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Tight rope Faller Wide 000

Elliott Wave

ELLIOTT WAVE GUIDE

CONTENTS

LESSON 1: Introduction to Elliott Wave

LESSON 2: Cycles Patterns and Waves

LESSON 3: Elliott Wave Formation

LESSON 4: Elliott Wave Channels

LESSON 5: 

LESSON 6:

LESSON 7:

LESSON 8:

LESSON 9:

LESSON 10:

GLOSSARY

Elliott Wave Cycles, Patterns and Waves

 

Lesson 2:
Cycles, Patterns and Waves

Waves
Patterns
Cycles
A Deeper Look
Rules Governing Motive Waves
   Extensions
   Failures/Truncations
   Diagonals, Ending Diagonals, and Leading Diagonals
Rules Governing Corrective Waves
   Zigzag Patterns
   Flat Patterns
   Triangle Patterns
   Combinations
Practice Makes Perfect
Summary

 


Waves

Waves are in essence the “smallest unit of measure” inside the EWT universe.  Waves come in two varieties:  Up (price increasing) or Down (price decreasing).  In the parlance of the theory, these are referred to as Impulse waves (upward movement) and Corrective waves (downward movement).

Spotting individual waves on a price chart is a lesson in simplicity.  If you’re looking at a line segment showing the price moving higher, you’re looking at an impulse wave.  If you’re looking at a line segment showing the price moving lower, you’re looking at a corrective wave.

By themselves, waves don’t really tell you much.  It is only when you begin looking at them in patterns and cycles that you begin to make astonishing discoveries.

When looking at Elliott Wave Pattern charts, you’ll see Impulsive Waves enumerated 1,2,3,4, and 5, with waves 1,3, and 5 pushing the price higher, and waves 2 and 4 being corrective actions within the impulsive wave, drawing the price down.

Corrective waves will be denoted A, B and C, with waves A and C pushing the price lower, while wave B is impulsive (within the corrective wave pattern), representing a brief countertrend that tries to pull the price back to a higher level before it plunges further (wave C).

Another way of saying it is this:  An impulsive wave is made up of five “wavelets,” three providing the momentum that pushes the price higher, and two being corrective in their nature, representing a hesitation or pause (and temporary lower price) during the upsurge.

Then comes the corrective wave, which pushes the price down, with a brief corrective action (wave B) which tries to bring the price higher, before continuing downward.  Collectively, this eight wave set (five impulsive, three corrective) represents in a nutshell, the basic mechanism that describes the market’s overall behavior.

Of course, it should be noted that this is a model, and models are simplified versions of reality.  There’s nothing magical about the numbers three or five, save for the fact that these represent the minimum (and thus, most efficient) wave forms that allow for price increases and price decreases. 

It is possible that you’ll see impulse waves consisting of more than five discrete “wavelets” and corrective waves consisting of more than three “wavelets” but markets tend to be highly fluid and efficient, and the vast majority of the time will follow the path of least resistance.  Often enough that these terms (5-wave impulse and 3-wave corrective) have become accepted conventions.

Patterns

Here’s where we start getting into the nuts and bolts of the thing.  Remember that Wave Theory is fractal, so individual waves are themselves made up of advances and reversals.  In fact, Elliott discovered that an Impulse Wave is in fact made up of a series of five sub-waves, moving in the same direction of the trend of the next larger size (see “Cycles” below).

Let’s look at a basic (conjectural) 5 wave impulse pattern.

Wave one is strongly up, with the price moving higher.

Then there’s a pullback, with wave two sending the price back down a bit.

Wave three again sends the price higher, with another pullback indicated by wave four, and finally, the pattern completes with the fifth wave pushing the price higher still.

((a simple graphic for here maybe?  Like fig. 1-1 in the ten part course you had sent me several months ago))

You can almost imagine the psychology behind these price movements.

As the price starts higher on wave one, there’s a growing feeling of uncertainty among a certain subset of the market.  These “nervous Nellies” sell their positions, fearing a downturn, which becomes a self-fulfilling prophecy (creating wave 2).

Other buyers, sensing an opportunity to “cash in on the wave” start buying, which creates wave 3, and we see the same kind of uncertainty creep into the equation which creates wave four, before the final push higher in wave five.

This psychology is everywhere in crowd behavior, which is why EWT can be applied to any aspect of human society.  It just happens that financial markets are a perfect laboratory to see this in action, in real time and in chart form.

