Impulse Wave Pattern: An Elliot wave pattern to study Stock Market Behaviour in Indian context.

Sibanjan Mishra Email- sibanjan@gmail.com Lecturer, Institute of Business and Computer Studies, Siksha O Anushandhan University, Bhubaneswar, Odisha Dr.Bimal Chandra Mishra Reader in Commerce, DD College, Keonjhar, Odisha

Impulse Wave Pattern: An Elliot wave pattern to study Stock Market Behaviour in Indian context.

Abstract This paper aims to study the presence of Elliot wave pattern (Impulse Wave) in Indian Stock Market. Academicians have tried to model the Elliot wave concept with advanced programming and computing techniques like neural networks, genetic algorithm, fuzzy logic, however the inferences stay poor, as the Elliot wave principle is based on a highly structured rule base and the researchers might not be able to incorporate all the required rules to conclude at a wave pattern. In this paper an attempt has been made to incorporate the rules mentioned in Neelys Mastering Elliot Wave regarding the Impulse Wave without trying to model them. Using reversal amount methodology of various levels an attempt is been made to study the market behavior and explore trading opportunities. The data relates to the NSEs Nifty. Span of data is from June 1996 - December 1998. The results shows that if we strictly follow the rules specified, Elliot wave pattern (in this paper only Impulse Wave) are evident and a trader can easily guide his trades in the direction of mass psychology, thus achieving trading success. Keywords: Elliotts theory; Fibonacci sequence; technical analysis; stock market; Nifty JEL Classification: G12, G17

Introduction The Elliott Wave Principle is a detailed description of how investors and traders behave in the stock market. It reveals that mass psychology swings from pessimism to optimism and back in a natural sequence, creating specific and measurable patterns. It occurs in the financial markets, where changing investor psychology is recorded in the form of price movements. It helps in identifying repeating patterns in prices; figures out where we are in those repeating patterns today and predict where we are going next. The study of Elliott Wave Principle is an exercise in probability. As per the Elliot wave theory, wave development in stock markets takes place in two modes: motive/impulse and corrective. An impulse is characterized by five waves, three of them moving in the direction of the larger or dominant trend and two retracements, (or corrections) moving against the larger trend. Impulses may be in the form of upward impulse or downward impulse. A upward impulse will always start at, or just after, a major low and trends upwards in the direction of the dominant trend prevailing in the market. However the downward impulse starts at, or just after a major high and trend downwards in the direction of the major trend.

The most common shape of an impulse wave varies considerably, depending on the time frame and the direction of the pattern (upward or downward). A upward impulse has two strong moves, waves 3 and 5. Wave 5 is generally steeper than wave 3. In comparison, the strongest move for a downward impulse is wave 3. Waves 1 and 5 move a similar price distance. These variances are the result of an entirely different trading psychology of the trading public, which makes sense, considering that one market is rising and the other market is falling. Note that in both rising and falling markets, waves 2 and 4 are very similar in price and time and wave 1 is generally a short, sharp move with the larger trend. When a trader has identified the first four waves of an impulse in a rising market, they can expect wave 5 to be a strong move up, similar to wave 3. However, in a falling market, the trader would expect wave 5 to move down a similar price distance to wave 1. Psychology of the traders behind each of the Wave

Wave 1. The stock makes its initial move upward. This is usually caused by a relatively small number of people that all of the sudden (for a variety of reasons real or imagined) feel that the price of the stock is cheap, so it is a perfect time to buy. This causes the price to rise. Wave 2. At this point, enough people who were in the original wave consider the stock overvalued and take profits. This causes the stock to go down. However, the stock will not make it to its previous lows before it is considered a bargain again. Wave 3.This is usually the longest and strongest wave. The stock has caught the attention of the mass public. More people find out about the stock and want to buy it. This causes the stocks price to go higher and higher. This wave usually exceeds the high created at the end of wave 1. Wave 4. People take profits because the stock is considered expensive again. This wave tends to be weak because there are usually more people who are still bullish on the stock and are waiting to buy in the valleys. Wave 5. This is the point that most people get on the stock and is most driven by hysteria. This is when the stock becomes the most overpriced. Contrarians start shorting the stock, which starts the ABC pattern. Objective To study existence of Elliot wave majorly Impulse pattern in Indian stock markets. Research Methodology To study the existence of an upward or a downward impulse pattern, the daily high and low values of NSEs Nifty from June1996 to December 1998 is considered. The values are then smoothed on a daily basis, by

