The Elliott Wave Principle

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There are two types of Elliott wave patterns:

• Motive (or impulsive waves) which are “trend” waves.
• Corrective waves, which are “counter trend” waves.

Motive (impulsive) waves contain five distinct waves that move the market forward in a trend. Countertrend waves are in 3 waves and simply correct the trend.

All these patterns move at what we call multiple degrees of trend (in other words, the market is fractal, meaning there are smaller series of waves that move in the same patterns within the larger patterns). The keys to analyzing Elliott waves is being able to recognize the patterns and the “degree” of trend (or countertrend) that you’re working within.

Impulsive (motive) waves move in very distinct and reliable patterns of five waves. Subwaves of motive waves measure out to specific lengths (fibonacci ratios) very accurately. Motive waves are the easiest waves to trade. You find them in a trending market.

Waves 1, 3, and 5 of a motive wave pattern each contain 5 impulsive subwaves. Waves 2 and 4 are countertrend waves and move in 3 waves.

Countertrend waves move in 3 waves and always retrace to their start eventually. Countertrend (corrective waves) are typically in patterns — for example, a triangle, flat, or zigzag. Waves within those patterns can be difficult to predict, but the patterns themselves are very predictable.

Trend waves move in 5 waves and partially retrace. The difference in these waves is not covered in “The Elliott Wave Principle” book. There are two types:

• Simple “5-wavers” are found in zigzags, flats, and other nondescript corrective patterns. They have 5 waves, and sometimes the third wave has a recognizable 5 wave pattern, but most of the time, they don’t.
• Impulsive waves require each of waves 1, 3, and 5 to have recognizable 5 wave patterns in their subwaves

Fibonacci ratios run all through the market. They determine the lengths of waves and provide entry and exit points. These measurements are really accurate in trending markets, but more difficult to identify in corrective markets (we’ve been in a corrective market in all the asset classes I cover since 2009).

To use Elliott wave analysis accurately, you must be able to recognize the difference between a trend wave (motive) and a countertrend wave (corrective). There’s very much more to proper Elliott wave analysis, but this gives you the basics.

 The Elliott Wave Principle: Key to Market Behavior by A.J. Frost and Robert Prechter (2005) Ralph Nelson Elliott (1871-1948) spent much of the 1930s studying the way the markets moved. I often wonder what would have happened had Dewey, Elliott, and Wheeler spent some time together. Their theories all intertwine and for the most part, the cycles they discovered run in parallel. Elliott waves are how the market moves. They are heavily based in Fibonacci numbers, which run all through nature and into the cosmos. When the market are running in a trend, they’re highly predicable and measurable. This book can get technical, but if you’ve been in the markets for a year or two, this will make it all come together for you. (Click on the book image to go to Amazon to purchase)

(There were a number of changes that Bob Prechter made to Elliott’s work, not always to good effect. There are many errors in the Elliott Wave Principle book, as I’ve highlighted in previous articles. However, it’s a great tool for learning the basics of Elliott Wave Theory).