A couple of interesting things to note about this, our very first chart.

First, make note of the fact that the “Impulse Wave” is actually comprised of five separate waves.  For our purposes, and to keep from using the word “wave” in different ways, we’ll informally call these individual waves “wavelets.”  That’s not standard EWT lexicon, but if you’ve never been exposed to the theory before, this is an easy way to differentiate between the overarching wave pattern and its individual components. 

We’ll gradually stop using the term as you get deeper into this guide, on the thinking that as you continue to read, you won’t be thrown off when the same word is used to describe both the pattern and its individual components.

Second, observe that the wavelets that make up the Impulse wave are labeled at their endpoints.  The “1” in wavelet one is listed at the end of that wavelet.  Wavelet 2 begins at wavelet 1’s endpoint, and continues on through the trough, where wavelet 3 begins, and so on.

When the peak of the five-wave impulse is complete, we see a three-wave corrective pattern, where the price drops (but of course, it does so in an uneven fashion), which signals the beginning of another impulse wave cycle.

((something like “Figure 1” in the ebook you sent me would be a good graphic for here))

Again, it’s important to point out that this is the basic model.  By itself, it is extremely useful, but there’s another important dimension required to fully explain market behavior, and that is the “degree” of the wave and pattern. 

That’s where cycles enter the picture.

Cycles

All waves can be categorized by degree or relative size.  It’s important to remember that the basic pattern is a fractal one, and repeats itself infinitely, with smaller wave movements building on, and feeding into ever larger wave pattern movements.  These larger and larger movements are referred to as cycles in EWT parlance, and cycles are effectively measures of degree. 

If you were to look at a price chart of the entire history of the stock market, you would very clearly see this in chart form.

Some price movements (up or down) are barely blips on the radar, while others are big enough to be notable and interesting, and some are truly epic movements that completely redraw the pricing map.

Broadly speaking, Ralph Elliott broke patterns into nine distinct possibilities.  These are as follows:

  • Grand Supercycle
  • Supercycle
  • Cycle
  • Primary
  • Intermediate
  • Minor
  • Minute
  • Minuette
  • Sub-Minuette

Essentially, these cycles describe the degree of each wave set.

This is extremely important, and understanding cycles is pivotal to making sense of the way Elliott Wave charts are labelled.  Here’s the standard way different cycles are enumerated in order to highlight their respective degree:

Another important thing to keep in mind is that in Elliott Wave Theory, the word “cycle” doesn’t mean what it means in day to day usage.  That is to say, “cycles” are not sets of impulsive and corrective waves in sequence (although they are that, by definition), but rather, a term used to describe the degree of price movement, up or down.

This is one of the reasons that EWT is said to be highly subjective.  Often there is sharp disagreement about exactly what different practitioners are seeing, because wave degree is not a function of any specific price or length of time.

Don’t worry too much about this though – you don’t have to know the precise degree of a given wave in order to conduct good analysis.  What’s far more important is the relative degree.

Waves themselves are defined (and dependent) on their form, which itself is a function of both time and price, while the degree of a form is a function of its size and position relative to its constituent parts, adjacent waves, and other, encompassing waves.

A Deeper Look

  • Within impulsive waves (set of five), one of the odd-numbered waves is usually, but not always longer than the other two.  Typically, this will be wave 3, but that’s not always the case.  Most impulsive waves move between parallel lines, although wave five will sometimes unfold inside a diagonal triangle, which is to say, between lines that are converging, rather than running in parallel.

    A variety of patterns have been identified inside the corrective waves of an impulse pattern, which create complex substructures.  These are often defined with terms like “double-three,” “zig-zag,” “triangle,” and “flat,” which are simply used as a convenience to describe the various forms they take.

    Within a corrective wave, you may see smaller-degree impulsive waves in A and C, but wave B will always be the corrective wave and will consist of three sub-waves moving against the larger downward trend.

    There are a couple of incredibly interesting things about waves and the various forms they take.

    The first is that every piece of information you get when you look at a price chart is informed by one or more pieces of information, and simultaneously, is itself, an important piece of information for future decision making.

    Further, it’s important to note that every wave in existence (literally each and every one) serves exactly one of two possible functions.  It is either an action or a reaction.  A wave may either advance the cause of its impulse or correction (action) or it may serve to interrupt it (reaction).  Wave function then, is determined by how it is acting and interacting with whatever type of wave pattern it is embedded in.