deriving the average values of the index, using the formula (High+Low)/2. The idea behind taking the average values is to filter out the entire anomaly present in the open or close values. With respect to the average values, a zig zag line is fitted to decipher the price action in the market. The zig zag line is calculated using the concept of Reversal Amount. The reversal amount is the amount of price movement required to shift the trend either upward or downward in a chart. This condition is used on charts that only take into consideration price movement instead of both price and time. For example, the zig zag line will only shift its trend in either side, if the previous price moves by, say five percent. We can modify it to a ten percent shift also. Once a zig zag line is fitted to the price chart we can group them into five monowaves (a monowave is the movement of a market starting from a change in price direction until the next change in price direction occurs) to observe whether an impulse pattern exists or not. Impulse behavior of the market action can be considered only if the following set of rules is satisfied: 1. Five adjacent segments must be present which meet the structure series requirement of a trending impulse pattern. 2. Three of the five segments must be thrust in the same upward or downward direction. 3. Immediately after the first segment, a minor move in the opposite direction takes place. This segment can never retrace the entire first. 4. The third segment must be longer than the second. 5. Immediately after the third segment, a minor move in the opposite direction of the third and same direction of the second must take place (segment four). The fourth segment must never retrace all of the third. 6. The fifth segment will always be longer than the fourth, but only has to be 38.2% of the fourth segment pricewise. When the fifth is shorter than the fourth it is termed as a failure. 7. When the vertical price distances are measured for first, third and fifth, the third does not have to be the longest but it can never be the shortest of the three segments.

The software used for calculations and charting the data is Metastock. Chart Analysis and Interpretation. At 10% Reversal Amount Figure 1

Table 1
Impulse Wave Pattern June 96 Dec 98 Conditi on 1 Satisfie d Conditi on 2 Satisfied Conditi on 3 Unsatisfi ed Conditi on 4 Unsatisfi ed Conditi on 5 Unsatisfi ed Conditi on 6 Satisfied Conditi on 7 Unsatisfi ed

Table 1(a)
Impulse June 96 Dec 98 Condition 1 Condition 2 Condition 3 Explanation Five adjacent segments (Wave 1,2,3,4,5) are present Three of the five segments (Wave 1, 3, 5) have thrust in the same downward direction. Immediately after the first segment (Wave 1), a minor move in the opposite direction takes place (Wave 2). This segment can never

retrace the entire first. Wave 2 (355 points) however has retraced all of Wave 1 (314 points). Condition 4 The third segment must be longer than the second. Wave 2 measures 355points, whereas Wave 3 needs to be the longest, measures only 193 points. Immediately after the third segment, a minor move in the opposite direction of the third and same direction of the second must take place (segment four). The fourth segment must never retrace all of the third. Wave 4 measuring 333points has retraced all of the 193points covered by the Wave 3. The fifth segment will always be longer than the fourth, but only has to be 38.2% of the fourth segment pricewise. When the fifth is shorter than the fourth it is termed as a failure. Wave 5 which is of 325points is more than 38.2% of wave 4 (333points) i.e. 127points. It is a 5th wave failure. When the vertical price distances are measured for first, second and third, the third does not have to be the longest but it can never be the shortest of the three segments. Wave 1 - 314points Wave 3 - 193points Wave 5 - 325points

Condition 5

Condition 6

Condition 7

Implication: From the above analysis of the chart at 10% reversal amount and its characteristics, it is clear that the market pattern is certainly not a trending impulse. For an Impulse Wave all the conditions need to be satisfied. The market is under some type of corrections (sideways movement). That means there will be no outburst in the price action. Such situation describes a pessimistic social mood. Under this scenario there is no scope to generate trading opportunities in intermediate to long term ranging from six months to two year. To get trading opportunities with a 10% reversal amount, the fundamentals factors affecting markets need to be boosted. Thus traders shifts focus on short term trading opportunities at 5% reversal amount.

