Elliott Wave Principle
Elliott Wave is a detailed description of how the markets behave. It is a context for market analysis. Every market decision is both produced by meaningful information and produces meaningful information. It is an effect and a cause. Corrections are necessary for directional market movement.
The 3 consistent aspects of the 5-wave form:
- Wave 2 never moves beyond the start of wave 1
- Wave 3 is never the shortest wave.
- Wave 4 never enters the price territory of wave 1.
Motive waves have 5-wave structures. Corrective waves have 3-wave structure, or a variation of. A complete cycle is an 8-wave pattern of 5 waves (3 motive, 2 retracement = 1,2,3,4,5) followed by 3 corrective waves labeled A,B,C.
During the 3 Corrective waves, a five-wave will form followed by a 3 wave correction in B followed by a 5-wave in C. The mode of a wave is not its absolute direction but its relative direction.
Motive waves are advancing waves. Corrective waves are retracements for both sides of the market.
Action is the primary direction of the larger trend. Reaction is against the larger trend and tends to occur in 3 waves.
9-wave names: Grand Supercycle, Supercycle, Cycle, Primary, Intermediate, Minor, Minute, Minuette, and Subminuette.
Motive waves are labeled with alternating sets of three Roman symbols followed by three Arabic symbols. Minor degree is Roman lower case followed with Arabic lower case.
Actionary waves trend in the same direction as the wave of one larger degree. The Reactionary or counter trend is the wave that trends in the opposite direction of the wave of one larger degree.
All reactionary waves develop in the corrective mode. Actionary waves usually develop in the motive mode; however, some Actionary waves do form in the corrective mode as well.
One of the motive waves (1,3,5) is typically extended and it is often wave 3. There are two rare motive variations called diagonal triangles that appear either only at the start of wave 1 or A or at the end of wave 5 of C of a larger wave.
Corrective waves have 3 main variations:
These can string together to form more complex corrections which are labeled W,X,Y,Z.
Impulse waves 2 and 4 usually alternate in form. One is a zigzag and then the other is not. Corrections usually terminate within the span of wave 4 of the preceding impulse of the same degree.
Motive waves subdivide into 5 waves and always move in the same direction as the trend of the larger degree. Wave 2 always retraces less than 100% of wave 1 and wave 4 always retraces less than 100% of wave 3. Wave 3 always travels beyond the end of wave 1. Wave 3 is never the shortest wave.
There are 2 types of motive waves: impulse and diagonal.
Impulse wave: Wave 4 does not enter the territory of wave 1. Exception: Futures markets, but it is rare.
The Actionary subwaves 1, 3, 5 of an impulse are motive waves, and subwave 3 is an impulse.
Guidelines of impulse formation (extension, truncation, alternation, equality, channeling, personality, and ratio relationships):
Extension is an elongated impulse with exaggerated subdivisions. Impulses usually have an extension in one wave. At times the subdivisions of an extended wave are nearly the same amplitude and duration as the four other waves, giving a total count of 9 waves of similar size rather than the normal count of 5. 9 and 5 have the same technical significance. An extension only occurs in one of the Actionary waves. If the first and third are about equal in length, then the 5th wave can be presumed to be extended. In the stock market, wave 3 is the most commonly extended wave. Wave 3 is never the shortest wave.
Truncation (or failure) often follows a strong 3rd wave. This is a shortened wave 5.
Diagonal Triangle, aka wedge, is a motive pattern but not an impulse as it doesn’t advance price. As with impulses, not reactionary, subwaves fully retrace the preceding Actionary wave. Diagonal triangles are the only five-wave structure in the direction of the main trend in which wave 4 almost always moves into the price territory of wave one. A diagonal triangle can rarely end in truncation. (Note: a diagonal triangle is shrinking price action as the price moves up. It looks like a compressed wave at the end of the pattern.)
The diagonal triangle is similar to standard triangles in that the trend lines converge and a breakout to the upside or downside occurs in the direction of the primary trend.
