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Elliott Wave Principle

Key To Stock Market Profits by Frost & Prechter 
(Expanded Edition1990)

Elliott Wave Principle >>>

 

Basic Tenets of the Wave Principle  

This chapter provides a succinct overview of the Wave Principle so that those new to the concept can get the idea as quickly as possible. That way, we can move on to address the validity of the concept of the Wave Principle and then discuss its implications and application. Full details are available in Elliott Wave Principle (1978/1998). This chapter is necessarily dry as a bone, but I promise that the steam will rise as we move along.  

 

R.N.Elliott’s Discovery  

In the 1930s, Ralph Nelson Elliott discovered that aggregate stock market prices trend and reverse in recognizable patterns. The patterns he discerned are repetitive in form, but not necessarily in time or amplitude. Elliott isolated and defined thirteen patterns, 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 patterns at the next larger size, and so on, producing a structured progression. He called this phenomenon The Wave Principle.

Many areas of mass human activity display the Wave Principle, but it is most popularly applied to stock market averages. There is voluminous, meticulously tabulated data on fincancial markets because people deem them important. Actually, the stock market is far more significant to the human condition than it appears to casual observers and even to those  who make their living by it. The level of aggregate stock prices is a direct and immediate measure of the popular valuation of man’s total productive capability. That this valuation has a form is a fact of profound implications that should ultimately revolutionize the social sciences.  

While Elliott progressed to the recognition of patterns and their linkage by a painstaking process of cataloging the minute details of price movement, we will forego such exercises and proceed directly to a description of the overall pattern.  

 

The Five-Wave Pattern  

In markets, progress ultimately takes the form of five waves of a specific structure. Waves (1), (3) and (5) actually effect the directional movement. Waves (2) and (4) are countertrend interruptions. The two interruptions are apparently a requisite for overall directional movement to occur. Elliott noted three consistent aspects of the five wave form. They are: Wave two never moves beyond the start of wave one, wave three is never the shortest wave, and wave four never enters the price territory of wave one. The stock market is always somewhere in the basic five-wave pattern at the largest degree of trend. Because the five-wave pattern is the overriding form of market progress, all other patterns are subsumed 
by it.  

 

Component Structures  

Figure 1 shows the first two waves in greater detail. Notice the difference in their subdivisions, which reflect the two
modes of wave development: motive and corrective. The two modes are fundamentally different in both their roles and construction.

A motive wave (also called a “five”) has a five-wave structure. Its subwaves are denoted by numbers (in this case 1,2,3,4,5). Both the five-wave pattern and its same-directional components, i.e., waves (1),(3) and (5), employ motive mode. Their structures are called “motive” because they powerfully impel the market. A corrective wave (also called a “three”) has a three-wave structure or a variation thereof. Its subwaves are denoted by letters (in this case, A, B, C). 
All countertrend interruptions, which include waves (2) and (4) employ corrective mode. Their structures are called “corrective” because each one appears as a response to the preceding motive wave yet accomplishes only a partial retracement of the progress it had achieved, “correcting” its extremity.

 

Self-Similarity and Degree  

When the motive wave ends, a corrective wave of corresponding size follows, so that overall, the result looks like Figure 1. Observe that the overall form is the same as that of its own subwaves (1) and (2), depicted in Figure 1. The word “degree” has a specific meaning and does not mean “scale”. 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 its relationship to higher and lower degrees. This is unlike the unfinite scaling relating to say, seacosts. Each same direction component of a motive
wave (i.e., wave one, three or five) and each full-cycle component (i.e. waves one + two, or waves three + four) of a complete cycle is a smaller version of itself.

In Fig. 1, each subwave 1, 3,and 5 is a motive wave that must subdivide into a “five”, and each subwave 2 and 4 is a corrective wave that must subdivide into a “three”. Waves 1 and 2, if examined under a “microscope” , would take the
same form as waves (1) and (2), and in further detail, waves [1] and [2], Regardless of degree, the form is constant. 
We can use Fig.1 to illustrate two waves, eight waves or thirty-four waves, depending upon the degree to which we 
are refering.