At 5% Reversal Amount Figure 2

Table 2
Impulse Wave Pattern June96Dec96 Dec96Conditi on 1 Satisfie d Satisfie Conditi on 2 Satisfied Satisfied Conditi on 3 Satisfied Satisfied Conditi on 4 Satisfied Satisfied Conditi on 5 Satisfied Satisfied Conditi on 6 Satisfied Satisfied Conditi on 7 Satisfied Satisfied

Dec98

Table 2(a)
Impulse June96Dec96 Condition 1 Condition 2 Condition 3 Explanation Five adjacent segments (Wave 1,2,3,4,5) are present Three of the five segments (Wave 1, 3, 5) have thrust in the same upward direction. Immediately after the first segment (Wave 1), a minor move in the opposite direction takes place (Wave 2). This segment can never retrace the entire first. Wave 2 (60 points) however has retraced 27.3% of Wave 1 (219 points). The third segment must be longer than the second. Wave 2 measures 60points, whereas Wave 3 measures 171 points. Immediately after the third segment, a minor move in the opposite direction of the third and same direction of the second must take place (segment four). The fourth segment must never retrace all of the third. Wave 4 measuring 79points has not retraced all of the 171points covered by the Wave 3. The fifth segment will always be longer than the fourth, but only has to be 38.2% of the fourth segment pricewise. When the fifth is shorter than the fourth it is termed as a failure. Wave 5 which is of 152points is longer than wave 4 (79points). Thus It is not a 5th wave failure. When the vertical price distances are measured for first, third and fifth, the third does not have to be the longest but it can never be the shortest of the three segments. Wave 1 - 219points Wave 3 -171points Wave 5 - 152points

Condition 4

Condition 5

Condition 6

Condition 7

Table 2(b)
Impulse Dec96Dec98 Condition 1 Condition 2 Condition 3 Explanation Five adjacent segments (Wave 1,2,3,4,5) are present Three of the five segments (Wave 1, 3, 5) have thrust in the same downward direction. Immediately after the first segment (Wave 1), a minor move in the opposite direction takes place (Wave 2). This segment can never retrace the entire first. Wave 2 (76 points) however has retraced 30.5% of Wave 1 (250 points). The third segment must be longer than the second. Wave 2 measures 76points, whereas Wave 3 measures 321 points. Immediately after the third segment, a minor move in the opposite direction of the third and same direction of the second must take place (segment four). The fourth segment must never retrace all of the third. Wave 4 measuring 200points has not retraced all of the 321points covered by the Wave 3. The fifth segment will always be longer than the fourth, but only has to be 38.2% of the fourth segment pricewise. When the fifth is shorter than the fourth it is termed as a failure. Wave 5 which is of 96points is more than 38.2% of wave 4 (200points) i.e. 76points. It is a 5th wave failure. When the vertical price distances are measured for first, second and third, the third does not have to be the longest but it can never be the shortest of the three segments. Wave 1 - 250points Wave 3 - 321points Wave 5 - 96 points

Condition 4

Condition 5

Condition 6

Condition 7

Findings: 1. Evidence of Elliot Wave Pattern at 5% reversal amount (Impulse Wave). 2. The market strictly follows the highly structured model of Elliot Wave Principle. Table 2. 3. It is beneficial for the investors, who do not want their money to be idle for a longer period of time. (at 10% reversal amount the market has no trading opportunities, however at 5% reversal amount, clear tradable impulse pattern were witnessed).

4. It also speaks about the investor/mass sentiment. At 10% reversal amount the markets looked pessimistic, however if we capture smaller market movements at 5% reversal amount there is some sense of optimistic trading zones.

Conclusion: One of the only tools that can give you an idea, in which direction the stock price is going to move next, is through the use of Elliott waves. With short, medium and long term Elliott waves trend analysis we can have a pretty good indication if price has a better chance going up or going down in those different periods. In addition it can give us price targets. The future scope for research lies in exploring the rules of corrective Elliot wave pattern like Flats, Zig Zag, and Triangles, which can also be studied and conceptual conclusions can be driven in support of trading opportunities in the stock market. In recent past market has turned really intriguing hence calling for methods to keep the traders in the right foot. In investments loss is always unguarded whereas profits are always guarded.

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