Some History and a Little More Detail 2

The Wave Pattern


Elliott's main discovery was that market behavior could be identified and measured through a repeating eight wave sequence, consisting of 5 waves that he called "impulsive," followed by a 3-wave "corrective" sequence. Impulse waves are labeled numerically 1 through 5, corrective waves are labeled A, B and C, as per the following example Below, the pattern is illustrated in a chart of the Dow Jones Industrial Average from 1921 to 1932:
The above chart also illustrates another of Elliott's key discoveries, namely that wave patterns themselves subdivide into smaller patterns that trend in the same direction as the wave of one larger size, or, as Elliott termed it, "degree." In this example, the encircled wave numbers are labeled as Primary waves. The Primary waves subdivide into a five-wave sequence of Intermediate degree waves, which, in turn, subdivide into a sequence of five Minor degree waves. A three-wave "corrective" sequence then begins from the 1929 market top and ends in July 1932, well below the start of the bull market, a loss of about 90% in the Dow's value.



Extended Impulse Waves


The above chart of the Dow also illustrates the concept of "extended" waves, which holds that one of the three impulse waves in an Elliott sequence will always be "extended" or longer than the other two, regardless of degree. In Elliott's original work, he noted that 5th waves were more frequently the extended wave in a sequence. Frost and Prechter in their 1978 book "Elliott Wave Principle," revised this view to suggest that 3rd waves were more commonly extended, and their view has come to dominate wave labeling. Each of these tendencies is seen in the above chart. Both at Primary and Intermediate degree, the 5th wave extends from 1926-29, and 1928-29, respectively. At the Minor degree level (1928-29) wave 3 is clearly the extended wave. Correctly identifying the extended wave is important in forecasting the depth of the correction to follow.



Differences Between Internal Wave Structures


Frost and Prechter classify internal wave structures as being one of two modes -"motive" or corrective. They use the term "motive" to describe those waves that "impel" the market. Internally, motive waves are always 5-wave structures; corrective waves are always 3-wave structures. In the impulse sequence, therefore, Waves 1, 3 and 5 are motive; Waves 2 and 4 are corrective. This should not be confused with the ABC corrective pattern (discussed below) whose internal waves may subdivide as motive or corrective, depending on the type of correction taking place.



Corrective Wave Patterns


Elliott, Frost and Prechter classified 21 corrective patterns, from simple forms to more complex structures and combinations. Three of the simple patterns, and those which form the building blocks of the more complex structures, are illustrated below. These are corrective patterns following an uptrend. The patterns would be inverted following a downtrend.



Zigzag: Zigzag patterns are sharp declines (or advances in a bear rally) that substantially correct the price level of the previous impulse sequence. Often wave B (the counter-trend wave of the ABC pattern) is the shortest relative to A and C. In zigzag patterns, the sequence may double or triple up until the price correction target is achieved. Zigzags internally subdivide 5-3-5 as follows: Wave A (5-waves, motive), Wave B (3-waves, corrective), Wave C (5-waves, motive).

Flats: Flats are triangular structures that tend to move the market in a what Elliott called a "sidewise" (sideways) pattern. The ABC waves also tend to be equivalent in length. In the flat pattern, wave B will often undo the work of A and frequently tops in the area of the previous wave 5. Because of this action, wave B's tend to fake-out traders who think the correction is over. Wave C then undoes the work of wave B. There are also variations on the flat correction pattern, which include "expanded" flats (Elliott described them as "irregular") in which wave B tops well beyond the start of wave A, and wave C is substantially larger than A, generally by 1.618 or 2.618 the length. In a "running" flat, waves A & B are similar to an expanded flat, but wave C is shorter than wave A. Flats internally subdivide 3-3-5 as follows: Wave A (3-waves, corrective), Wave B (3-waves, corrective), Wave C (5-waves, motive).

Triangles: Elliott described two distinct types of triangles: Diagonal and Horizontal. Diagonal triangles are part of ending sequences in a wave pattern, and therefore can occur within a wave 5 or a wave C. According to Elliott, diagonal triangles form when market action has moved "too far, too fast" and represent exhaustion of the trend. The 5th wave of the diagonal will frequently spike sharply above the upper trendline of the triangle in what Elliott called a "throw-over." A trader should be alert to a diagonal triangle formation, as it signals an impending and sharp trend reversal. Horizontal triangles, on the other hand, are corrective structures. Also called "wedges," horizontal triangles are identified by drawing parallel trend lines along the peaks and troughs of the wave labels. D and E labels are added to fill out the sequence. In heavily corrective and choppy markets, there can be as many as 11 to 15 waves within the overall horizontal triangle structure. In all cases, the completion of a triangle pattern is normally followed by a sharp "thrust." The direction of the thrust is determined by the wave pattern in progress. One unique type of triangle, that is related to the family of "irregular flats" is the "Running Triangle," which was described by Frost and Prechter as one in which Wave B of the triangle exceeds the start of Wave (A). Since Running Triangles are cousins to both flats and horizontal triangles, they are most common to fourth waves and other corrective wave patterns.
Internally, all subwaves in a triangle are "threes", which tend to overlap. The only exception is a structure identified by Frost and Prechter (though not originally by Elliott) called a "leading diagonal" triangle, which occurs in the first wave position and subdivides 5-3-5-3-5 (like an impulse wave). Unlike an ending diagonal, this structure implies a continuation of the trend. They caution, however, against confusing this with a progression of first and second waves, which is far more common.

By Itme