Info

AlgoChirp

Oct 05, 2024

Why AlgoChirp?
AlgoChirp site segments
AlgoChirp sauce
Elliott Wave rules & guidelines
Elliott Wave theory & Case studies

1. Why AlgoChirp?

The ultimate goal for Investors/Traders is to predict future Stock price movements, something millions attempt daily using various tools.
Many are drawn to simple indicators like RSI, MACD, and others. While effective, these indicators are now widely used in Trading Algos, which can react much faster than the average Joe.
Market makers have built these indicators into their Algos, leading to patterns where stop-losses get triggered just before the price moves in the anticipated direction.
Elliott Wave (EW) Theory, based on the principles of Wave Theory, is a time-tested forecasting tool offering a unique perspective.
Unlike typical indicators, EW is probabilistic and requires specific wave-counting applications, making it harder to incorporate into Algos.
EW reflects collective market psychology, enabling it to anticipate major downturns and rallies well in advance, such as the Dot-com crash, the Global Financial Crisis, COVID downturns, and subsequent market surges.
However, mastering EW analysis can be complex. This is where AlgoChirp offers support. AlgoChirp analyzes stock patterns, providing insights into likely future behavior based on Elliott Wave analysis.
Learn to apply Elliott Waves in your own analysis and validate your wave counts by comparing them with AlgoChirp’s expert insights.

2. AlgoChirp site segments

3. AlgoChirp Sauce

We at AlgoChirp analyse stock price charts using Elliott Wave Theory. This theory has several rules & guidelines, and we use those to assess price movement for stocks and Indices. In our charts, we often call out the most important rules & guidelines that influence our analysis.

Elliott Wave theory is somewhat subjective, as it requires the analyst to count the waves, and two analysts can sometimes have different counts and hence different viewpoints. Having analyzed waves using Elliott Waves for the past decade, AlgoChirp strongly believes that the counts hold much better on larger timeframes. Wave counts done at shorter timeframes are often prone to more false alarms. Due to this, all analyses, on this site, are done on monthly, weekly, or daily timeframes. AlgoChirp analysts also look at charts on 4H, 2H, and 1H timeframes, but this is done to seek confirmations on the overall trends at longer timeframes.

Implication: Readers should give time for the wave count to develop. AlgoChirp charts are not very relevant for intraday trades but are super powerful for trades that span a few weeks.

4. Rules & Guidelines - Elliott Wave

Over the years, thanks to intense work by EW analysts, the EW theory has evolved. Today, there are several different interpretations of Elliott Wave and Analysts use them in different fashions. We at AlgoChirp use the following rules & regulations to inform our analysis.

Rules (Can not violate)

ER1: Wave 2 cannot retrace more than 100% of Wave 1

ER2: Wave 3 can never be the shortest among Waves 1, 3, and 5

ER3: Wave 4 cannot overlap the price territory of Wave 1, unless it is a Triangle or Diagonal pattern.

Guidelines (Influence confidence level)

EG1: Wave 3 is often the longest and strongest

EG2: Wave 2 typically retraces 50%, 61.8%, or 78.6% of Wave 1

EG3: Wave 4 usually retraces 23.6% or 38.2% of Wave 3

EG4: Wave 5 often exhibits weaker momentum compared to Wave 3

EG5: Alternation Principle - If Wave 2 is sharp, Wave 4 is likely to be flat or more complex and vice versa

EG6: Wave 1, 3, and 5 move in the direction of the trend (impulsive), while Waves 2 and 4 are corrective

EG7: Fibonacci relationships often exist between wave lengths: Price levels and retracements often respect Fibonacci ratios like 38.2%, 50%, 61.8%, 100%, or 161.8%.

EG8: Corrective waves often find support near the Wave 4 termination of a previous degree

EG9: In a flat ABC correction, A and C often terminate very close to each other

EG10: As part of an expanded ABC correction, Wave B can go to a maximum of 1.618% of Wave A, typically doesn’t go beyond 1.23% of Wave A.

EG11: Sometimes Wave 5 end with contracting triangles. If this happens then one should watch for a throw over as a bull trap.

EG12: Wave 5 targets

Wave 5 = Wave 1, if Wave 3 was extended.
Wave 5 = 1.6 times Wave 4
Wave 5 = 0.6 times Wave 3
Wave 5 = 2.6 times Wave 4
Wave 5 = 1.6 times (Start of Wave 1 to Top of Wave 3) in an extended Wave 5

EG13: If start of Wave 1 to the top of Wave 5 is 1, then Wave 4 bottom is either 0.618 from the top or from the bottom.

EG14: Wave C targets

Wave C = Wave A
Wave C = 1.6 of Wave A
Wave W = Wave Y
zigzag = 0.6 retracement of the previous wave
flat = 0.38 retracement of the previous wave

EG15: If the initial movement against the larger trend is a five-wave pattern, it is not the end of the correction, but only part of it.

