Elliott Wave: Extracting Extremes and Predicting next One by Neural Network
The Elliott Wave model is used in stock market forecast. It is based on a crowd psychology that changes between optimistic and pessimistic trends creating patterns that can be fitted to reoccurred sequences. To use waves for prediction the assumption is made that waves are developing in the sequence of Fibonacci, harmonic, or fractal ratios. So that each wave has a programmed position and characterized by a particular direction and duration with extreme as a reversal point.
Although the model was developed almost a century ago and looks very attractive due to its strict formalism and deterministic outcome, its predictive power is very weak because of a few reasons. Firstly, the predictive values are dependent on waves that were counted - determining where first and next wave start can be subjective. Secondly, according to Efficient Market Hypothesis, using an exact Elliott Wave model by traders could lead to the disappearance of the patterns they anticipate. And finally, nowadays one's trading success based on predictions is rather a chance game in a modern market with its irrational behavior.
The purpose of this research was to explore if Elliott Wave principle can be used these days in stock market forecast. To eliminate the subjectivity in counting waves, Neural Network (NN) was used to analyze and predict waves. Also instead of assuming that waves obey only the sequence of Fibonacci, harmonic, or fractal ratios, a more general approach used - the software processes all extracted waves. Besides, employing NN enables identifying both the price and date of extremes. The first experiment has been done using an artificial data set. The data consist of two sinusoidal functions with different periods. The second group of experiments have been done on a real market data.
The main conclusion is that the Elliott Wave idea can be used in predicting stock market. Although it does not generate always accurate and consistent forecasts, its result can be successfully used as an additional input for making a trading or investing decision in modern market conditions.
Charts and calculation results by SMFT-1 (TA-1 sub-system Waves module interface)