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The Elliott Wave Principle

In the 1930s, Ralph Nelson Elliott, a corporate accountant by profession, studied price movements in the financial markets and observed that certain patterns repeat themselves. He offered proof of his discovery by making astonishingly accurate stock market forecasts. What appears random and unrelated, Elliott said, will actually trace out a recognizable pattern once you learn what to look for. Elliott called his discovery "The Elliott Wave Principle," and its implications were huge. He had identified the common link that drives the trends in human affairs, from financial markets to fashion, from politics to popular culture.

Robert Prechter, Jr., president of Elliott Wave International, resurrected the Wave Principle from near obscurity in 1976 when he discovered the complete body of R.N. Elliott's work in the New York Library. Robert Prechter, Jr. and A.J. Frost published Elliott Wave Principle in 1978. The book received enthusiastic reviews and became a Wall Street bestseller. In Elliott Wave Principle, Prechter and Frost's forecast called for a roaring bull market in the 1980s, to be followed by a record bear market. Needless to say, knowledge of the Wave Principle among private and professional investors grew dramatically in the 1980s.

When investors and traders first discover the Elliott Wave Principle, there are several reactions:

• Disbelief – that markets are patterned and largely predictable by technical analysis alone
• Joyous “irrational exuberance” – at having found a “crystal ball” to foretell the future
• And finally the correct, and useful response – “Wow, here is a valuable new tool I should learn to use.”

Just like any system or structure found in nature, the closer you look at wave patterns, the more structured complexity you see. It is structured, because nature’s patterns build on themselves, creating similar forms at progressively larger sizes. You can see these fractal patterns in botany, geography, physiology, and the things humans create, like roads, residential subdivisions… and – as recent discoveries have confirmed – in market prices. 

Natural systems, including Elliott wave patterns in market charts, “grow” through time, and their forms are defined by interruptions to that growth.

Here's what is meant by that. When your hands formed in the womb, they first looked like round paddles growing equally in all directions. Then, in the places between your fingers, cells ceased growing or died, and growth was directed to the five digits. This structured progress and regress is essential to all forms of growth. That this “punctuated growth” appears in market data is only natural – as Robert Prechter, Jr., the world's foremost Elliott wave expert and president of Elliott Wave International, says, “Everything that thrives must have setbacks.”

 

 

 

 

 

 

 

 

 

 

The first step in Elliott wave analysis is identifying patterns in market prices. At their core, wave patterns are simple; there are only two of them: “impulse waves,” and “corrective waves.”

Impulse waves are composed of five sub-waves and move in the same direction as the trend of the next larger size (labeled as 1, 2, 3, 4, 5). Impulse waves are called so because they powerfully impel the market.

A corrective wave follows, composed of three sub-waves, and it moves against the trend of the next larger size (labeled as a, b, c). Corrective waves accomplish only a partial retracement, or "correction," of the progress achieved by any preceding impulse wave.

As the figure to the right shows, one complete Elliott wave consists of eight waves and two phases: five-wave impulse phase, whose sub-waves are denoted by numbers, and the three-wave corrective phase, whose sub-waves are denoted by letters.

What R.N. Elliott set out to describe using the Elliott Wave Principle was how the market actually behaves. There are a number of specific variations on the underlying theme, which Elliott meticulously described and illustrated. He also noted the important fact that each pattern has identifiable requirements as well as tendencies. From these observations, he was able to formulate numerous rules and guidelines for proper wave identification. A thorough knowledge of such details is necessary to understand what the markets can do, and at least as important, what it does not do.

You have only just begun to learn the power and complexity of the Elliott Wave Principle. So, don't let your Elliott wave education end here. Join Elliott Wave International's free Club EWI and access the Basic Tutorial: 10 lessons on The Elliott Wave Principle and learn how to use this valuable tool in your own trading and investing.

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Realtime Elliott Wave Structures 

(c) ELLIOTT today, December 2005

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 Essential Design  

 

Source: Elliottwave International

 

 

1) 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.    