5. What are Elliott Waves?

Source - Investopedia/Elliott Waves

Overview
- The Elliott Wave Principle posits that social or crowd behaviour tends to move in trends and reversals, which form recognisable patterns.
- These patterns are apparent in stock market price data, where prices do not move randomly but instead follow a structured design.
- Elliott identified 13 different wave patterns that recur in price movements. These waves are repetitive in form, although their size and timing vary.
Basic Structure of Elliott Waves
- Five-Wave Structure (Motive Waves): Market progress generally takes the form of five waves—three waves moving in the direction of the larger trend (labelled 1, 3, and 5), separated by two waves moving against the trend (labelled 2 and 4). This five-wave structure forms the core of the market’s overall direction and is referred to as a motive wave.
- Three-Wave Structure (Corrective Waves): After the five-wave motive structure, a market correction usually follows in the form of three waves—labelled A, B, and C. These waves move in the opposite direction to the motive waves and are referred to as corrective waves.
- The Complete Cycle: A full market cycle consists of five waves up (the motive phase) and three waves down (the corrective phase), forming an eight-wave cycle. Once one cycle is complete, it is followed by a new cycle, repeating the process.

Why do we use Elliott Waves?

The Elliott Wave Principle provides an analytical framework for understanding how mass psychology influences the stock market. Rather than viewing markets as random, Elliott's work suggests that the collective mood of market participants follows a structured and repetitive path. This insight helps investors identify potential turning points in the market and assess the probabilities of future market trends.

By understanding the wave structure and the role of mass psychology, investors can align their strategies with the likely emotional state of the market, whether it be overly optimistic or pessimistic.

Elliott Wave Principle and social behaviour: Elliott recognised that stock market prices move not only due to external factors like earnings and economic data but also due to shifts in collective human psychology. These psychological shifts create patterns of optimism and pessimism that manifest as waves. Elliott isolated 13 specific patterns, or waves, that recur in stock market price data and reflect these behavioural changes.
Progress and setbacks: a reflection of mass mood: The five-wave impulse (where waves 1, 3, and 5 represent movement with the trend, and waves 2 and 4 are corrective) reflects collective optimism that propels the market higher in stages. The three-wave corrective structure (A-B-C) represents collective pessimism or the aftermath of over-exuberance, resulting in a market pullback.
- According to Elliott, this cyclical pattern of progress and setback follows a "three steps forward, two steps back" rhythm. Periods of rising stock prices are driven by a generally optimistic outlook, while corrections or declines are caused by a prevailing sense of pessimism.
Per Elliott, the same psychological patterns play out across different timeframes. Small, short-term fluctuations in market prices are reflective of the same behavioural principles that drive long-term market movements. Thus, mass psychology operates in cycles at various degrees, from minor day-to-day changes to major market trends spanning years.
Herd mentality and extremes of emotion: Market participants tend to follow the crowd, which leads to exaggerated movements in the market. When the crowd is excessively optimistic, markets rise in impulsive waves. However, this optimism is often unsustainable, leading to corrective waves as reality sets in and prices reverse.
- The final stages of impulsive waves, such as Wave 5, are often characterised by extreme optimism and speculative behaviour, while corrective waves are driven by extreme pessimism, as reflected in the sharp declines of Wave C.
Predicting Market behaviour through mood changes: Elliott believed that his wave patterns were a reflection of natural human behaviour. This allowed the patterns to be used predictively, as they could give insight into where the market might be heading based on its current position within a wave cycle.
- Mass psychology shifts between optimism and pessimism can be anticipated using the Elliott Wave structure. The start of a new impulsive wave often marks a return of positive sentiment, while the corrective waves signal increasing uncertainty and fear in the market.

Significance of (5 +3) waves

First waves: These follow Bear markets or substantial drops in stock prices. These are either part of a "basing" process, heavily corrected by the second wave, or rise dynamically from large bases or extreme compression. They often show subtle signs of market improvement, such as increased volume and breadth, despite prevalent bearish sentiment.
Second waves: These waves often retrace most of the gains from the first wave, leading investors to believe the bear market is returning. There is a significant drop in option premiums due to heightened fear, although indicators such as low volume suggest selling pressure is drying up.
Third waves: These are the most powerful and unmistakable waves, marked by strong trends, increased confidence, high volume, and significant price movement. They often lead to breakouts and large gains across multiple timeframes. Third waves also provide key clues for identifying wave counts.
Fourth waves: These are often sideways corrections, differing in form from second waves. They serve as a base for the final fifth wave. Market weakness starts to appear as lagging stocks begin to decline, setting the stage for non-confirmations during the fifth wave.
Fifth waves: Fifth waves are less dynamic than third waves, often showing reduced price change speed and volume unless they extend. While optimism is high during these waves, breadth narrows, and the market may struggle to make new highs. Even extended fifth waves lack the strength seen in previous waves, despite high investor confidence.
"A" waves: These waves occur at the start of bear markets, often seen as just a pullback by the investment community. Investors remain optimistic, but technical cracks begin to appear in stock patterns. The structure of wave A sets the tone for wave B, where a five-wave A suggests a zigzag B, and a three-wave A suggests a flat or triangle.
"B" waves: These are deceptive waves, also known as bull traps, attracting speculators and creating a false sense of market strength. They often focus on a narrow set of stocks, are technically weak, and usually retrace fully by the following C wave. B waves display characteristics of market instability, and analysts often sense that "something is wrong."
"C" waves: Declining C waves are destructive and have the traits of third waves, causing widespread market damage. Fear overtakes optimism, and investors struggle to find safe havens. C waves can cause severe market drops, as seen in historical examples like 1930-1932, 1962, and 1973-1974. Advancing C waves during bear markets are dynamic and may appear like the start of a new uptrend, but they are part of the larger corrective pattern.