 

The Essential Design  

 

  Figure 1 

 

The Essential Design  

Now observe that within the corrective pattern illustrated as wave (2), waves A and C , which point downward, are each composed of five waves: 1,2,3,4,and 5. Similarly, wave B, which points upward , is composed of three waves:A,B and C. This construction discloses a crucial point: Motive waves do not always point upwards, and corrective waves do not always point downward. The mode of a wave is determined not by its absolute direction but primarly by its relative direction. Aside from four specific exceptions, which are discussed in the literature, a wave divides in motive mode (five waves) when trending in the same direction as the wave of one larger degree of which it is a part, and in corrective mode (three waves  or a variation) when trending in the opposite direction. Waves A and C  [ (A) and (C) ]  are motive, trending in the same direction as wave [2]. Wave (B) is corrective because it corrects wave (A) and is countertrend to wave [2]. In summary, the essential underlying tendency of the Wave Principle is that action in the same direction as the one larger trend develops in five waves, while reaction against the one larger trend develops in three waves at all degree of trend.  

The phenomena of form, degree and relative direction are carried one step further in figure 1. This illustration reflects the general principle that in a market cycle , waves will subdivide a shown in the table below.  

 

  Number of Waves at Each Degree

 

 

                                  Impulse        +       Corrective         =   Cycle    

 

Largest waves                1                             1                         2

Largest subdivisions         5                             3                         8

Next subdivisions           21                            13                        34

Next subdivisions           89                            55                       144 etc.

 

 

Following the form, this larger cycle automatically becomes two subivisions of the wave of next higher degree. As long as progress continues, the process of building to greater degrees continues. The reverse process of subdividing into lesser degrees apparently continues indefinitely as well. As far as we can determine, then, all waves both have and are (or at the largest degree, will be) component waves.

 

Why 5-3 ?  

Elliott himself never speculated on why the market’s essential form was five waves to progress and three waves to regress. He simply noted that it was happening. Does the essential form have to be five waves and three waves? I think so.  

First, were there no fluctuation, there would be no progress. A steadily increasing trend of 3% per year, for instance, would be stasis; nothing would ever change. Fluctuation in a net sideways trend, i.e., one with no net change, would also be stasis. Progress must include setbacks and net change over time. From the point of view of a participant, punctuated progress is the only kind of progress that is possible to perceive.  

Second, the 5-3 pattern is the minimum requirement for, and therefore the most efficient method of, achieving both fluctuation and progress in linear movement when the only constraint is that the lengths of odd-numbered waves of each degree be longer than those of the even-numbered ones. One wave does not allow fluctuation. The fewest subdivisions to create fluctuation is three waves. Three waves in both directions do not allow progress. To progress in one direction despite fluctuation, movements in the main trend must be at least five waves, simply to cover more ground than the three waves. While there could be more waves than that, the most efficient form of punctuated progress is 5-3 , and nature typically follows the most efficient path.

 

Notation and Nomenclature 

Waves are categorized by degree. The degree of a wave is determined by its size and position relative to component, adjacent  and encompassing waves.

Elliott named nine degrees of waves, from the smallest discernible on an hourly graph of stock prices to the largest he could assume existed from the data then available. He chose the following terms for these degrees, from largest to smallest: Grand Supercycle, Supercycle, Cycle, Primary, Intermediate, Minor, Minute, Minuette, Subminuette. Cycle waves subdivide into Primary waves that subdivide into Intermediate waves that in turn subdivide into Minor waves, and so on. This specific terminology is not critical to the identification of degrees, although out of habit, longtime practitioners have become comfortable with Elliott’s nomenclature. 

It is important to understand that these names and labels refer to specifically identifiable degrees of waves. By using a nomenclature, an analyst can identify precisely the positon of a wave in the overall progression of the market , much as longitude and latitude are used to identify a geographical location. To say, “The Dow Jones Industrial Average is  in Minute wave (v) of Minor wave 1 of Intermediate wave (3) of Primary Wave 5 of Cycle wave I of Supercycle wave (V) of the current Grand Supercycle” is to identify a specific point along the progression of stock market history.

