Elliot Wave Oscillator

Overview

Elliot Wave Theory is named after Ralph Nelson Elliot. It was inspired by the Dow Theory and by observations found throughout nature; Fibonacci numbers provide the mathematical foundation. Each of the cycles defined by Elliot are compromised of a total wave count that falls within the Fibonacci number sequence. From this information, Elliot concluded that the movements of the financial markets could be predicted by identifying this naturally repetitive series of waves.

After Elliot's passing, much research and advancement was done on Elliot Wave Theory during the 1950's - 1970's by Hamilton Bolton, Robert Prechter, and A.J. Frost. However, the basic concepts of Elliot Wave Theory are outlined below:

* Action is followed by reaction

* The basic Elliot Wave pattern consists of 8 waves which are often labeled as 1, 2, 3, 4, 5, a, b, c

* There are 5 waves in the direction of the main trend followed by 3 corrective waves (a.k.a. "5-3" count); Waves 1, 3, and 5 are called "impulse" waves while waves 2 and 4 are called "corrective" waves; Waves 1-5 can be either up or down; Waves a, b, and c correct the main trend and always travel in the oppisite direction of waves 1 - 5.

* A 5-3 count completes a cycle; this completed count then becomes 2 subdivisions of the next higher 5-3 wave; The cycles are as follows: The largest wave count is called the Grand Supercycle which consists of Supercycles which consist of Cycles. This process continues into Primary, Intermediate, Minute, Minuette, and Sub-minuette wave cycles.

* The underlying 5-3 pattern remains constant, but the time frame required to complete the pattern may vary

However, there is an inherent weakness of the Elliott Wave Theory - its predictive nature is very dependent on an accurate wave count. Determining where one wave starts and another wave ends can be extremely subjective.

Enter the Elliot Oscillator indicator.

In an effort to keep better track of the complicated and very subjective Elliot Wave counts the Elliot Oscillator measures the Rate of change of one wave compared to the Rate of Change of another wave.

The Elliot Oscillator is simply the difference of a 5-periods simple moving average and a 34-periods simple moving average displayed as a histogram that oscillates above/below a zero line.

The most important Elliot Oscillator concepts are:

* The highest/lowest value of the oscillator identifies a potential bullish/bearish wave 3

* Wave 4 almost always pulls back to or crosses over the zero line in the oppisite direction of the main trend

* Wave 5 usually makes a new high or low price for the swing, but often diverges from the Elliot Oscillator; if Wave 5 makes a new high/low price, but doesn't diverge from the indicator, alternate analysis may conclude that the wave was not wave 5, but instead an extended wave 3.

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