Spread Betting and Elliott Waves
The principles behind modern Elliott Wave theory had their origins in the 1930s, when they were discovered by Ralph Elliott. He, in turn, had been inspired by a trader by the name of Charles Dow and several others.
The most referred to textbook about Elliott Wave analysis for the modern trader is undoubtedly ‘The Elliott Wave Principle: Key to Market Behavior’ by Robert Prechter and A.J. Frost.
Prechter rose to fame when he used Elliott waves to correctly predict the stock market crash of 1987. 19th October 1987 is known in the annals of history as ‘Black Monday’, since stock market indices saw an unprecedented drop of 23% in a single day.
Unfortunately, Prechter had much less success, towards the end of the 20th century, in correctly predicting market movements using his understanding of Elliott Wave theory.
Spread Betting and Elliott Waves
Elliott was, in the first place, an astute observer of crowd behaviour. He noticed that a period of mass optimism was nearly always followed by a period of darkness or pessimism.
By studying this behaviour he was able to determine certain patterns, which he was later able to apply to the prices of shares.
The basic Elliott wave structure can be seen in the above figure. It consists of five waves, three of which are fairly large and follow the main trend (Waves 1, 3 and 5) and two of which are smaller, countertrend movements, (Waves 2 and 4).
The two countertrend waves are vital for the overall directional movement to take place.
Although there are a number of different variations of Elliott waves, they all fit into the basic structure shown above. Theoretically the spread betting markets are, at any given moment, somewhere on this five-wave Elliott chart.
Spread Betting and Elliott Wave Theory
The basic Elliott waves pattern repeat themselves over time. Elliott noticed that after the initial five-wave pattern, three of which follow the same direction as the main trend, there is normally a smaller three-wave movement going against the main trend, which is upwards in this case.
An example of this can be seen in the figure below. Waves one, three and five follow the main upward trend, while waves two and four are merely corrections.
After wave five, we see a 'three-wave abc' corrective pattern, with waves a and c heading down and b being a smaller corrective upward wave.
Spread Betting and Elliott Waves - Continuing the Trend
The moment of truth arrives after wave c of the first pattern.
If this abc wave pattern is merely a correction during a longer term bull run, we will see the start of a new five-wave pattern heading upwards again.
This is what happens in the figure below:
After the red line, at the end of the abc corrective pattern, we see that the market resumes the previous up-trend with a new series of five Elliot waves. The second series also has three increasing waves (waves one, three and five) and three smaller, corrective waves, (two and four).
Eventually we get another three-wave abc corrective pattern, after which we hope the market will resume its upward trend.
Spread Betting and Elliott Waves - Reversing the Trend
If, on the other hand, the abc pattern was no mere correction, but the start of a major downtrend, the market will not recover after wave c, but we will rather see something like the following:
The thick red line in the figure above corresponds to the end of the original abc wave pattern, which we initially hoped to be a corrective wave.
What happens after this shows that this was in fact the beginning of a major downtrend.
Spread Betting and Elliott Waves - Long Term Strategy
The problems that the world’s foremost Elliott Wave expert, Robert Prechter, had with correctly applying Elliott Wave analysis during the latter part of the 20th century serve to remind us that it is not as easy as it looks.
Theoretically, smaller wave patterns like the ones above, form part of bigger, long-term wave patterns. Whether we see a continuation of the trend or a reversal, as seen in the above examples, would therefore depend on how many smaller five-wave patterns we have already had in the direction of the longer-term trend.
The longer-term wave patterns should follow the same pattern as the basic form. Any major up-trend should therefore consist of three upward wave patterns, after which we will see a reversal. This can be seen in the figure below.
For the first two movements, the market continued rising after the abc wave corrective pattern, as we saw in Continuing the Trend example.
However, on the third movement, we had a major turn in the market and we saw the same scenario we had in the Reversing the Trend example; the market started moving lower.
Spread Betting and Elliott Waves
Elliott Wave analysis will usually deliver the best results when used in combination with one or more other technical indicators, such as Fibonacci analysis, as part of a more complete technical analysis.
It takes years of practice to become an experienced Elliott Wave analyst and, as shown by Robert Prechter, even this does not guarantee success.
For a more in-depth look at Elliott Waves also see our feature, Elliott Wave Trading Analysis.
Technical Analysis Theory
For more articles looking at technical analysis see:
For a comprehensive list of technical trading articles looking at the financial spread betting markets also see Technical Trading.
Daily Technical Analysis
For the most up-to-date daily technical analysis also see:
Good luck and happy trading
Shai Heffetz, InterTrader
(Original article written 20 January 2012).
Spread betting carries a high level of risk and you can lose more than your initial deposit, so you should ensure spread betting meets your investment objectives.
The contents of this report are for information purposes only. It is not intended as a recommendation to trade. Neither InterTrader nor CleanFinancial.com accept any responsibility for any use that may be made of the above or for the correctness or accuracy of the information provided.
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'Spread Betting and Elliott Waves' edited by DB, updated 13-May-13
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