 

Variations on the Basic Theme     

The basic model is simple, but reality is a bit more complex, as there are specific variations on the underlying theme that Elliott catalogued in detail. He also noted the important fact  that each pattern has identifiable rigidities  as well tendencies. From these observations, he was able to formulate descriptions of typical wave behavior and therefore rules and guidelines for proper wave identifications. For example, in the five-wave pattern (termed an “impulse”) , the middle wave is usually the longest, and the two corrective waves usually alternate in form, the first “sharp” , the second “sideways”. A thorough understanding of such details is necessary to know what the market can do, and at least as important,what it does not do. However,as the purpose of this chapter is limited to introducing the general hypothesis,a discussion of such nuances is omitted.  

 

Modern Science Comments on the Wave Principle Hypothesis 

1996 was an important year for the Wave Principle. In that year, the Journal of Physics published  a scientific study entitled ”Stock Market Crashes, Precursors and Replicas” by Didier Sornette and Anders Johansen, then of the Laboratoire de Physique de la Matiere Condensee at the University of Nice, France, and collaborateur Jean-Philippe Bouchard. The authors make this statement:

It is intriguing that the log-periodic structures documented here bear some similarity with the “Elliott waves” of technical analysis (citation Elliott Wave Principle). Technical analysis in finance can be broadly defined as the study of financial markets, mainly using graphs of stock prices as a functions of time, in the goal of predicting future trends. A lot of effort has been developed in finance both by academic and trading institutions and more recently by physicists (using some of their statistical tools developed to deal with complex time series) to analyze past data to get information on the future. The “Elliott wave” technique is probably the most famous in the field. We speculate that the “Elliott waves” … could be a  signature of an underlying critical structure of the stock market. ²  

¹ Elliott, R.N. (1938). The wave principle.

² Sornette,D., Johansen A., and Bouchard, J.P. (1996). “Stock market crashes, precursors and replicas.” Journal de Physique I France 6, No.1,pp.167-175. 

The Wave Principle of Human Social Behavior and The New Science of Socionomics,©1999 by Robert R. Prechter Jr.

   

 

Terminology and Labeling

 

Wave Degree	5's With the Trend	3's Against the Trend
Grand Supercycle	[I] [II] [III] [IV] [V]	[A] [B] [B]
Supercycle	(I)  (II) (III) (IV) (V)	(A) (B) (C)
Cycle	I   II   III   IV   V	A    B   C
Primary	[1] [2] [3] [4] [5]	[a] [b] [c]
Intermediate	(1) (2) (3) (4) (5)	(a) (b) (c)
Minor	1   2   3   4   5	a  b  c
Minute	(i)  (ii)  (iii)  (iv)  (v)	(a) (b) (c)
Minuette	i   ii    iii    iv    v	a  b  c
Subminuette	.i  .ii  .iii  .iv  .v	.a  .b  .c

(Labeling adjusted, Elliott today)

Literatur : The Wave Principle of Human Social Behavior and the New Science of Socionomics,
1999, Robert Rougelot Prechter,Jr., New Classics Library, Gainesville, GA, USA 

Elliott Wave Principle, Expanded Edition, Frost & Prechter, 1990

 

 

DJIA September 1986 - August 1987

 

Figure 2

 

Late November 1986 right in time with the so called Boesky-affaire ["Wall Street" - Michael Douglas & Charly Sheen] the DJIA finished wave e of a triangle in Intermediate wave (4). At the high of July 1986 the DJIA already gained 1.618 times the length of wave (1) and at that time we expected wave (5) to unfold to new record highs to complete the primary degree five wave structure from the low of 577 points back in 1974.

Figure 2 shows the detail of 5 Minor waves to complete Intermediate wave (5). As you can see, not only does the wave subdivide i,ii,iii,iv and v [1,2,3,4,5], but it also travels within a parallel trend channel. Waves 2 and 4 sport alternation by taking different forms (zigzag and triangle), thus satisfying the most guideline of impulse wave formation.