    Look back at the classic five wave impulse pattern.  Waves 1, 3, and 5 represent action as they all serve to propel the price higher.  Waves 2 and 4 are reactive, because they respond to the price being pushed higher by interrupting what would other be a straight-line progression.

    When looking at a corrective wave, we see the same thing.  Waves A and C represent action, propelling the price lower in keeping with the wave form, while wave B is a correction, temporarily interrupting the downward pressure on the price of the asset.

    This reveals another important convention of Elliott Wave Theory:  Odd-numbered (and lettered) waves are action waves and even-numbered (and lettered) waves are reactive waves.

Rules Governing Motive Waves

Okay, so having outlined in broad terms how the overarching theory works, let’s drop back down to the wave level and take a closer look at each type, starting with Motive Waves.

Remember, motive waves are actually comprised of five “wavelets” numbered 1,2,3,4, and 5.

As we mentioned in the last section, the odd-numbered waves (1,3, and 5) are action waves, propelling the price higher, while the even numbered waves (2,4) are corrective in their nature in that they interrupt the upward climb of the price.

But there’s more:  Elliott observed several commonalities when studying large numbers of impulse waves, including the facts that:

  • Wave 2 never retraces more than 100% of wave 1
  • Wave 4 never retraces more than 100% of wave 3
  • Wave 3 always pushes the price higher than wave 1
  • Wave 3 is often (but not always) the longest of the five wave set
  • Wave 3 is never the shortest of the five wave set

We should also note here that there are actually two types (variants) of motive waves:  Impulse and Diagonal Triangle.  Of the two variants, Impulse is far and away the most common. 

In an impulse wave, wave 4 never crosses into the territory of wave 1, provided that the market is unleveraged.  When you introduce leverage into a market (allowing people to buy “on the margin”) you can see wild, unexpected price swings that will cause this not to be the case.  Even then though, it’s an extremely rare event, and usually caused by extraordinary circumstances.


Extentions

Many (but certainly not all) Impulse waves contain what R. N. Elliott referred to as “extensions.”  These are impulses that have exaggerated sub-divisions and are, for lack of a better word, “elongated.”  In most cases where an extension exists, it will occur in exactly ONE of the impulse waves, which will be notably longer than all the others.  Usually (but again, not always), wavelet 3 will be where the extension is found, and sometimes, the extended wave is nearly the same amplitude as the other four waves constituting the impulse.

When and where this occurs, you may even see a nine-wave set, rather than the standard five-wave impulse.  If you find yourself scratching your head about this, the following figure should help to clarify:

 

Extensions

((this is figure 1-5 from the 10-part course you had sent me many moons ago…you may want to tweak/modify so we’re not using exactly the same material, but I wanted to post the image for clarity).

Given that extensions normally occur on only one actionary wavelet, this can serve as a useful predictive tool.  In other words, if wavelets 1 and 3 are about the same length before a correction occurs, then you can assume with high degree of confidence that wave 5 will be significantly longer and represent a sustained surge in price.

In a similar vein, if the protracted surge occurs in wave 3, then you can assume that in almost all cases, wave 5 will much more closely resemble wave 1 in its amplitude.

This is of special significance, especially to short-term traders.  Knowing that one of the impulse waves is likely to be extended, if you want to maximize your profits, then you want to make sure you can identify when those extensions are likely to occur, because that’s where the bulk of your profits are going to be made.  If you close out your position early (before the extension), you’re essentially leaving money on the table.

Long term traders won’t pay as much attention to any particular wave pattern on a given day, but it still matters as you inch closer to the time when you want to sell to lock in your profits.  If you only master one skill where Elliott Wave Theory is concerned, focus on identifying when those extensions will occur (and again, bear in mind that the vast majority of the time, the extension will occur in wave 3.  Just knowing that single fact can make you a tidy sum).

This is where things can get both interesting and infuriatingly complex.   Extensions can sometimes occur within extensions.  Check out the following illustration of how that happens, and what the chart looks like when it does:

((this is figure 1-9 and 1-10 from the ten part course, and again, you may want to tweak it slightly))

Note that the graphic illustrating the “Fifth Wave Extension” isn’t something you will see terribly often.  If you trade in commodities markets, and there’s a strong bull market, you may see it, but otherwise, consider it a rarity.