An ENDING triangle produces a count of 3-3-3-3-3-3. In double or triple threes, they appear on only wave C. They are found at the termination points of larger patterns. In other words, an ending triangle is a reversal pattern. Volume tends to diminish as a diagonal or ending triangle progresses but as it ends, there is often a spike of high volume when a throw-over (reversal) occurs.
A rising diagonal is bearish and is usually followed by a sharp decline retracing back to at least the same level it began. A falling triangle is bullish. 5th wave extensions, truncations, and diagonals mean a dramatic reversal is ahead.
Leading Diagonal occurs in wave 1 of impulse. Wave and wave a position of zigzags. Subdivisions are: 5-3-5-3-5. A leading triangle is a continuation pattern rather than a reversal pattern. The overlapping of wave 1 and 4 and the convergence of the trendlines is the same as a diagonal and ending but the subdivisions are different. The key to identifying a leading diagonal is the very slow price change in the fifth subwave relative to the third.
Markets move against the major trend with difficulty. Corrective waves are thus clearly identifiable. Corrections are never fives. Only motive waves are fives. If a fifth forms then it is a motive wave. Sharp corrections angle steeply against the trend, sideways are sideways.
Zigzag forms a 5-3-5. Types are: single, double, and triple
Flat forms a 3-3-5. Types are regular expanded and running
Triangle 3-3-3-3-3 has 4 types: 3 contracting: ascending, descending, and symmetrical. 1 expanding or reverse symmetrical, aka broadening triangle.
Combination: is 2 types either double three and triple three or ….
Zigzag in a bull market is an A-B-C pattern. 5-3-5. Where B is lower than the start of wave A. Inverted zigzag forms in a bear market. Same configuration. A Double Zigzag or Triple is a repeat of the zigzag pattern and can be an extension of an impulse wave. Second waves are often zigzags but fourth waves rarely are.
The count is W-X-Y-Z with W as the first corrective pattern.
Flat correction is a 3-3-5 pattern moves sideways rather than down or up. B terminates near start of A and C terminates near low of A. Flat corrections usually retrace less than zigzags into the preceding impulse wave. Flats usually occur in stronger trends so are typically found after an extension so are often 4th waves.
Expanding flats is where C extends beyond A and B, and B extends slightly beyond A. If B breaks down into 5 waves it is usually the first wave up of an impulse wave rather than a continuation of a correction.
Triangle corrections are a 3-3-3-3-3 pattern that gets smaller as the action continues and reflects a balance of power between supply and demand and strong breakout on conclusion. A-B-C-D-E is the correct labeling. There are two varieties of triangles; contracting and expanding. Within that is the symmetrical, ascending and descending. And the reverse symmetrical of broadening formation.
Symmetrical has a declining top and bottom is rising to diverge the trendlines:
Descending has a flat bottom and declining top
Ascending has a flat top and a rising bottom
Expanding or broadening has a symmetrical pattern of a rising top and declining bottom trendline. Can be either bull or bear markets for both.
It is common for wave B of a contracting triangle to exceed the start of wave A and this is called a running triangle. All triangles have a net retracement of the preceding wave at wave E’s end.
A triangle always occurs in a position prior to the final Actionary wave in the pattern of one larger degree. Such as wave 4 in an impulse wave B in A-B-C or the final wave X in a double zigzag.
If a triangle forms in the 4th wave, then 5th wave is often swift and can travel the distance of the distance of the widest part of the triangle. This can be an impulse of an ending diagonal.
Combinations are most often zigzags. You can have a flat then any three (zigzag) then a triangle formation. Or a flat then any three then a zigzag. Combinations occur because the first zigzag was not large enough to constitute an adequate price correction so another zigzag occurs.
Triangles alone usually precede the final movement of a larger trend.
An impulse wave has a total count of 5 with extensions of 9 or 13. Corrective waves with a count of 3 have extensions of 7 or 11 or 15.
Orthodox top is the top determined when there is an extreme price move beyond the normal Elliott pattern.