Here is the point of discussion. The herding impulse, rather than the rational neocortex, drives the decisions of most financial market participants. Both the herding impulse and its attendant emotions are hard-wired nearly identically into people's unconscious minds. Whatever certain individuals may decide rationally, such decisions are diverse, and the herding impulseis ubiquitous. Thus, in the aggregate, individual rational decisions tend to cancel out, leaving herding impulses to determine the market's overall trend. EWT, March 2001 

 

Prechter's  Forecast For The Superbullmarket

13.September 1982 + 6.April 1983 

[The Wave Principle of Human Social Behavior and the New Science of Socionomics, R.Prechter 1999]

This is a thrilling juncture for a wave analyst. For the first time since 1974, some incredible large wave patterns may have been completed, patterns that have important implications for the next five to eight years. The technical name for wave IV by this count is a “double-three”, with the second “three” an ascending triangle. This wave count argues that the Cycle wave IV correction from 1966 ended last month (August 1982). The lower boundary of the trend channel from 1942 was broken briefly at the termination of this pattern. A brief break of the long term trendline, I should note, was recognized as anoccasional trait of fourth waves, as shown in R.N.Elliott’s Masterworks. 

The task of wave analysis often requires stepping back and taking a look at the big picture and using the evidence of the historical patterns to judge the onset of a major change in trend. Cycle and Supercycle waves move in wide price bands and truly are the most important structures to take into account. They indicate, a period of dramatically stability and soaring stock prices has just begun. One must conclude that a bull market beginning in August 1982 would ultimately carry out its full potential of five times its starting point, thus targetring 3885. 

[Note: In the midst of the most extreme stock market pessimism since 1942, Prechter identified the end of a 16-year-period of net loss for the Dow a month after its end at 777 and projected a climb to what was perceived as an absurd level of nearly 4000.] 

A normal fifth wave will carry , based on Elliott’s channeling methods, to the upper channel line, which in this case cuts through the price action in the 3500-4000 range in the latter half of the 1980’s. Elliott noted that when a fourth wave breaks the trend channel [as this one did in 1982], the fifth will often have a throw-over, or a brief penetration through the same trend channel on the other [i.e. top] side. 

What might we conclude about the psychological aspects of wave V? 

As the last hurrah, it should be  characterized , at its end, by an almost unbelievable institutional mania for stocks and a public mania for stock index futures, stock options, and options on futures. In my opinion, the long term sentiment gauges will give off major trend sell signals two or three years before the final top, and the market will just keep on going. In order for the Dow to reach the heights expected by the year 1987 or 1990, and in order to set up the U.S. stock market to the Wave Principle, is due to follow wave V, investor mass psychology should reach manic proportions, with elements of 1929, 1968 and 1973 all operating together , and, at the end, to an even greater extreme. 

 

 

 

 

 

"Motive waves do not always point upward, 
and corrective waves
do not always point downward." 

(The Wave Principle of Human Social Behavior 
and the New Science of Socionomics, Robert R.Prechter, 1999. p.26-27.)

 

Corrective Waves

The single most important rule that can be gleaned from a study of the various corrective patterns is that corrections can never be fives. Only impulse waves can be fives. In other words, an initial five-wave movement against the larger trend is never the end of a correction, only part of it. [Elliott Wave Principle, Frost & Prechter,1990, p.34]

"Motive waves do not always point upward, and corrective waves do not always point downward." (The Wave Principle of Human Social Behavior and the New Science of Socionomics, Robert R.Prechter, 1999. p.26-27.)

 

 

 

Describing in What Ways Waves Are Identical 
and in What Ways They Are Variable 

The concept of a robust fractal is difficult to depict visually because a single illustration cannot convey both those aspects of an Elliott wave that are invariant and those that are variable, i.e., what its manifestations have in common and what they need not. We can draw the essence of an Elliott wave but not state the precise path that any manifestation of it will actually take. Elliott waves in reality always conform to a few simple rules of patterning, but vary considerably within that format.