 

Failures / Truncations

When R. N. Elliott first penned his work, he used the term “failure” to describe situations where wavelet 5 failed to advance beyond the territory captured by wavelet 3.  In more recent times, this circumstance has come to be described as a “truncation” but should you see the older term used, just understand that they’re both describing the same phenomenon. 

Most commonly, you’ll see this occur when wavelet 3 is particularly strong.  Here are a couple of examples to illustrate:

Bear Market Truncation

((these figures are 1-11 and 1-12 from the ten part course and again, you may wanna tweak to make them unique – just needed to include them to provide a graphical reference to go with the description))

While these do happen, large amplitude truncations are rare.  In fact, there have only been a couple of examples in the history of the stock market.

The first occurred in 1962, during the Cuban Missile Crisis, and followed the crash depicted as wavelet 3.

The second occurred toward the end of 1976 and followed on the heels of an extended surge (wavelet 3) that occurred between late 1975 and early 1976.

 

Diagonals, Ending Diagonals and Leading Diagonals

Earlier, we mentioned that there were actually two variants of impulse waves:  Impulsive and Diagonal.  Bear in mind that diagonal waves are not nearly as common, so don’t expect to see them cropping up day to day, but even so, it’s important that we outline what they are and how they differ from traditional impulse waves so you recognize them when you see them.

Diagonal waves obey most of the same rules as impulse waves in that none of the corrective wavelets fully retrace the actionary wavelet that came before it, and the third impulsive wave is never the shortest, but there’s a key difference:  Wavelet 4 almost always overlaps with wavelet 1.

Every once in a while you may see a diagonal wave that ends in a truncation, but honestly, you could go your entire trading career without ever actually seeing that happen, so while it’s worth mentioning, it’s not something you need to be concerned about as a practical matter, and even if you do see it, the truncation will be exceedingly mild.

There are two additional subsets of diagonals:  Ending and Beginning, and we’ll take a closer look at both of those next:

The Ending Diagonal

This is a very special subset that almost always occurs in the position of wavelet five if and where the preceding actionary waves have been unusually long (representing a significant runup in price that many in the market may fear is “too much, too quickly.”

About the only place these types of waves are found are at the termination points of some larger pattern, and they have a definite sense of finality about them.  When you see one of these, you know that the larger pattern has been exhausted, and is at an end.

This wave form invariably takes on a wedge-shaped structure within a pair of converging lines.  If you’re having trouble visualizing that, then the graphic below will help make it clearer:

((these are figures 1-15 and 1-16 from the ten part course))

The reason it’s important to learn to spot these patterns is that when you see this, or a truncation, it means exactly one thing:  You can expect the market to dramatically change direction in the period ahead.  These formations only occur at the end of a big surge, or a big decline.

The Leading Diagonal

This is something else that you’ll almost never see, but again, it’s worth mentioning it so you’ll recognize it if and when you do see it.  Once in a great while, you’ll see a diagonal appearing in wavelet 1 (impulse) or position A (corrective).

Since they only rarely occur, the big danger when they do crop up is that you’ll misidentify what you’re seeing, and wind up labeling this as 1,2 wavelets.

If you do see a leading diagonal, you can expect to see a steep correction immediately following, as indicated in the following chart:

Leading Diagonal

((this is figure 1-21 from the ten part course))

Rules Governing Corrective Waves

If the market is moving strongly in a given direction, then movements against the grain happen only with great difficulty.  While it cannot be said for certain, this may explain why corrective waves tend not to develop the same five-wave structure and exist in compressed form.

Whatever the reason, one thing has been proved correct via the analysis of thousands of wave patterns over time.  Corrective waves are never five-wave patterns.

Unfortunately, market dynamics make corrective waves more highly variable than impulsive waves.  Not only do they exist in a greater number of varieties and permutations, but they occasionally increase or decrease in their complexity as the market move unfolds, which can make interpreting what you’re seeing quite a challenge, even for an experienced EWT practitioner.  It’s very easy to mistake waves of the same degree for waves of an entirely different degree.

All that to say that when the market is trending downward, you, as the analyst, must exercise somewhat more care and caution than you would when the market is trending upward.