Labels for Actionary waves are 1-3-5-A-C-E-W-Y-Z
Labels for reactionary waves are 2-4-B-D-X
All reactionary waves form in a corrective mode. Most Actionary waves form in a motive mode. Some Actionary waves form in the corrective mode called Actionary corrective waves which are:
- Waves 1,3,5 in and ending diagonal
- Wave A in a flat correction
- Wave A,C,E in a triangle
- Wave W, Y in a double zigzag and a double three
- Wave Z in a triple zigzag and a triple three
Terms that denote Purpose:
Any motive wave upward that is not a corrective mode is termed a progressive wave and labeled 1,3,5.
Any declining wave regardless of mode is a regressive wave. An upward wave regardless of mode that occurs within a corrective wave of any larger degree will be termed a proregressive wave. Both regressive and proregressive waves are part of all of corrections.
Only a progressive wave is independent of countertrend forces.
Bull market is a progressive wave.
Bear is a regressive wave.
Bear market rally is a proregressive wave.
Terms that denote Relative Importance:
Cardinal waves are the essential wave form and are always denoted by numbers as they are the impulse waves. Waves denoted by letters are termed consonant or subcardinal waves because they are components of cardinal waves. 2 and 4 may not serve any other capacity.
Alternations states that if a sharp correction occurs the next wave correction is likely to be a sideways correction and vice versa. Sharp corrections never include a new price extreme or one that moves beyond the orthodox end of the preceding impulse wave. They are almost always zigzags.
Sideways corrections usually include a new price extreme. The concept of alternation is that in one of the two corrective phases there will be a move back to or beyond the top (low) of the preceding impulse and the other will not. What this means is that a double top forms at the high of that impulse wave.
A diagonal triangle does not display alternation between subwaves 2 and 4. Typically both are zigzags. Corrective waves also have alternation. If A is a flat then B is a zigzag.
Depth of correction. 4 waves travel the maximum retracement within the previous 4th wave of one lesser degree.
If the first wave is the extended wave, then the fifth wave will have will limit the bottom of the second wave of lesser degree.
When the fifth wave is the extended wave, then the correction is steep and will find stop at the beginning of the 2nd wave correction. So what forms is an inverse V shape with shoulders. 5th waves are followed by swift retracements.
Two waves in the impulse wave pattern usually are about the same length in time and magnitude. This provides you with a measuring tool when you identify the extended wave, the third wave will be about the same length as the first.
The foremost aim of wave classification is to determine where prices are in the stock markets progression.
Channeling. A parallel channel can be used around wave patterns. If the fourth wave ends at a point not touching the parallel channel you must reconstruct the channel to have it touch in order to estimate the boundaries for wave 5.
A throw-over is when wave 5 exceeds the channel lines and moves on a burst of volume at a more vertical angle. A throw-under is when wave 4 dips beyond the channel and is usually followed by a throw-over.
Scale: Elliott used semi-log scaling. Arithmetic is advised by authors or use both.
Volume: A decline in volume in selling is a decline in selling pressure. Fifth wave primary has less volume than wave 3 often. If volume is greater in 5 than an extension is likely. On rare occasions both 3 and 5 extend on huge volume.
At a primary degree or greater volume tends to be higher in an advancing 5th. Primary degrees tend to run at all time highs. Volume spikes at throw-overs or a diagonal triangle resistance line.
If wave 4 terminates well above the top of wave 1, a 5 wave sequence must be classified as an impulse.
Short term charts for fast moving markets. Long term for slow moving.
Wave Personality considers the aspect of human emotions in the waves. Mass psychology.
First waves are dynamic and only moderately retrace. Second waves end on very low volume. Third waves are strong and easy to identify. With broad participation and strong volume. Third waves produce continuation gaps, volume expansions, and exceptional breadth. Virtually all stocks participate in 3rd waves.
Fourth waves are the alternation and should be different from 2nd waves. Lagging stock build tops and declining during this wave since they only went up due to the overall market strength.
