at waves A and B of the cycle degree in a little more detail by using the weekly chart of Nifty, as attached above. Also shown is some part of wave V of the cycle degree. As we know, wave V is a motive wave in the impulse wave of the cycle degree and hence must follow the 5 numbering system. In the charts waves 2 to 5 of the primary degree of wave V of the cycle degree have been shown and numbered keeping all rules and guidelines of the Elliott Wave Principle in mind. If you look at wave 4 of the primary degree of wave V of the cycle degree, it shows a pattern of a, b and c and rightly so because wave 4 is a corrective wave of the impulse wave of the next higher degree. Here you can see that the top of wave b has crossed the top of wave 3 and there is nothing wrong with that. That can happen and is within the rules and guidelines laid down by "Elliotters". Such a pattern is also called a flat. Coming to wave A of the cycle degree, now, we know that wave A is a corrective wave of the cycle degree but is an impulse wave of the primary degree and hence must follow a numbering system rather than a lettering system. Hence the five impulse waves of the primary degree of the corrective wave A of the cycle degree have been numbered 1, 2, 3, 4 and 5. Seeming to be a little repetitive now, but wave 3 of the primary degree also seems to be an extended wave and the 5 waves inside that of the lower (intermediate) degree have been numbered i, ii, iii, iv and v. As I said earlier, we currently seem to be in corrective wave B of the cycle degree and since wave B is a corrective wave of the primary degree, it must be numbered as a, b and c, which have been so numbered on the chart and we currently seem to be in wave c of the primary degree of wave B of the cycle degree. 




Now, let's try and analyse the wave B in a little more detail by looking at the daily chart of Nifty attached above. Now, as I told you earlier, the wave formations in a corrective wave tend to be a little more complex than usual. And since wave B is a corrective wave of a corrective wave of larger degree, it is complex in its formation. And since it's a corrective wave, it will be lettered a, b and c. And since wave c of the primary degree happens to be the motive wave for wave B of the cycle degree, its intermediate waves would be numbered i, ii, iii, iv and v. And wave v of the intermediate degree happens to be ending in a leading diagonal.

The Analysis:

As far as the analysis goes, if our numbering is correct (and that is a VERY BIG IF), then wave B may have already ended or may soon be ending. A cross of the high of wave V of the cycle degree (6338) cannot be ruled out, though it seems highly unlikely. Since the length of wave B is almost as much the length of wave A, wave C is also more likely to be the same or maybe more. The length of wave A happens to be 1807 points(6338-4531). If we assume that wave B has already ended then we may be looking at a drop of 1800 points from here and that would bring us to a target of 4300 (6100-1800). Unbelievable??? Maybe, but quite possible IF our numbering is correct. Though, fundamentally I see no reason why it should drop that much. The market at the moment is looking weak and I do see a drop of a few hundred points but there may be events which are not known to us right now or which will emerge later which may take us down to those levels. Who knows? Not me, not you. Only God, or shall I say, the waves???

Since I do not claim to be an authority on Elliott Waves, I suggest you to just use this post as a reference but your actions should not be made on the knowledge imparted in this post. However, I would like to be corrected on the numbering and if any knowledgeable people on the Elliott Wave Principle pass by, I would deeply appreciate your comments on this post for my benefit and for the benefit of my readers.

Update: A review of this analysis was done a few days later and you can read it by clicking here


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Happy Investing!!!