Broadly speaking, corrections take one of two forms:  Sharp corrections and sideways corrections.  Despite the name of the second variant, both forms of corrections wind up producing a net retracement of the preceding motive wave, but they arrive at that position by way of very different paths.

Breaking it down further, we find three basic categories or groupings of corrective patterns, with each pattern having various sub-types associated with them.  These are:

  • Zigzag (5-3-5)
    • Single
    • Double
    • And Triple
  • Flat (3-3-5)
    • Regular
    • Expanding
    • And Running
  • And Triangle (3-3-3-3-3)
    • Contracting
    • Barrier
    • And Expanding

We’ll cover each of these in detail in the sections that follow.

Zigzag Patterns

The single zigzag is obviously the easiest pattern to identify.  In a bull market, it’s the classic three-wave declining pattern you’d expect.  You find a 5-3-5 subwave sequence, with the peak of the “B” wave being notably lower than the start of the “A” wave.  Here’s a quick illustration to make that more clear:

((this is figure 1-22 and 1-23 from the ten part tutorial you sent me))

In a bear market, the zigzag correction obviously takes place in the opposite direction and you’ll sometimes see it referred to as an “inverted zigzag.”

Doubles and triples (two or three zigzags happening in rapid succession) only rarely occur, but it’s still important to make mention of them.

In cases where they occur, they’ll invariably be interrupted by an intervening 3-wave set, which acts as a separator between them and at least makes them a little easier to identify.  It would look something like this:

((this is figure 1-26, as taken from the ten part series))

In R. N. Elliott’s original work, these patterns were identified as double or triple 3’s, with the intervening moves marked as wave “X.”  On the chart then, you will see this denoted as:  ABC-X-ABC.

Unfortunately, the original notation left something to be desired because it made it difficult to differentiate between the second and third zigzag patterns as they occurred, so in more recent times, you’ll see W, Y, and Z used to help clarify the situation (see graphic above).

Again, double and triple zigzags aren’t terribly common, so don’t lose sleep over it if you’re a bit confused by them.  For now, it’s enough to know that they exist, and if you think you might be looking at one, you can always revisit this section for clarification.

Flat Patterns

Flat patterns are interesting and have the following characteristics you can use to identify them:

  • They tend to retrace less of a preceding impulse than zigzag patterns do
  • They most commonly appear within the confines of a large, strong trend
  • They (almost) always follow on the heels of extensions

In addition to that, the more powerful and pronounced the underlying trend, the briefer the flat will be.

In the context of an impulse wave, you most commonly find flats appearing in wavelet position 4, and somewhat less commonly in wavelet position 2.

“Flat” is a bit of a catch-all term, describing any correction that breaks down into a 3-3-5 configuration.  The three subtypes can be differentiated by way of the following distinctions:

  • Regular flats see wavelet B ending at about the same level of wavelet A.
  • Wavelet C ends slightly beyond the end point of wavelet A.
  • Expanded flats contain a price extreme that lies beyond the limits of the preceding impulse wave.
  • A running flat sees wavelet B ending well beyond the starting point of wavelet A

Here’s a quick example of an expanded flat in bull and bear markets:

 

 

in bear markets

((these are figures 1-33, 1-34, 1-35, and 1-36 from the ten part course))

And here are a couple of examples of running flats in bull and bear markets:

running flat

((these are figures 1-38, 1-39, 1-40 and 1-41 in the ten part course))

Important note!

As we mentioned at the start, corrective waves are much more difficult to properly identify than impulse waves.  Here’s a great example of that.

If you see what you think is a running flat, and wavelet B breaks into five waves, then it’s almost certainly not what you think it is.  Instead, it’s likely the first wave of an impulse of the next higher degree.  The reason that’s important is because if you mis-identify it, then you’ll buy when you should sell or sell when you should buy, and be staring at a hefty loss in short order.  Again we caution you to be extremely careful when analyzing and labeling corrective waves!

Triangle Patterns

Triangles tend to appear when there are a balance of market forces, working against each other more or less equally.  When this happens, it causes a “sideways” motion in the market, where prices aren’t clearly rising or declining with any consistency.  This is most often associated with declining volume and volatility.

Triangle patterns can be identified by the presence of five overlapping waves that subdivide thus: 3-3-3-3-3, labeled A-B-C-D-E.

To create the triangle, you draw lines to connect the termination points of waves A and C, then B and D.  The “E” wavelet can either overshoot or undershoot the A-C line, and in practice, this happens a majority of the time.

