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The Elliott wave theory is the basis of a technical analysis technique for predicting the behavior and market trends in the stock market, invented by Ralph Nelson Elliott in 1939. It is based on the belief that markets exhibit well-defined wave patterns that can be used to predict market direction: specifically that stock prices are governed by cycles which adhere to the Fibonacci sequence 0, 1, 1, 2, 3, 5, 8, 13, 21, etc.

It claims that the stock market, acting as a meter for mob or crowd psychology, displays many of the same geometric features as other organic structures. Proponents of the Elliott wave theory claim that the pattern is exhibited repeatedly in past market price patterns, and that the fractal nature of such patterns creates a repetition of them on varying levels of order and magnitude.

Criticism

The theory is far from universally accepted. Critics deride it as being too vague to be useful, since there is not always a clear definition of when a wave starts or ends, and prone to subjective revision. Some critics have gone so far as to call it a borderline fraud, useful only for selling information to naive investors.

One major complaint is that if the theory is true, widespread knowledge of its patterns would lead so many investors to "bet" with it that the patterns would be altered, rendering it useless. This is a criticism that can be, and is, levelled against any predictive method based on public, market-wide data. The efficient markets hypothesis states that no such method can yield positive average profits.

Specifics of the theory

According to the Elliott wave theory, markets move in a predetermined number of waves up and down. Specifically, markets move in five waves up and three waves down and price charts have a self-similar fractal geometry. This is true for bull markets. Waves 1, 3, and 5 are called impulse waves, and subdivide 1, 2, 3, 4, 5. Waves 2 and 4 are corrective waves, and subdivide a, b, c. In a bear market, the pattern is reversed, five waves down and three up.

References

"The Elliott Wave Principle" by Frost & Prechter. Published by New Classics Library P.O. Box 1618 Gainsville Georgia 30503.

See also

• Business cycle
• Grand supercycle
• The Wisdom of Crowds

External links

• Elliott Wave Theory - ChartSchool - StockCharts.com
• CyclePro Elliott Wave Rules and Guidelines - Updated 11/1/98

• Technical analysis