Module 9 - Elliott Waves and Cycles of Time

The Responsible Trader Lessons
The Responsible Trader’s - POV
Module 9 – Elliott Waves and Cycles of Time

The Responsible Trader’s - POV
• The Responsible Trader's POV (Point of View).
• These are my notes, my own additional research and studies on the
Topic that I posted, and my personal observations and opinions that I
am sharing to further enhance our knowledge and understanding.
• Some of these were previously posted on “The Responsible Trader”
thread, Stock Market Pilipinas (www.stockmarketpilipinas.com). This
is the latest version of previous posts I made.
• Some of these plus further explanations and discussions will be
appearing in my forthcoming book “The Responsible Trader.”

1. Size – the larger and more solid the candles, the higher the sentiment.
Increasing size of green candles
show bullish sentiment.
Increasing size of red candles
show bearish sentiment.
Charts courtesy of Amibroker Charting Software

2. Shape – The shape of the candlestick or pattern determines the type of pattern
generated, the possible trading signal and the potential direction of the trend.
Bullish engulfing – a large green candle
engulfing a small red candle in a downtrend
Bearish engulfing – a large red candle
engulfing a small green candle in an uptrend

Single Candle Patterns – the Hammer and the Hanging Man – both have the same shape but their names
vary depending on their location.
Hammer in a Downtrend, a Reversal Signal A Hanging Man in an Uptrend, a Reversal Signal
3. Location – determines what the Pattern is called

Ideally, in an uptrend prices should move along a straight line in an upward direction through
time.
The stock market does not work in ideal conditions. I call deviations from the straight line
movements, distortions.
For every distortion there is always an equal and opposite correction. In trading, we also call
corrections as Retracements.

Correction in the Stock Market comes in two Forms. The First is Correction in Price. The
deviation from the straight line shown by the price movement upward is immediately corrected
by a movement back towards the straight line.

The Second is Correction in Time. The deviation from the straight line shown by the price
movement upward is slowly corrected by a sideways movement back towards the straight line.

If we continue this pattern of upward price movements and correction, we are going to
have the figure below. Do you recognize the pattern?
You are right. This is the basic Elliott Wave Pattern and I have color coded them here.
This called the 5-3 Patttern.

The first 5-wave pattern (1,2,3,4,5) are called impulse waves. The last 3-wave pattern
(a,b,c) are called corrective waves.
The first 5 wave Patterns (1,2,3,4, and 5) are Trend Waves. Waves 2 and 4 are corrections
within the Trend.
The corrective Waves a,b, and c are Counter-Trend Waves.

Whenever I discuss Elliott Waves, there are always two names that come to my mind. The
first is Ralph Nelson Elliott.
Ralph Nelson Elliott - American accountant and author who developed the Wave Principle
a form of technical analysis that identifies trends in the financial markets.

Wave 1 – Initial Take Off – Mostly professionals, No amateurs
Wave 2 – Profit Taking After Initial Take Off – Mostly professionals, No amateurs
Wave 3 – The Strong Rally – Mostly professionals and some amateurs

Wave 4 – Profit Taking and Buying on Dips. Professionals taking profit and amateurs
buying on dips
Wave 5 - Irrational Exuberance. Few professionals and mostly amateurs
Wave a,b,c – Professionals shorting the market, Mostly amateurs cutting losses.

As Elliott observed, wave patterns form larger and smaller versions of themselves.
This repetition in form means that price activity is fractal.

A Grand Supercycle is made up of Supercycle waves which is made up of Cycle waves which is
made up Primary waves, which is made up of Intermediate waves which is made up of Minor
waves which is made up of Minute waves which is made up of Minuette waves which is made up
of Sub-Minuette waves.

The second name that comes to my mind is Leonardo Pisano for the Fibonacci Retracements
Leonardo Pisano, better known by his nickname Fibonacci, was a great Italian
mathematician who first observed certain ratios of a number series that are regarded as
describing the natural proportions of things in the universe, including price data.

The ratios arise from the following
number series: 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144 ……
This series of numbers is derived by starting with 1 followed by 2 and then
adding 1 + 2 to get 3, the third number. Then, adding 2 + 3 to get 5, the fourth
number, and so on.
The Fibonacci ratios are derived by dividing any number in the series by the
next higher number, after 3 the ratio is always 0.625. After 89, it is always
0.618. If you divide any Fibonacci number by the preceding number, after 2 the
number is always 1.6 and after 144 the number is always 1.618. These ratios
are referred to as the “golden mean.” Additional ratios were then derived to
create ratio sets as follows:

When R.N. Elliott wrote about the Wave Principle, he stated that the Fibonacci sequence was its
mathematical basis. Elliott waves both impulsive and corrective adhere to specific Fibonacci
proportions.
Common objective for Wave 3 is 1.618. Wave 5 is equal to Wave 1, Wave 2 is .618 of Wave 1 and
Wave 4 is .382 of Wave 3.

3 Cardinal Rules of the Elliott Wave Theory
Rule Number 1: Wave 2 can never retrace more than 100% of Wave 1.
Rule Number 2: Wave 4 may never end in the price territory of Wave 1
Rule Number 3: Out of the three impulse waves 1,3 and 5, wave 3 can never be the shortest.
A violation of one or more of these rules implies that the operative wave count is incorrect.

Summary:
1. Elliott Waves are fractals. Each wave can be split into parts, each of which is a very
similar copy of the whole. Mathematicians like to call this property "self-similarity".
2. A trending market moves in a 5-3 wave pattern. The first 5-wave pattern are called
impulse waves. These are also called Trend Waves.
The second 3-wave pattern are called corrective waves. Letters are used instead of
numbers to track the correction. These are also called Counter Trend Waves.
3. There are 3 Rules to be observed when using the Elliott Wave theory
Rule Number 1: Wave 2 can never retrace more than 100% of Wave 1.
Rule Number 2: Wave 4 may never end in the price territory of Wave 1
Rule Number 3: Out of the three impulse waves 1,3 and 5, wave 3 can never be the
shortest.

For your information, in connection with my Advocacy, Responsible Trading, I have established the
following in order to reach out to you more effectively and serve you better.
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Module 9 - Elliott Waves and Cycles of Time

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