As mentioned earlier, triangles come in three “flavors:”  Contracting, Barrier and Expanding.  When R. N. Elliott wrote his original work, his contention was that the horizontal line of a barrier triangle could occur on either side of it.  Decades of pattern evaluation have proven this to be incorrect.  The horizontal line will, in fact, always occur on the side that the next wave will exceed. 

Even though the overarching conclusion was wrong, the terms “ascending” and “descending” to describe the orientation of a triangle are still of value when discussing triangles as this gives some indication of whether the (Barrier) triangle is occurring in a bull or bear market.

Here are some graphic depictions that will help bring the descriptions above into sharper focus:

((these are figures 1-42 and 1-43 from the ten part series))

Here’s a real-world example of a nine-wave triangle.  Note that most of the sub-waves within this structure are zigzags.  That’s fairly common, although it’s not unheard of to see some sub-waves take on more complex forms (like a multiple zigzag, for example).

If triangles (or zigzags) take on more complex structures like this, they can gain characteristics similar to extensions in Impulse waves.

nine wave triangle

((this is figure 1-44, and will almost certainly need to be re-created to make it different from the original work, but it’s too good an example to pass on!)

Here’s an interesting fact about triangles that should serve to help you identify them.  They always occur wavelet 4 of an Impulse wave, position B of a corrective wave, or as the last wave (X) in a double or triple zigzag or combination.

Triangles can also occur as the final actionary pattern in a corrective combination.  In these cases, both conditions are usually true.  That is to say, it is the final actionary pattern in a corrective combination and it precedes the final actionary wave (of a degree larger than the corrective combination).

In the stock market, if you see a triangle in the wavelet 4 position of an Impulse wave, wavelet five is sometimes a very short, swift move, where the line travels more-or-less the distance of the widest part of the triangle.  Most often, this final “thrust” is an impulse, but in some cases it can present as an ending diagonal.

If there are powerful forces in the market, pushing prices strongly up or down, this fifth wave won’t be a short and swift, but a protracted move in one direction or another.  That’s an important point to note, because if you see the line travel beyond the bounds of the widest point of the triangle, it’s a clear signal that you’re looking at a protracted wave.

The last thing to note about triangles is that they typically take time to develop.  A great many analysists who are new to EWT will, when confronted with a triangle, rush to label it as such, and in doing so, completely misread the market, which can easily throw your entire investment strategy into a tailspin.

The major lesson then, is to always give triangles time to develop before making a decision about where and how to invest.

Combinations

R. N. Elliott used the term “double three” to describe market conditions where two sideways corrective patterns occur, and building on that lexicon, three sideways corrective patterns were termed “triple threes.”

Combinations are exactly what they sound like.  A grouping of corrections (zigzags, flats and triangles).  They are, in essence an extension of a flat correction.  The labeling convention is the same here as it is when labeling a double or triple zigzag, as follows:

Combinations

((this is figure 1-45 and 1-46 from the ten part tutorial))

Note that combinations can be comprised of any combination of the three (zigzags, flats, and triangles) and as such, can be notoriously hard to properly identify.  Here are a couple of illustrative examples to give you some idea what the chart will look like when you’re facing a combination:

By and large, combinations are horizontal in their nature, but taken as a whole, the combination, whatever form it takes, always supports (moves in the direction of) the larger trend.  R. N. Elliott originally wrote that combinations could sometimes move against the larger trend, but in practice, no instances of this behavior have ever been found.

While combinations can take many different forms, here are a few things we’ve found to be true, after studying thousands of chart patterns:

  • There’s never more than one zigzag in a combination (although you may see a double or triple zigzag, but we count this as a single item)
  • There’s never more than one triangle in a combination
  • If a triangle is present in a combination, it will be the last item in the set (final wave).

