March 15, 2012 in Elliott Wave Principle
What is Elliott Wave
I’m planning to write short articles on Elliott Wave Principle as an on-going project. These articles would be based mainly on general Elliott Wave as well as my experience and findings in applying it. Let me start by giving an overview of the history behind Elliott Wave Principle.
Elliott Wave Theory or better known as Elliott Wave Principle is a study of movement in the stock market by using fractals. Elliott Wave is based on Fibonacci sequence which occurs naturally in many living and dynamic aspect of nature. A simple example is the growth of sunflower seeds. The rate of the growth of the sunflower seeds can be modelled by using Fibonacci sequence.
Fibonacci sequence was found by a mathematician in Italy by the name of Leonardo of Pisa in the year 1202. He experimented with rabbits to find the rate of increase in the rabbit population. What he discovered was that the growth of the rabbit population occurred in a sequence of numbers of 0, 1, 1, 2, 3, 5, 8, 13, … This sequence later became known as the Fibonacci sequence. Notice that when any two adjacent numbers in the sequence is added, the result will equal to the following number. For example, 1+2 equals 3 and 2+3 equals 5.
Another important finding from the Fibonacci sequence is that the ratio between any two adjacent numbers yields the magic Fibonacci number 1.618 or 0.318. For example, when 13 is divided by 8, it gives 1.625 (this number will approach 1.618 as the numbers in the Fibonacci sequence gets larger). When we take 1 and divide that by 1.618, we get 0.618.
In the 1930s, Ralph Nelson Elliott, an accountant, discovered that stock markets actually do behave in waves which are fractals and are predictable. He studied the stock market using the magic Fibonacci number of 1.618 and discovered that the stock market generally advances based on a multiple of 1.618 or retraces the previous move by 0.618 or by 0.382 (1-0.618). That was how Elliott Wave Principle was discovered.
In those days, there were no computers neither were there any charting software. Every analysis had to be plotted manually using pencil and a paper. This was probably one of the reasons why Elliott Wave Theory was not adopted early on although it can be a great companion to any investor. Robert Prechter found the writings of R.N.Elliott and found it intriguing. He was the one who brought Elliott Wave Principle to the investment community and is currently the foremost expert in Elliott Wave Principle. His book titled Elliott Wave Principle is a must read for anyone who is serious about learning Elliott Wave Principle.
In the next article, I’m planning to touch on how I apply Elliott Wave Principle to identify the waves. If you would like me to touch on a specific topic, do let me know and I’ll try to cover that as well.