Technical Analysis: Eliott Waves

 Technical analysis (TA) is a set of statistical methods for understanding stock movements. Unlike fundamental analysis, technical analysis does not use company-specific information. The main idea is that this information is already reflected in the price. Beware, Forex and derivatives traders often use the term TA, but what they mean are technical patterns. Patterns are actually the results of statistical analysis and the main point is that it is possible to see a given pattern by looking at a chart. This is not always easy to put into practice.

One of the technical patterns I like is the Elliott waves. These patterns are based on the belief in a behavioral investment model. Based on the tendency of investors to follow each other in response to market disturbances, like in the sea, the waves appear in series. 

The first wave section is an impulse, which follows a more general trend (the current). Afterwards, the second section is a correction that can go up to 100% of the first section. Sections 1,3,5 represent bullish impulses. Sections 2 and 4 are corrections. Finally, sections A,B,C correct the total rise of sections 1-5. 

Figure 1. Eliott waves. Source: Investopedia

You can see that the 1-C waves look like the crest of a wave - this is not a coincidence. Wave theory is fractal, which means that each wave is made of smaller waves.

Figure 2. Fractal waves. Source: Wikipedia

Like almost all other patterns, Eliott waves can predict market movements more or less well. Perhaps better than others, unfortunately, it is very difficult to distinguish the beginning of a wave from a corrective movement.