Definitions and History

Wave - a movement in the market, either up or down. The size of the wave depends upon the period of time that is being analyzed.

Impulse Wave - a wave that moves in the direction of the main trend of the market. It subdivides into 5 smaller waves (1-2-3-4-5). Waves 1, 3, and 5 move in the direction of the market's main trend. Waves 2 and 4 move against the market's main trend. (They are called corrective waves.)

Corrective Wave - a wave that moves counter to the direction of the main trend of the market. It subdivides into 3 smaller waves (a-b-c). Waves a and c move against the market's main trend. Wave b moves in the direction of the market's main trend, but subdivides into 3 waves.

Types of Impulse Waves

Basic 5-Wave Structure (1-2-3-4-5) - if the main trend is up, wave 3 is higher than wave 1...wave 5 is higher than wave 3...and wave 4 does not correct below the top of wave 1. If the main trend of the market is down, wave 3 is lower than wave 1...wave 5 is lower than wave 3...and wave 4 does not correct above the bottom of wave 1.

Extended Wave - a complex impulse wave where one of the subwaves (either 1, 3, or 5) further subdivides into 5 waves.

Failure - when the 5th subwave of an impulse wave fails to move beyond the end of the 3rd subwave...indicating a strong and/or prolonged move in the counter direction.

Diagonal Triangle - a terminal wave (often called a wedge), either a 5th wave or c wave, where the 5 subwaves subdivide into threes (a-b-c). See diagonal triangle examples. (In the case of c waves patterns, I have observed that they often do not demonstrate the typical look and characteristics of a wedge, yet the 5 component waves still do subdivide into threes.) Upon completion, there is usually a strong move in the counter direction.

Type of Corrective Waves

ZigZag - a corrective wave (a-b-c)...where the b wave retraces only a part of wave a and wave c moves beyond the terminal point of wave a. Waves a and c subdivide into 5 waves and wave b into 3 waves. (Double zigzags are two zigzags in succession connected by an x wave.)

Flat - a corrective wave (a-b-c)...where the b wave retraces all or more of wave a. Wave a subdivides into 3 waves and wave c may or may not terminate beyond the terminal point of wave a.

Horizontal Triangle - a corrective wave (a-b-c-d-e)...which often develops after a very strong move in the market...with 5 subwaves, each further subdividing into threes, i.e., 5 successive corrective patterns forming a sideways pattern in the market (more or less).

Combination - a prolonged corrective wave that combines into one larger corrective wave 2 or 3 corrective waves, which are connected by one or two x waves. Two corrective waves connected by an x wave is called a double three. Three corrective patterns, each connected by an x wave, is called a triple three. The x wave, like other corrective waves in the direction of the main trend, subdivides into three waves (a-b-c).

Other Elliott Wave Concepts

Wave Degree - each 5 wave and 3 wave cycle can be found to subdivide into waves of a smaller scale and/or be found to comprise a part of a wave of a larger scale. Waves can be labeled in degrees which last only a matter of minutes or as long as centuries.

Parallel Trendlines - waves tend to channel between parallel trendlines. Depending on the time period analyzed the market may channel between parallel trendlines on an arithmetic scale chart or on a semi-log scale chart.

Extent of Corrective Wave - generally, a corrective wave will take the market to the area of the 4th wave of one lesser degree...especially when the corrective wave itself is a 4th wave. In other cases, the market will often find support at the top of wave 1 of one lesser degree.

Rule of Equality - two of the subwaves of an impulse wave (1, 3, or 5) are often related equally in terms of price advance and time.

Rule of Alternation - waves, especially corrective waves, tend to vary in complexity and/or type from one to the next.

Fibonacci - a series of numbers created by adding the last two numbers in the series to produce the next number in the series, i.e., 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, etc. Successive numbers in the series relate to each other by the ratio .618 or 1.618. This ratio has sometimes been called the golden ratio and underlines one methodology of analyzing the mathematical relationships between waves. With your CMMS computer and the assistance of a good math tutor you can do an in-depth study of the mathematical relationships between waves.

Variable Life Insurance - a variable life insurance policy is a type of permanent life insurance that can be hard to find because the company that sells it to you must have agents who are licensed in securities. This type of life insurance is better suited for a younger person still in their working years and who wants the possibility of leaving a high life insurance benefit to heirs without a high premium.

Elliott Wave History

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 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.