 

 

DJIA, August 1998 - January 2000

The "Five Wave Structure"

 

 

Figure 1

 

In his 1938 book, The Wave Principle, and again in a series of articles published in 1939 by Financial World magazine, Elliott pointed out that the stock market unfolded according to a basic rhythm or pattern of five
waves up and three waves down to form a complete cycle of eight waves. The three waves down are referred
to as a "correction" of a preceding five waves up. The basic concept of five waves in the direction of the main trend following by three corrective waves is shown in real-time on the chart of the DJIA from August 1998 to January 2000. 

The impulse subdivides into five waves, which may be labeled 1,2,3,4 and 5.

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). DJIA September 1986 - August 1987

Elliott Wave Princple>>>

 

 

The Five-Wave Structure
In The S&P500 10min Chart

S&P 500 Index (SPX) 7/13/04-7/19/2004

 

 

Figure 2

 

A clear five-wave structure of small degree from the high of wave IV can be seen on the chart. Wave 3 is not the shortest wave and wave 4 did not move beyond the end of wave 1. On a smaller degree, waves i,iii and v as labeled on the chart, each subdivide into five waves. Waves ii and iv each subdivide into a corrective pattern. 

The guideline of alternation touches almost every aspect of The Wave Principle and is a useful one to keep in mind when analyzing wave formations and assessing future possibilities. the guideline tells us to expect alternating patterns in virtually all wave movements. If, for example corrective wave two cuts sharply against the trend, expect wave four to be a sideways correction, and vice versa. Figure 1 shows the most characteristic breakdowns of impulse waves, both up and down, as suggested by the guideline of alternation. Waves i and iii formed almost exactly the same pattern (!), a 5-3-5 zigzag, therefore, the count violates the guideline of alternation and should be considered wrong. Figure 2 shows an alternate count. Elliott Wave Princple>>>

 

 

The Five-Wave Structure
In The S&P500 10min Chart

S&P 500 Index (SPX) 7/13/04-7/19/2004
Alternate Count

 

 

Figure 3

 

Elliott used parallel trend channels to assist in determining normal wave targets and
to provide clues to possible development of trends. In The Wave Principle, he asserted
that as a wave progresses , "it is necessary that the movement be channeled between
two parallel lines." He regarded trend channeling as an important tool in establishing
wave completion targets and in the segregation of individual waves.

Here I labeled the second wave, wave ii as a more complex correction, a double three
a-b-c x a-b-c. Note, the first a-b-c as an "expanded flat", a 3-3-5 structure and the
second a-b-c as a "running flat." This is a rare variation on the 3-3-5 flat , which 
we call a "running correction," Wave b terminates well beyond the beginning of wave 
a as in an expanded flat, but wave c fails to travel its full distance, falling short of
the level at which wave a ended. Elliott Wave Princple>>>

 

S&P500 Chart,10min., 7/23/04 - 7/29/04

 

 

Figure 4

 

From the wave iv high at 1105 the market declined to below 1080 tracing out another 
five-wave structure. On 7/26/04 the market retraced sharp and formed a clear cut 
five-wave structure in the opposite direction. This first wave up was labeled as wave a
of a possible larger a-b-c. On 7/28 the market fell sharply and the steep decline looked
impulsive. Notice that while impulse waves have a total count of 5,9,13 or 17 waves, and 
so on, corrective waves have a count of 3,7, or 11 waves , and so on. In this case, the 
S&P traced out 7 waves down. Therefore the labeling is correct. Another helpful tool in 
this case was the fact, that prices hit the lower channel line of the midline (yellow dotted)
exactly to the minute.

