Elliott Wave Principle     What Is The Wave Principle

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Because The Wave Principle describes patterns of collective behavior, the accuracy of any resulting market forecast is dependent upon (1) the reliability of the investing's crowd behavorial patterns and (2) the ability of an analyst to identify the relevant ones properly. In fact, the patterns, while varied, are more than reliable; in a fundamental sense, they are inviolate, a characteristic that makes wave analysis incalculably superior to other methods. Investors form
a crowd whose collective action reflects a key aspect of man's nature as a social animal: 
He is strongly induced to adopt the feelings and convictions of the group. In a realm such as investing, in which so few are knowledgeable, the tendency toward dependence is virtually impulsive. 

As a result, market trends are steered not by the rational decisions of individual minds but by
the peculiar collective sensibilities of the herd. The pervasive dependence among its members produces an emotional interpersonal dynamic that, like all feedback systems, has form. As a result, the crowd behaves essentially the same way in every market cycle, regardless of degree. Some trends last longer than others and some travel further than others, but the psychological progression through each bull and bear market is always the same.

[At The Crest Of The Tidal Wave, Chapter 1, p.12, Robert R. Prechter, Year 2000 Edition].

It is imperative to understand that certainty about the probabilities is not the same as certainty about one specific outcome. Since analysis is based upon price patterns, a pattern identified as having completed is either over, or it isn't. If the market changes direction, the analyst has caught the turn. If the market moves beyond what the appearantly completed pattern would have allowed, the position is wrong, and any funds at risk can be reclaimed immediately. 

Most other approaches, whether fundamental, technical or cyclical, do not allow other than arbitrarily chosen stop points, thus keeping risk and frustration high. There are also times when an Elliott Wave analysis allows for a number of outcomes, or when there is no clearly preferred probably outcome. 

At such times, forecasting and formulating investment strategy should merely be foregone until the pattern resolves and the probabilities shift dramatically in favor of one specific outcome. At such times, the probability that a turning point is at hand can sometimes rise to near certainty. 

Sources: Elliott Wave International, At The Crest Of The Tidal Wave, 1995, Robert R.Prechter, 2000 Edition.The Wave Principle Of Human Social Behavior, 1999, Robert R.Prechter

 

 

Know the Wave Principle, Know Thyself 
1/12/2005 

The "Best Of" Series
Excerpts from Prechter's Perspective

In the 2004 edition of the book, Prechter's Perspective, that contains interviews with Bob Prechter, one reporter asked Bob about the difference between knowing the Wave Principle 
and using it for trading. Let's see what Bob had to say:

Does knowing the Wave Principle guarantee profits?

Only the most trained and experienced market participants can act against their natural tendencies. I have yet to meet a person who invested or traded with a completely rational
program based on reasonable probabilities, without allowing greed, fear, extraneous opinions
or irrelevant judgments to interfere. It is man's emotional side - particularly his social 
dependency- that makes him think the way his fellows do; when he does this, he loses 
money in the markets. At least using Elliott, you have a basis that makes winning possible.

What do you advise people to do who want to learn to use the Wave Principle?

The first thing to do is begin following market charts closely. Label and channel the moves according to the Wave Principle. You'll gain confidence immediately if the market is in an 
impulse rather than a corrective pattern. This is when I was fortunate enough to begin, so I
quickly saw what was happening. Corrections are more varied and difficult; still, they are components of impulse waves and also contain impulse waves, so you will always find corrections at some degree.

What are the Wave Principle's key strengths?

A.J. Frost [co-author with Bob Prechter of the basic Elliott wave textbook called Elliott Wave Principle, Key to Market Behavior] liked to say, "Its most striking characteristics are its
generality and its accuracy." Its generality gives market perspective, most of the time, and 
its accuracy in pointing out changes in direction is at times almost unbelievable.

Why does it work so well?

Because the Wave Principle is 100% technical. No armchair theorizing from economics and politics necessary.

What's its biggest shortcoming?

There is one main weakness, and this accounts for just about all the problems: There are 11 different patterns for corrections. When a correction starts, it is impossible to tell in advance which pattern has begun, so you do not know how it's going to unfold. Therefore, the best that
you can do is apply some of Elliott's observations as guidelines in making an intelligent guess
as to what it is.

Are there situations where the Wave Principle does not hold true?

No. It always holds true. But it's one thing to say the markets will follow the Wave Principle
and another thing entirely to forecast the future based on that knowledge. It's always a question
of probabilities. Once you have hands-on experience with it, once you understand the rules and guidelines, it's a lot like becoming Sherlock Holmes. There are many possible outcomes, but guidelines force you along certain paths of thinking. You finally reach a point where the evidence becomes overwhelming for a certain conclusion. 
(Source: Elliott Wave International)

 

 

Elliott Wave Fractals [Pattern]
© ELLIOTT today,March 2004

The foremost aim of wave classification under the Elliott system is to determine where we are in the stock market cycle. This exercise is easy as long as the wave counts are clear, as in fast moving markets, particularly in impulse waves, when minor movements generally unfold in an uncomplicated manner. However, in lethargic or choppy market actions, particularly in corrections, wave structures are more likely to be complex and slow to develop. They are part of the reality of the market, though, and must be taken into account. The wave counts presented on the charts fits Elliott's theme of the "right look." 

The construction of the (a)-(b)-(c) (x) formation from December to January has an uncanny resemblance to the markets structure from February to March. Following an (a)-(b)-(c) zigzag with wave (b) a triangle, the market advanced in three waves up and completed wave (x) on January 13,2003. The decline from that high traced out five waves down for wave (a) and three waves up for wave (b). 

