Ralph Nelson Elliot was a successful accountant and financial advisor to a number of railroad companies. After the market crash of 1929, Elliot began to devise the formula that bears his name.
As a result of studying market chart patterns over several decades, Elliott came to the assumption that market behavior could be identified and measured through an 8-wave sequence that continually repeated itself. This pattern consisted of 5 waves that he named "impulsive", which were followed by a 3-wave "corrective" sequence. He labeled impulse waves 1 through 5, and he labeled corrective waves A through C.
The information that the elements of this pattern are as follows:
• Wave "1" signals the changing of market opinion from bear to bull. It is usually fueled by a rebound from extremely low prices. It is the shortest of the rising impulse waves.
• Wave "2" marks the loss of most of the gains from wave "1". The loss occurs because market participants have used the rebound to sell their losing stocks at slightly better prices.
• Wave "3" is the break out from the reversal patterns completed by the first two waves. This is the beginning of a new trend. This is the longest and strongest of the impulse waves.
• Wave "4" is the consolidation phase of this new rebound.
• Wave "5" is the final stage of the second rebound and it often shows a divergence with technical indicators like the Relative Strength Index.
• Wave "A" looks like a correction to the rebound. This correction, however, is actually a new dominant market direction.
• Wave "B" is the bear market correction that gives sellers a second chance to sell.
• Wave "C" usually breaks through support levels and the peak of wave "3". The technical indicators in this wave confirm that the original rebound is over.
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