From of the low of 7/28/05 another sharp advance started tracing out three waves.
The arrow at the top of the chart points to the previous fourth wave, a natural stopping
point. Although wave iii has not yet reached wave iv, wave on the other hand, did. From
here the market declined sharply in a five-wave affair, i.e., wave c of an expanded flat
(3-3-5). Elliott Wave Princple>>>

 

S&P 500 Daily Chart  6/7/2004-8/2/2004 

 

Figure 5

 

Here is the daily chart from June 7 to August 2,2004. The S&P500 reached 1108.60 and 
completed a three-wave structure from the low of 1078.78. The high of 1108.60 should 
be labeled wave b of the second a-b-c of a double zigzag correction. Nevertheless, the
sharpest decline followed and the S&P500 lost almost 40 points in four trading days.
On August 13, 2004 the S&P 500 Index bottomed at 1060 and completed a five-month
corrective pattern. Elliott Wave Princple>>>

 

 

2) Special's: 

Expanding Triangles

 

 

Figure 6

 

There are several real life examples of triangles in the charts of this website. As you
will notice, most of the subwaves in a triangle are zigzags, but sometimes one of the 
subwaves (usually wave c) is more complex than the others, and can take the shape
of a regular or expanded flat. In rare cases, triangles will protract into nine waves, so
that one of the subwaves (usually wave e) itself is a triangle. Thus, triangles, like 
zigzags, occasionally display a development which is analogous to an extension. 
One example occurred in the SPX 7/12/04 to 7/16/04 on a 10minute chart.

On July 13,2004 the S&P500 formed a small degree contracting triangle for wave b of b.
On July 15,2004, the S&P500 formed another small degree contracting triangle for 
wave e  of a higher degree expanding triangle. Elliott Wave Princple>>>

 

 

 

3) Wedges 

Expanded Wedge

 

 

 

 

 

 

 

 

 

 

 

Figure 7

 

R.N.Elliott observed a pattern in the market that he named a "diagonal triangle." 
Figure ..shows a classic diagonal triangle, a 3-3-3-3-3 pattern within converging lines 
that slope in the same general direction (up in a bull market, down in a bear), unlike 
the converging lines of a corrective-wave triangle, which slope in opposite directions.
This pattern always appears as the final wave in an impulsive or corrective pattern;
it is usually wave five, but sometimes wave C. Knowledge of the diagonal triangle has 
been indispensable to several of the most dramatic calls - to the day or hour. 

 

 

Figure 8

 

Contracting triangle wave b, leading diagonal triangle wave 1 of an expanding wedge (wave c).

 

4) Diagonal Triangles

Ending DT, Leading DT

Diagonal Triangle Wave C
(Ending DT)
DJIA, 15min., April12,2002

Figure 9

 

Diagonal triangle. Ending Pattern. A "diagonal triangle" is a special type of wave which occurs primarily in the fifth wave position at times when the preceding move has gone "too far too fast", as Eliott put it. A very small percentage of diagonal triangles occur in the C wave position, usually as the last C wave in a double or triple three. In either case, they are phenomena which are found at the termination points of larger patterns, indicating exhaustion of the larger movement. (EWP, p.31). Elliott Wave Princple>>>

Leading Diagonal Triangle, Type 2

Figure 10

 

Diagonal Triangle Type 2. When diagonal triangles occur in the fifth or C wave 
position, they take the 3-3-3-3-3 shape that Elliott described. However, it 
has recently come to light that a variation on this pattern will be found in the 
A wave position of zigzags and in the first wave position in "fives" in very rare
cases. The characteristic overlapping of waves one and four and the convergence
of boundary lines into a wedge shape remain as in the standard diagonal 
triangle. However, the subdivisions are different, tracing out a 5-3-5-3-5 
pattern. (EWP, p.47) Elliott Wave Princple>>>

A leading diagonal triangle (Type 2) can be seen on the chart of the DJIA.
The structure of this formation fit the spirit of the Wave Principle in that the 
five-wave subdivisions in the direction of the larger trend communicate a
"continuation" message as opposed to the "termination" implication of a 
three-wave subdivisions in the standard diagonal triangle. 

