optimism becomes excessive and leads to a bubble at which prices peak. The bubble bursts
and the market is then carried lower in the wave pattern.
Elliot wave theory is sometimes supplemented by the use of Fibonacci numbers. Fibonacci numbers seem to fit the pattern of development of a range of natural phenomena from the reproduction of petals on a flower to the formation of galaxies. They are also believed to explain stock market developments. Fibonacci numbers are taken from a sequence in
which each number is found by adding together the previous two in the series. The sequence runs 1, 1, 2, 3, 5, 8, 13, 21, 34, and so forth. Users of the theory employ various combinations and ratios of Fibonacci numbers to predict market tops and bottoms, along with support and resistance levels. Elliot wave theory sees cycles as comprising eight waves, five on the upswing and three on the downswing, which are Fibonacci numbers.
Technical analysts also use other indicators, such as filter rules, relative strength, and short interest ratios.
Filter rule states that an investor should buy when a stock price (or market index) has risen by a predetermined percentage above a previous low point. Conversely, the investor should sell when the price or index falls by a particular percentage below a previous high. The percentages are decided by the investor, but they should be established prior to the market movements.
Relative strength is measured by the ratio of a stock price to a market index. Changes in the ratio are taken to indicate buy or sell opportunities. For a momentum trader a rise in the ratio is a signal to buy the stock (and a fall is a signal to sell).A contrarian trader would interpret a rise in the ratio as a sell signal (and a fall as a buy signal).
The short interest ratio is the ratio of short sale s to total trading. A rise in the ratio has two opposite interpretations. First, a rise in the ratio as indicative of bearish sentiment, and hence is a sell signal. Second, a rise is a buy signal, since it is believed that the short positions will have to be covered by stock purchases. These stock purchases would tend to
push up stock prices.
Trin statistic is the ratio of the average trading volume in stocks with declining prices to average volume in stocks rising prices. Ratio above 1 show a bearish market, since a relatively high volume of trades in declining stocks is indicating net selling pressure. Conversely, ratios below 1 are seen as indications of a bullish market.
Trading volume is considered an indication of the strength of a trend. If a price movement is accompanied by a relatively high quantity of trades, it is considered more significant than the price movement in a low trading volume market.
Breadth of the market shows the extent to which movement in a market index is reflected widely in the price movements of individual stocks. The most common measure of breadth is the difference between the number of stocks that rise and the number that fall. If the difference is large, the market movement is considered to be strong, since it is widespread. A market rise is viewed stronger, if prices of large majority of stocks are rising. Conversely, market rise is viewed as weaker, when only prices of stocks of a few large capitalization companies are increasing.
Mutual fund cash holdings, if they increase, might an indication of a market rise based on belief that the cash will be used to buy shares. This demand for shares would tend to push prices up. Conversely, low mutual fund cash holdings are seen as a bearish signal.
Put-call ratio.Put options give the right to sell shares at a specified price, and are bought by investors who expect share prices to fall. Call options give the right to buy shares at a specified price, and are bought by investors who expect share prices to rise. The ratio of puts bought to calls bought is used as an indicator of the expectations of investors.