Famous stock market analyst Ralph Nelson Elliot Elliott developed the Elliott Wave Theory during the 1920s and 1930s. It provides a technical analysis of price patterns based on investor sentiment and market psychology. The theory identifies impulse waves of a primary trend and finds corrective waves to the prevailing and dominant trend.
Elliott believed stocks and stock markets have a well-defined structure and specific patterns and are not as chaotic and random as they appear. His work on cycles and waves remains the core basis for long-term and shorter-term forecasting among his disciples. The technical analysis discipline may be a helpful tool for traders and investors. However, it should be deployed with other technical analysis disciplines and indicators when confirming buy and sell signals.
For every price action, there is a reaction. For every impulsive move, there is a corrective one. The first five waves are the impulse moves that follow the direction of the primary trend. The subsequent three waves provide the countertrend or corrective waves.
The golden rules of the Elliot Wave Theory are as follows:
Wave 2 cannot retrace more than 100% of Wave 1. Wave 3 cannot be the shortest of the three impulse waves (i.e., Waves 1, 3, and 5). Wave 3 will always go above the top of Wave 1. Wave 4 cannot come into the territory of Wave 1. Wave 5 is the extended wave of all of the impulse waves. It should be at least 38.2% of wave 4. One of the five impulse waves must be extended moves from Wave 1, Wave 3, and Wave 5, where an extension is the longest in an impulse wave.
An update of an Elliot Wave analysis of the SPX Index (SPX) is enclosed.
The analysis starts from the market bottom in mid-October 2022 at an intraday low of 3,491.58 (10/13/22). A well-defined 1-year uptrend channel soon developed via a series of higher lows and higher highs, suggesting a well-defined bullish primary uptrend channel.
Impulse Wave 1, or the 10/13/22-2/2/23 rally from 3,491.58 to 4,195.44, led to a temporary peak and a corrective Wave 2. From 4,195.44 (2/2/23 high), Wave 2 found pivotal support at 3,808.86 (3/13/23) or above the 61.8% retracement (3,761) from Oct 2022-Feb 2023 rally and the Dec 2023 low (3,764.49). Impulse Wave 3 triggered an explosive rally toward 4,607.07 (7/27/23). The bearish island reversal on 7/27/23 warned of the start of corrective Wave 4. Since then, five (5) more negative outside days and three gap-downs reaffirmed the corrective phase. The summer-to-fall correction of 417.85 points or -9.07% may be nearing a critical stage.
Is corrective Wave 4 ending? And is this the start of Impulse Wave 5?
Based on the golden rules of Elliot Wave Theory and combining the principle with other technical disciplines (i.e., 61.8% Fibonacci retracement (4,115) from 10/13 to 7/27, 200-day moving average (4,237), the bottom of the Oct 2022 uptrend channel (4,342), prior May 2023 breakout (4,195), the bottom of the Jul 2023 downtrend channel (4,164), 5/24/23 low (4,103.98), and others) it would imply corrective Wave 4 should bottom around 4,100-4,300 during late-September to October 2023.
The 1-year primary uptrend channel currently severely tested as the recent decline (4,189.22 – 10/23/23) has briefly violated the bottom of the channel (4,342), the May 2023 breakout (4,195), and the 200-day ma (4,237). However, the Oct 2022 primary uptrend can continue with Impulse Wave 5 if SPX retains critical support corresponding to the 61.8% retracement (4,114) from the 3/13 to 7/27/23 rally and maintain above the bottom of the Jul 2023 downtrend channel (4,159) and 5/24/23 low (4,104).
The ability to find support at 4,100-4,159 may lead to the start of Impulse Wave 5. A Wave 5 rally may lead to SPX rebounding to key resistance at 4,377-4,401 (the 50-day ma, 10/17/23 high, and the 9/21/23 gap-down) and above 4,448.5-4,455 (Jun 2023 highs and the top of the Jul 2023 downtrend channel).