Fifth waves are typically less dynamic than 3rd in terms of breadth and are usually slower and less volume. It is not correct that the market accelerates at peaks (?) During 5th waves optimism runs high despite a narrow breadth. Fifths often do not make new highs.
During an A wave of a bear market, most believe this is just a correction that will end quickly with a resumption of the uptrend. A five wave A indicates a zigzag for B. A three wave A indicates a flat or triangle for B.
B waves are phonies and suggest a return to the upside when they are not. Often the advance is unconfirmed and is mostly caused by odd-lot buying. X and D waves follow this pattern of B wave.
Good breadth is a property of impulse waves not corrective waves. B waves of intermediate degree and lower show a diminution of volume while B waves of primary degree show volume heavier than that of the preceding bull market. This indicates wide participation.
C waves are the final decline and are deep. C waves are persistent and broad. Advancing C waves within upward corrections in a bear market are just as dynamic and are mistaken for the start of a new upswing.
D waves except for expanding triangles have increasing volume. D waves advance within corrective waves are as phony as B waves.
E waves are a secondary type similar to collapsing prices in C waves. Triangles are often the platform for a new downtrend. E waves are as emotional as 5th waves.
Fibonacci and Phi and the Golden Ratio:
Fibonacci lived in Pisa 1170-80 was born. Introduced Arabic numbers to Pisa and math at that time. Before that Roman numbers had been used.
Golden Ratio: the ratio of any number to the next higher number is .618. The ratio to any lower number is 1.618. Phi is the only number that when added to 1 yields its inverse: 1+ .618 = 1/.618.
1.618 X .618 = 1
1 – .618 = .382
2.618 – 1.618 = 1
- No two Fibonacci numbers have any common factors.
- The sum of any ten numbers in the sequence is divisible by 11.
- The sum of all numbers in the sequence up to any point plus 1 equal the number 2 steps ahead of the last one added.
- The sum of the squares of any consecutive sequence beginning at the first 1 will always equal the last number of the sequence chosen times the next higher number.
Golden Section: Any length can be divided in such a way that the ratio between the smaller part and the larger part is equivalent to the ratio between the larger part and the whole. That ratio is .618.
Golden Rectangle: the sides of the rectangle are proportional to 1.618 to 1. Draw a line from the mid point of once side of the square to one of the corners formed by the opposite side. Pythagoras around 550 BC proved that the square of the hypotenuse (X) of a right angled triangle equals the sum of the squares of the other two sides. X(2) = 2(2) + 1(2) or X(2) = 5.
To complete the golden rectangle, extend the line CD making EG equal to the square root of 5 or 2.236. When complete, the sides are proportion of the Golden Ratio so it is a golden rectangle.
Golden Spiral is created using the golden rectangle dividing it into squares within squares. From the center point of those squares you can draw the curve of the spiral at the outer edges of each square. The length of the arc to its diameter is always 1.618. The golden spiral is a type of logarithmic or equi-angular spiral. A spiral implies growth or motion. Euclidean geometric forms don’t.
Pythagoras five point star = phi.
The Fibonacci sequence: Man’s collectively expressed emotions are keyed to this mathematical law of nature. It is the ratio in the Fibonacci sequence that is most important.
Ratio analysis is the assessment of the proportionate relationship in time and amplitude of one wave to another. Market suggests that although not precise retracements the Golden Ratio is present. Every wave amplitude is related to the next adjacent or higher wave amplitude.
Retracements: sharp corrections tend to retrace 61.8% or 50% of the previous wave, particularly wave 2 of an impulse, B of a larger zigzag or X in a multiple zigzag.
Sideways corrections tend to retrace 38.2% of the previous impulse wave, especially wave 4.
Waves have a tendency to divide into sections with the 1.618 or .618 or .382 division. If it divides first at .382 then the next correction may occur at around .618 and vice versa. Triangles will often form with ratios: 1.00 then .618, then .382, then .236.