Elliott described five elementary patterns in the stock market, which he called impulse, diagonal triangle, zigzag, flat and triangle. The first two occur in motive mode (i.e. when prices are moving in the direction of the trend of one larger degree, effecting the larger wave’s progress), while the latter three occur in corrective mode (i.e. when prices are moving opposite the direction of the trend of one larger degree, punctuating its progress). In corrections, sometimes two of the patterns 
will occur side by side, interrupted by an intervening zigzag, as noted under the heading , “Double Three.”

Each of the five elementary patterns has its own description as well as a short catalog of variations that are similarly delineated by differences in form . For instance, sometimes both boundary lines of a triangle slope toward each other , and sometimes either the top or bottom line is horizontal. As another example, somtetimes wave B of a flat ends at the level of the start of wave A , and sometimes it ends beyond it. Elliott attached a name to each of these differences in form so that with his terms, we know immediately what form and variation we are talking about.

If Elliott was anything, he was menticulous. His description of waves, their position within larger waves, and their relative frequency of occurrence have stood the test of sixtiy years’ intensive application by some very dedicated practitioners, 
with only minor modifications. (The Wave Principle of Human Social Behavior and the New Science of Socionomics, Robert R.Prechter, 1999. S.57-60.)    

Now observe that within the corrective pattern illustrated as wave (2) , waves a and c, which point downward, are each composed of five waves: 1,2,3,4 and 5. Similarly, wave b , which points upward is composed of three waves: a,b and c. 
This construction discloses a crucial point:  

Motive waves do not always point upward, and corrective waves do not always point downward.

The mode of a wave is determined not by its absolute direction but primarily by its relative direction. Aside from four specific exceptions, which are disscussed in the literature, a wave divides in motive mode (five waves) when trending in the same direction as the waves of one larger degree of which it is a part, and in corrective mode (three waves or a variation) when trending in the opposite direction. Waves a and c are motive, trending in the same direction as wave (2). Wave b is corrective because it corrects wave a and  is countertrend to wave (2). In summary, the essential underlying tendency of the Wave Principle is that action in the same direction as the one larger trend develops in five waves, while reaction against the one larger trend develops in three waves, while reaction against the one larger trend develops in three waves, at all degree of trend. (The Wave Principle of Human Social Behavior and the New Science of Socionomics, Robert R.Prechter, 1999. S.26-27.)

 

Realtime Elliott Wave Structures 
As They Occured Live In The Markets

(c) ELLIOTT today, 2005

 

Examples

The Alltime-high January 14,2000

DJIA 1998 - Five Waves Up

 

 

The Alltime-high January 14,2000

DJIA 1998 - 2000

"Five Waves Up" 

 

Sign Of A Top

Die Abbildung zeigt den DJIA vom Oktober 1998 bis Januar 2000. 

5 Wellen vom Tief vom Oktober 1998 wurden am 14.Januar 2000 komplettiert. Die Struktur ist eine klassische Elliott Wave Impulswelle. Wenn 5 Wellen komplett sind braucht es kein Warum, Wenn und Aber - die folgende Sequenz ist eine Korrektur - eine a-b-c (Variationen) Struktur. Alle Begründungen, Meinungen, künstlich hergestellte kausale Zusammenhänge, haben keine Bedeutung. Der Markt hat immer Recht ! 

There is more information the market or the market structure has given to us. According to Elliott the supposed setback will carry the market back to the price zone of the previous fourth wave of one lesser degree. 

 

---

Wave Principle: The Preferred & the Alternate Counts
5/24/2007 3:21:25 PM

Those who are new to the Wave Principle sometimes wish that it would identify one wave count on a price chart as the one and only correct count. What they forget is that wave analysis is no magic bullet for seeing into the future, just as no other tool of technical or fundamental analysis is a magic bullet. Like most analytical tools, the Wave Principle involves probabilities. Price charts offer probable wave counts, and an investor must choose the one that seems to be most probable, the next most probable, and so on. The Wave Principle does offer an advantage, though: It provides rules and guidelines that help investors to determine which wave count is most likely and to know when a wave count no longer applies. In this excerpt from Bob Prechter and A.J. Frost's seminal book about R.N. Elliott's Wave Principle, the authors explain why the alternate count matters to anyone who trades.