5) The Fourth Of The Third

July 2002, Elliott Wave International published an article to subscribers, entitled 
"The Fourth Wave of the Third Wave" and pointed out, "whithin most five-wave 
declines, there is one point that repeatedly provides , in the ensuing upward 
correction, both a magnet for rising prices and a ceiling of resistance for further 
advance. That point is the (usually small) fourth-wave rally within the third wave
down. The level of the "fourth of the third" wave is a reliable target for a rally
when wave four peaks lower than wave four of three and when the third wave is
fairly long relative to the first wave." 

This is actually the most common development, so the target is often applicable.
this target is less often valid when wave five is extended , in which case the
ensuing rally generally tops between the peak levels of wave two of five and wave
four. 

This target is almost never valid when the first wave is extended because, by the 
rules of wave construction, wave three is then shorter than wave one , and wave 
five is even shorter than wave three. In these cases, the ensuiung rally typically
carries to around the peak of the preceding wave two or even wave four of one. 
This retracement is not common to reactions in bull markets. It seems to come into
play after a short fifth wave. Normally, though, the area of the preceding fourth 
wave is the most common target for bull market corrections. (EWT, 02/07).

 

 

S&P500 Index (SPX), 10min., 10/04-10/09/2002

Figure 11

 

As can be seen on the chart (figure 7) wave c of 4 of the expanded flat retraced back 
to the area of the "fourth wave of one lesser degree", as outlined in EWP. Even more 
important, waves a and (iv)on October 4 and october 7, both retraced back to the 
"fourth of the third." Readers will note, that wave a of the expanded flat correction
from October 8 to October 9, 2002 "stretched" up and could be misleaded as a "five". 

S&P 500 Index, (SPX), 60min., 03/16-04/12/2005 

Figure 12

 

The 60minute chart of the S&P 500 Index as shown in figure 10 displays a similar 
picture as in figure 9. This time around the S&P 500 Index formed a 3-3-5 flat 
correction after touching a low on March 29,2005. Again, the upward correction 
stopped almost exactly at the "fourth of the third", this time at the end of wave
e of a rising wedge, which ended on March 22,2005. 

It is interesting to observe, that on March 22 wave e of iv ended with a wedge shape
formation (diagonal triangle) and about the same level on April 8 ended a DT in wave v
of (c) of 2. The entire structure from the low of March 29 to April 8 counts as a flat.

 

 

Depth Of Corrective Waves
March Crude Oil, February 12,2005

 

Figure 13

 

No market approach other than Elliott gives as satisfactory an answer to the question, 
"How far down can a bear market be expected to go?" The answer to this question alone
is sufficient importance to entitle Elliott to a special place in market analysis, as only the 
Wave Principle can tell the investor what reasonable to expect. In November 2004 Crude Oil
finished a five-wave structure, as wave (v) of 5 reached exactly the upper parallel of a 
classic Elliott trend channel. From that top the market traced out a clear three-wave
structure labeled (a)-(b)-(c) which in Elliott terms is named a zigzag (5-3-5). 

As you can see on the chart wave (c) ended right in the area of the previous fourth wave 
of one lesser degree (see arrow). Indeed the market started an advance to about $50.00. 
I may add, that retracement ended short of a 0.618 Fibonacci retracement, too. 

 

 

6) The Fibonacci 0.618 Retracement

DJIA, 10min., 09/16/04-09/22/04

 

 

Figure 14

 

A classic 0.618 Fibonacci retracement. The Mid-Line technique did a pretty good job to identify possible targets for a countertrend-rally. The intersection of the Fibonacci 0.618 retracement together with the ML (dotted line) gave strong indication that the market has run its course. (10.270)

 

 

DJIA, 10min., 11/17-11/17/2004

 

 

 

Figure 15

The chart displays four retracements as they occured live in the DJIA:
0.382, 0.50, 0.618 and 0.786.