Practice Makes Perfect

One of the most important skills you can develop as you learn to work with Elliott Wave Theory is to proper label the charts you study.  In the earlier section, we presented a table that showed the standardized notations marking wave types, numbers and degrees (cycles).  What was missing in the summary chart, however, was an example of how those notations are used live.  Here are a couple of examples to help you master the art of proper notation:

((This was taken from Figure 1-9 and 1-10 of the ten part course you had sent me previously.  Again, you may want to make slight changes so we’re not using identical material, but I wanted to include it here for reference))

 

((same story with this one – this was originally figure 1-6, 1-7 and 1-8 of the ten part course))

In this figure, the reasons that the first two examples are listed as “incorrect counting” are as follows:

  • In the first figure, you will note that wavelet 4 overlaps the top of wavelet 1.
  • In the second figure, wavelet 3 is shorter than wavelet 1 and shorter than wavelet 5

Based on the rules we discussed earlier, both of these charts would be mislabeled.  Our final example illustrates proper labelling and notation, which brings the chart into alignment with the EWT paradigm.

We keep coming back to this point, but it’s important to really drive it home:  EWT is highly subjective.  As such, two seasoned practitioners could look at the same data and reach different conclusions.  That’s okay.  Don’t jump to the conclusion that an alternate interpretation of the data from the one you reached is “bad” simply because it’s different.

EWT is an essentially rules-based system (by design).  Accordingly, while interpretations may differ, the fact that the system is rules-based helps keep the total number of variant interpretations to a minimum.  The popular convention when dealing with multiple interpretations is as follows:

The interpretation that most closely adheres to the rules is considered the primary interpretation, but markets aren’t always rational, and sometimes, they break the rules.  This is the true value of having alternate interpretations.  Consider them to be valid, but having a somewhat lower probability of occurring, and use them as a backup plan in the event that the primary interpretation proves faulty in some way.

Summary

  • Waves come in two basic flavors:  Impulse and Corrective
  • Impulse waves are comprised of five “wavelets” numbered 1,2,3,4, and 5
  • Corrective waves are comprised of three “wavelets” designated with A, B, and C
  • Waves also have one of two modes:  Actionary and Reactionary.
  • Actionary wavelets move the price in the direction of the overall trend.  These waves notated using odd numbered (and lettered) designations (1, 3, 5, A, and C)
  • Reactionary wavelets run counter to the prevailing trend (2, 4, and B)
  • Finding and analyzing patterns is fundamental to employing Elliott Wave Theory
  • Wave patterns tend to abide by various rules.  They’re regarded as rules because over time, and the study of thousands of wave patterns, they consistently hold true.  Mastering these rules and committing them to memory is essential to learning to use EWT well.
  • Learning to spot extensions is essential to maximize your profits as a trader, because the extension is where you’ll realize the bulk of your gains.  Exit your position too early, and you’re leaving money on the table.
  • The word “cycles” in EWT parlance doesn’t mean the same thing as it does in everyday use.  “Cycles” here are really the study and classification of wave amplitude
  • Truncations and ending diagonals are somewhat rare, but important patterns, as these always occur at the end of a big move, signifying that the market is about to radically change direction.  Knowing when these radical changes are on the horizon positions you to take savvy market positions that will reap big rewards.
  • Leading diagonals are also quite rare, usually occur in the wavelet 1 position, and always signify that a steep correction is to come.  Again, knowing this will allow you to plan your trades accordingly and maximize your profits.
  • One of the most important skills you can develop as you begin to master Elliott Wave Theory is proper wave notation.  Improper notation can lead you to faulty conclusions, which will cost you money!
  • Corrective waves are somewhat harder to identify and interpret than motive waves and come in more varieties.  As such, great care must be taken in situations where the market is trending down.
  • Corrective waves can be broadly grouped into three categories, with sub-types existing in each of the broad categories, as follows:
    • Zigzag
      • Single
      • Double
      • Triple
    • Flat
      • Regular
      • Expanding
      • Running
    • Triangle
      • Contracting
      • Barrier
      • Expanding
  • Flats, Triangles, and Zigzags can often acquire complex structures, making them more challenging to identify
  • Triangles tend to take relatively longer to develop, and great care should be taken to avoid labeling the end of a triangle too early, lest it throw your investment strategy off
  • Flats, Triangles and Zigzags can also exist in combinations
  • If and where they do, and if a triangle is present, it will be the last element in the set
  • You’ll never see more than one zigzag or triangle in a combination, although it is possible that those items could present as a double or triple (but in those cases are counted as a single item in the combination)
  • Sometimes (often) two seasoned EWT analysts can reach different conclusions when looking at the same data.  In those cases, consider the interpretation that most closely adheres to EWT rules to be primary, but don’t completely discount the alternative interpretation.  Use it as a lower-probability backup!

 

 

 

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