* * * * *

Excerpted from Chapter 2 of Elliott Wave Principle: Key to Market Behavior by A.J. Frost and Robert Prechter

The Preferred Count – Limiting the Possibilities

Without Elliott wave analysis, there appear to be an infinite number of possibilities for market action. What the Wave Principle provides is a means of first limiting the possibilities and then ordering the relative probabilities of possible future market paths. Elliott's highly specific rules reduce the number of valid alternatives to a minimum. Among those, the best interpretation, sometimes called the 'preferred count,' is the one that satisfies the largest number of guidelines. Other interpretations are ordered accordingly. As a result, competent analysts applying the rules agree on both the list of possibilities and the order of probabilities for various possible outcomes at any particular time. That order can usually be stated with certainty.

Do not assume, however, that certainty about the order of probabilities is the same as certainty about one specific outcome. Under only the rarest of circumstances do you ever know exactly what the market is going to do. You must understand and accept that even an approach that can identify high odds for a fairly specific event must be wrong some of the time.

The Alternate Count – Putting Unexpected Market Action into Perspective

You can prepare yourself psychologically for such outcomes through the continual updating of the second best interpretation, sometimes called the "alternate count." Because applying the Wave Principle is an exercise in probability, the ongoing maintenance of alternative wave counts is an essential part of using it correctly. In the event that the market violates the expected scenario, the alternate count puts the unexpected market action into perspective and immediately becomes your new preferred count. If you're thrown by your horse, it's useful to land right atop another.

Always invest with the preferred wave count. Not infrequently, the two or even three best counts comfortably dictate the same investment stance. Sometimes being continuously sensitive to alternatives can allow you to make money even when your preferred count is in error. For instance, after a minor low that you erroneously consider to be of major importance, you may recognize at a higher level that the market is vulnerable again to new lows. This recognition occurs after a clear-cut three-wave rally follows the minor low rather than the necessary five, since a three-wave rally is the sign of an upward correction. Thus, what happens after the turning point often helps confirm or refute the assumed status of the low or high, well in advance of danger.

A Built-in, Objective Method for Placing a Stop

Even if the market allows no such graceful change of opinion, the Wave Principle still offers exceptional value. Most other approaches to market analysis, whether fundamental, technical or cyclical, have no good way of forcing a reversal of opinion or position if you are wrong. The Wave Principle, in contrast, provides a built-in objective method for placing a stop. Since wave analysis is based upon price patterns, a pattern identified as having been 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 apparently completed pattern allows, the conclusion is wrong, and any funds at risk can be reclaimed immediately.

Of course, there are often times when, despite a rigorous analysis, there is no clearly preferred interpretation. At such times, you must wait until the count resolves itself. When after a while the apparent jumble gels into a clear picture, the probability that a turning point is at hand can suddenly and excitingly rise to nearly 100%. It is a thrilling experience to pinpoint a turn, and the Wave Principle is the only approach that can occasionally provide the opportunity to do so.


Those who are new to the Wave Principle sometimes wish that it would identify one wave count on a price chart as the one and only correct count. What they forget is that wave analysis is no magic bullet for seeing into the future, just as no other tool of technical or fundamental analysis is a magic bullet. Like most analytical tools, the Wave Principle involves probabilities. Price charts offer probable wave counts, and an investor must choose the one that seems to be most probable, the next most probable, and so on. The Wave Principle does offer an advantage, though: It provides rules and guidelines that help investors to determine which wave count is most likely and to know when a wave count no longer applies. In this excerpt from Bob Prechter and A.J. Frost's seminal book about R.N. Elliott's Wave Principle, the authors explain why the alternate count matters to anyone who trades.

 picture tells more than a thousand words............. 

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Elliott Wave Principle

Key To Stock Market Profits by Frost & Prechter 
(Expanded Edition1990)

Elliott Wave Principle >>>