elliott wave theory

The Elliott wave theory is the basis of a technical analysis technique for predicting the behavior of the stock market, invented by R. N. Elliott in 1939. It is based on the belief that markets exhibit well-defined wave patterns that can be used to predict market direction. The Elliott wave theory hypothesizes that stock prices are governed by cycles which adhere to the Fibonacci sequence 0, 1, 1, 2, 3, 5, 8, 13, 21, .... 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 corrections, and subdivide a, b, c. In a bear market, the pattern is reversed, five waves down and three up.

Adherents

Well-known adherents include Robert R. Prechter, Jr. of Elliott Wave International

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. 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 levelled against any predictive method based on public, market-wide data.

Reference

"The Elliott Wave Principle" by Frost & Prechter. Published by New Classics Library P.O. Box 1618 Gainsville Georgia 30503. Co-author Robert Prechter publishes a monthly newsletter called "The Elliott Wave Theorist".