 

 

SPX, 10min., 11/23/2004

 

 

Figure 16

 

Starting with a small-degree five-wave decline (i,ii,iii,iv and v) the ensuiung correction 
traced out a three-wave structure. Wave b of the three-wave structure traced out a 
contracting triangle.  Since triangles as a general rule occur only in positions prior to the 
final movement in the direction of the larger trend, i.e., as wave four or B, the next move
of importance is considered down. From 1185 to 1168 the S&P 500 lost -17 points and 
again formed a "five-wave structure" down. The following correction again traced out
what looks like a "three", an a-b-c x a-b-c double zigzag correction. Note the declining 
momentum as indicated by the RSI (bottom blue line) as the second a-b-c progresses. 
Again, the market stopped shy of a 0.618 Fibonacci retracement of the preceding decline.

 

Example Of A 0.885 Retracement
S&P 500 Index (SPX)
February 2000-December 2000

 

Figure 17

 

The Top in the S&P 500 Index (SPX) on March 24,2000. In a relatively short time
the index delined -16% (1553-1339). Again, the form gave an early warning of 
more to come to the downside. A rising wedge is considered a very bearish pattern. 
(1339-1530).

 

 

7) Time & Price
(c) ELLIOTT today, March 12,2000

 

 

Figure 18

Time & Price displays the Fibonacci ratio. 

 

 

 

DJIA, September 1986-August 1987

Elliott Channel, Five Wave Structure, Triangle, Fibonacci & Time

 

 

Figure 19

 

The famous crash of October 1987 occurred like textbook Elliott. On August 25,1987 a five-wave structure of Intermediate degree from November 1986 completed a larger degree Primary degree [3] from 1980. The following "crash" corrected 50% of the distance 729 to 2733*. (*2733 is the hourly high on August 25,1987). TimeZone did a pretty good job to nail the top in time, because a web of Fibonacci time relationships came together on August 25,1987. From an Elliott point of view, the market reached the upper channel line of a classic Elliott trend channel and it was time for a reversal.

 

 

 

 

The Famous 61.8% Fibonacci 
Retracement In Nasdaq of 2000

(c) ELLIOTT today, August 2000

Figure 20

 

Nasdaq Composite: A classic 61.8 % Fibonacci Retracement:

5039 - 3042 = -1997. 1997 x 0.618 = 1234.14
3042 +1234.14 = 4276.14 (+/-2.14)

More examples of 0.618 Fibonacci retracements in the markets>>>

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Chart: futuresource.com

Figure 21

 

December DAX 2002, 60min.: Here we have a triangle in the 4th wave position (left on the chart), a five-wave advance and a five-wave decline. Next, there is a 0.618 Fibonacci retracement of the preceding decline together with a three-wave structure. The following decline was sharp, (wave iii) as it should be. The following "sideways" movement traced out a clear contracting triangle (in Elliott terms) and retraced 0.382 of the preceding decline. Since triangles precede the final wave in a five-wave sequence, the five-wave decline to 3040 marked the end of the movement from 3480, at least temporarily and the ensuing correction should terminate in the area of the 4th wave of one lesser degree: and it did so in textbook fashion. 

 

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.

 

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. (The Wave Principle Of Human Social Behavior, 1999, Robert R. Prechter.) 

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 sixty 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.)

"According to the rules and guidelines of the Wave Principle, the most important is wave pattern. The biggest signal that the bear market is underway was the five wave decline in the S&P 500 and the NASDAQ Index from March 2000 to September 2001. Those patterns are unmistakable. They say in no uncertain terms that the major trend is down. 

The internal wave structure supports the outlook for an ending diagonal triangle for wave C. EWP, p.31: “Diagonal triangle take wedge shape within two converging lines, with each subwave, including the impulse waves, subdividing into a ‘three’. A rising wedge is bearish and is usually followed by a sharp decline retracing at least back to the level where the diagonal  triangle began.”  

 

 

 

Pattern or Coincidence?

 

 

 

Source: Elliottwave International

 

 

 

S&P 500 ChartMap>>>

Elliott Fractals>>>