As the chart shows [not shown], both first initial declines have the same length [point (c) December and point (a) February but slightly different patterns. Elliott described how waves at each degree become the components of waves of the next higher degree, and so on, producing a structured progression. Component waves vary in size, but it always takes a certain number of them to create a wave of the next higher degree. Thus, each degree is identifiable in terms 
of its  relationship to higher and lower degrees. Elliott found, that there are specific patterns to the stock market 
fractal that are neverthless highly variable within a certain definable latitude. 

In other words, some aspects of their form are constant and  others are variable. Component patterns do not simply display discontinuity similar to that of larger patterns, but they form,with a certain latitude, replicas of them.

In the 1930s , Ralph Nelson Elliott discovered that aggregate stock market prices trend and reverse in recogniziable patterns. That patterns he discerned are repetitive in form, but not necessarily in time or amplitude. Elliott isolated and defined thirteen pattern, or “waves,” that recur in market price data. He named and illustrated the patterns. He then described how they link together to form larger versions of themselves, how they in turn link to form the same pattern at the next larger size, and so on, producing a structured progression. He called the phenomenon The Wave Principle. [The Wave Principle Of Human Social Behavior And The New Science Of Socionomics, Robert R. Prechter,1999]

It is particulary evident in those free markets where public participation in price movements is extensive. Those who have attempted to deal with the market’s movement have failed to recognize the extent to which the market is a psychological phenomen. They have not grasped the fact that there is regularity underlying fluctuations of the market, or, stated otherwise, that price movements in stocks are subject to rhythmus, or an ordered sequence. The wild, senseless and apparently uncontrollable changes in prices from year to year, from month to month, or from day to day, link themselves inta law-abiding rhythmic pattern of waves. The same rules apply to the price of stocks, bonds, grains, cotton, coffee, and all the other activities previously mentioned.  

¹ ) R.N.Elliott’s Masterworks (1980/1998) by Frost & Prechter, which includes all of Elliott’s original books, 
     articles and major essays, as well as a biography.

² ) Elliott Wave Principle – Key To Stock Market Behavior (1978/1998) by Frost & Prechter, a concise
    summary of Elliott’s work.

 

                                                            

DAX [German Stock Market Index]
©ELLIOTT today, March 2004

 

Chart: futuresouce.com

Five waves down, three waves up. Wave ii traveled to the fourth wave of one lesser degree, 
which in this case was a contracting triangle (EWP,p.41). The DAX declined into March 2003
to 2188 for a loss of roundabout 1000 points !

ELLIOTT WAVE PRINCIPLE, Frost & Prechter

Nasdaq 100

©ELLIOTT today, March 2004

Chart: technical-investor.de

On March 13, 2002 the market "gapped" down from a completed diagonal triangle 5th wave. The ending pattern itself completed five-waves up for wave (c). Since diagonal triangles preceed dramatic reversals ahead, the "unexpected" fall was normal occurrence under the rules and guidelines of the Elliott Wave Principle. 

ELLIOTT WAVE PRINCIPLE, Frost & Prechter

DJ Transportion

©ELLIOTT today, March 2004

Chart: tradesignal.com

Another example of a dramatic reversal after a diagonal triangle has been completed.

ELLIOTT WAVE PRINCIPLE, Frost & Prechter

Contracting Triangle in the S&P 500

(c) ELLIOTT today, Sept.9,2003: 

 

ELLIOTT today, Sept.9,2003: 
In targeting the ultimate low-end of the triangle the following Fibonacci calculation was made: 1018-960= -58 points. 58 x .618 = 35,8. 1018-35,8=982,2. Wave e ended at 983 completing  wave iv of the triangle and from there another powerful advance started. 

 

ELLIOTT today, Update: Fibonacci,January 4,2004:

Often wave four divides an impulse into the "Golden Section". If so, wave v should top out at 1133 points. Why?

788-960=195 or 24,74%. 24,74% times .618 = 15,29%. 9.83 x 15,29 = 150,30. 983+15,29=1133,3. 

Another guideline deals with typical Fibonacci relationships between price lengths of waves, which allow forecasting to be even more specific. Wave i traveled +107 points and 107 times 1.618 gives 173 points. When added to the low of the triangle at 960 the target will be 1133. The next powerful resistance level in the S&P should be the 50% retracement level measured from the alltime-high: 1553-768= -785. 785/2=392,5. 768+392,5= 1160,5.

These developments are remarkable high enough, but substantially more is involved in the fascinating mathematical relationships of the wave structure. 

High Of December 2,2002
©ELLIOTT today, Dec.2,2002

Chart: quote.com

Wave (a) traced out what looks like a "diagonal triangle type 2", [leading diagonal triangle]. 
Note the wave ii low came close to the low of wave (b). Connecting waves ii and iv and drawing
a parallel across the top wave iii "catched" the top of wave v of (c) of 2 right to the minute. 
A perfect example of R.N.Elliott's description of market behavior. The S&P 500 declined to768 
on March 12,2003. 

ELLIOTT WAVE PRINCIPLE, Frost & Prechter

 

 

 

 

and the DOW...
©ELLIOTT today, Dec.2,2002

 

 

Chart: futuresource

ELLIOTT today,December 2,2002: In the Dow, the a-b-c zigzag correction in wave (b) is clear visible. Within wave iii waves ii and iv sport alternation by forming different structures: zigzag and flat, and again zigzag and double three. Wave b in the first three of the double-three correction in wave iv may have taken the form of an expanded flat. Note the parallel trend channel which is drawn according to the description in The Wave Principle. Wave v of (c) reached the upper parallel line exactly to the minute. The five-wave advance in wave v in the Dow is more clearly visible than the same wave in the S&P 500. From there, the DJIA fell to 7416  [-1638 points or 18%]
on March 12,2003.