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ELLIOTT WAVE THEORY BASICS

Like many things Elliott Wave theory can be simple or complex, it's up to you. The basicpremise is that high volume, free markets (no Government intervention over the long haul) aresubject to the individual investors hopes (greed) and fears en masse. These emotionalcapitulations are reflected graphically at any point of any day by price. Portraying these swingsin chart form provides a picture of the current market psychology. In the earlier part of thiscentury Ralph Nelson Elliott promulgated tools with which to interpret the chart patterns andhence, the name of the theory. This page shows the bare minimum. If you want to learn moreget this FREE 10 lesson tutorial.

ELLIOTT WAVE IMPULSE PATTERN

The major trend in every time frame takes the form of five waves (impulse wave) which, oncecomplete, are corrected by three waves. The following is a bull market description: Wave One(W.1) is up and Wave Two (W.2) is down correcting W.1. When W.2 is finished, W.3 againmoves upward followed by a downward W.4 that corrects W.3. The final upleg is labeled W.5ending the entire swing. The corrective W.2 and W.4 normally retrace W.1 and W.3 by aFibonacci relationship.

ELLIOTT WAVE CORRECTIVE PATTERNS

Now that five waves have been completed in the direction of the major trend, they too will becorrected in a three wave retracement. To avoid confusion with the numerically labeled five waveimpulsive sequence, letters are used to represent the three wave corrective swings. Within thesame bull swings W.A is down, W.B is up and W.C is again down.

FIBONACCI RATIOS ARE IN CORRECTIVE PATTERNS

Fibonacci relationships are evident in corrective waves too, both internally and externally.Internally as to how W.A, W.B, and W.C relate to one another and externally by the way theentire corrective process relates to the previous five wave swing. A Flat is distinguished from themore common Zig-Zag by the depth of W.C in relation to W.A.

The area that often provides the most challenge is the corrective patterns. They range from asimple A-B-C pattern to the more complex double and triple A-B-C combinations ("threes") and

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triangles that converge or expand in five overlapping legs.

For the most part, the most complex patterns occur in W.4 just before the final push in W.5. Oldtimers say that if you don't know where you are in the wave count it's probably a 4.

Here are rules and guidelines that govern the entire process. The distinction is that the rules areinviolate while the guidelines are high percentage applications.

ELLIOTT WAVE RULES

Movements in the direction of the main trend of the market occur in 5 waves (impulsewaves) while corrective waves are always three wave affairs.W.2 can never retrace more than 100% of W.1. If that happens, the impulse interpretationwas incorrect.W.3 is never the shortest wave in terms of price. It does not have to be the longest, but insuch a case either W.1 or W.5 must be shorter.W.4 cannot overlap W.1.In recent years there has been a trend to accept an overlap on a range (bar) chart but nota closing (line) chart. The author knows of no such distinction by Mr. Elliott. Practitionersof the "modern" rules permit diagonal patterns with overlaps in W.1 and W.5 but not inW.3. The occurrences are primarily related to the various commodities and to individualstocks which are more volatile and swing independent than historical indexes such as theDow with years of trend.

ELLIOTT WAVE GUIDELINES

Alternation is a common theme. A classic example compares W.4 with W.2. Alternationimplies that if W.2 was a simple corrective sequence (A-B-C) then W.4 will likely becomplex (double three, triangle, etc.) pattern. Alternation basically tells you what not tolook for. In this case don't look for a simple W.4.W.3 is generally the longest (price-wise) and strongest (technically) of the impulse waves.When W.3 is the longest wave, W.1 and W.5 tend toward equality in both price and time.Retracements tend to halt at the prior fourth wave of lessor degree. This statement simplymeans that once a five wave sequence is done it becomes the next larger degree impulsewave, say a W.1. The correction that follows (larger W.2) will be three waves into thezone of the prior w.4 which is a component of, and therefore a degree smaller (lessor)than, the completed W.1.

ADDITIONAL SOURCES OF INFORMATION

The definitive source for understanding the theory is "The Elliott Wave Principle", by A. J. Frost

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and Robert Prechter, Jr. Two other good sources for utilizing the theory to trade are "DynamicTrading" (which includes an excellent software package), by Robert C. Miner and "TradingChaos", by Dr. Bill Williams. Besides "Dynamic Trading", two of the best available Elliottsoftware programs are "ELWAVE", by Prognosis Software Development and "Advanced GET",from Tom Joseph at Trading Techniques, Inc. See Elliott Wave Fractals to find out howAdvanced GET does not implement pure Elliott Wave theory.

Alas, commercial quality Elliott Wave software is not cheap.

THE ELLIOTT WAVE IS A REPEATING FRACTAL

When a five wave sequence is complete it can be labeled a larger W.1 and the three wavecorrection can be labeled the larger W.2. Thereafter, the process begins anew on the next level.Of course you can investigate higher or lower levels at any time to help clarify a wave count andmarket position. That's one of the beauties of Elliott Wave theory. In fact, it's essential tounderstand where you are on all levels at all times to apply wave counting correctly. Harmony atall degrees is a prerequisite.

An oft-heard complaint is that the pattern can always be seen in hindsight but not so well in thepresent moment. Admittedly, there are times when the pattern is much more lucid than at othertimes. Referring back to the very first sentence of this article, when those situations occur, itmay be best to wait until the wave form clears up before forcing a particular count; don't make itmore complex than it has to be.

One consolation is that even then, the pattern offers objective price levels at which to confirm orrebut an ongoing interpretation. Those objective levels are determined based upon the unique,time-tested rules. A sensible plan when the waters get muddy is to look for clarification at ahigher degree. Moving up in time when the pattern becomes cloudy provides the overallperspective from which to begin addressing the lower level options.

YOU ONLY GAIN IN KNOWLEDGE WHAT YOU GIVE IN TIME

Understanding this exotic theory is possible by everyone, but make no mistake about it, withonly a few Rules and Guidelines the application is more of an art form than a mathematicallyprecise exercise. And like any art form the more you practice it the better you'll get. You can getthe hardcover Elliott Wave Principle by Frost and Prechter from us for $16.18, including shippingwithin the USA. It's the "Bible" of Elliott Wave theory

If you have neither the time nor the desire to become your own Elliott Wave expert then take thecourse (so you know what you're getting) and spend the money to hire the experts at ElliottWave International - there are none better.

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