It has been well established by Ralph N. Elliott in his Elliott Wave Theory that price movements of a security can be predicted by observing and identifying a repetitive pattern of waves. The price movement consists of 5 waves in the direction of the main trend followed by 3 waves in the corrective trend. The duration of these waves can last for centuries (Grand Supercycle), decades (Supercycle), years (Cycle), months (Primary), weeks (Intermediate / Minor), days (Minute), hours (Minuette) and minutes (Sub-Minuette). The 5-3 pattern remains constant although the time span of each may vary.
Technical traders use this theory to identify breakouts for profitable investment opportunities. There are several web sites and books related to this theory; Wikipedia describes the principles in detail. Cyclpro has an exhaustive list of rules and guidelines which need to be observed during the Elliott Wave Analysis.
However, for those with limited resources of time and energy, there are few basic rules that need attention.
- Wave 2 cannot retrace beyond low of Wave 1; i.e. not more than 100%
- Wave 3 is never the shortest among impulse waves 1, 3 and 5. This means either Wave 1 could be the shortest or Wave 5 could be the shortest.
- Wave 4 cannot fall below high of Wave 1.
Using Fibonacci retracements of 38.2% and 61.8%, following relationships between waves can be identified.
Wave 2 = 61.8% of Wave 1
Wave 3 = 161.8% of Wave 1
Wave 4 = 38.2% of Wave 3
Wave 5 = 100% of Wave 1
The above values are approximate and have been found to occur frequently in well trending markets. It is not uncommon for Wave 2 to fall below 61.8%, there are cases in which Wave 2 has retraced only 38.2% of Wave 1. Similarly, Wave 3 has sometimes retraced even 261.8%.
So, what may happen in case these guidelines are violated?
The answer is simple. The move becomes “suspicious.” This is usually considered as a warning sign; a trend reversal may follow soon.
Let us now discuss the long term chart of Nifty.
In the above chart, it can be seen that:
- The long term bull market started in April 2003 when Nifty had a low of 920
- Wave 1 ended at 2015 during January 2004
- Wave 2 retraced 66% and ended during May 2004.
- Wave 3 retraced 227% of Wave 1 and ended during May 2006.
- Wave 4 retraced 47.4% of Wave 3 and ended during June 2006.
- Wave 5 retraced 343% of Wave 1 and ended during January 2008.
- Wave a retraced 75.5% of the entire movement from low of Wave 1 (920) to high of Wave 5 (6357) and ended during October 2008 with a low of 2253.
- Wave b has retraced 60.7% of Wave a when it touched 4744 in August 2009.
Cyclepro guidelines suggest that Wave b is likely to retrace 38.2%; the next most likely retracements are 50% and 61.8%. It also says that the time taken by Wave b is usually between 61.8% and 161.8% of the time taken by Wave a. Wave a lasted for 9 months; wave b is currently in its 11 th month.
Taking all these facts into account, we may come to the conclusion that Wave b may end anytime and Wave c is likely to start afterwards.
Nifty has not shown any kind of reversal signs so far in daily charts. The support trendline remains unpenetrated yet. We may see some more sideways movement in the near future. Nifty will face strong resistance around 4797.
Bullish stocks for short term:
CMP = Current Market Price BB = Bullish Breakout TT = Technical Target
- Binani Cement: CMP 63.55 BB on August 28 TT 83.85
- Gitanjali Gems: CMP 117.65 BB on August 25 TT 162.30
- ISMT Limited: CMP 37.55 BB on August 27 TT 56.40
- Omaxe: CMP 116.45 BB on August 28 TT 170
- Tata Sponge: CMP 222.40 BB on September 4 TT 265.80