Thursday, August 16, 2007

The Elliott Waves

Basics of Wave Analysis
The Elliott waves principle is a system of empirically derived rules for interpreting action in the markets. Elliott pointed out that the market unfolds according to a basic rhythm or pattern of five waves in the direction of the trend at one larger scale and three waves against that trend. In a rising market, this five wave/three-wave pattern forms one complete bull market/bear market cycle of eight waves. The five-wave upward movement as a whole is referred to as an impulse wave, and the three-wave countertrend movement is described as a corrective wave (See Figure EW1). Within the five-wave bull move, waves 1, 3 and 5 are themselves impulse waves, subdividing into five waves of smaller scale; while waves 2 and 4 are corrective waves, subdividing into three smaller waves each. As shown in Figure 6.1, subwaves of impulse sequences are labeled with numbers, while subwaves of corrections are labeled with letters.

Figure EW1. The basic Elliott Wave pattern

Following the cycle shown in the illustration, a second five-wave upside movement begins, followed by another three-wave correction, followed by one more five-wave up move. This sequence of movements constitutes a fivewave impulse pattern at one larger degree of trend, and a three-wave corrective movement at the same scale must follow. Figure EW2 shows this larger-scale pattern in detail.
As the illustration shows, waves of any degree in any series can be subdivided and resubdivided into waves of smaller degree or expanded into waves of larger degree.

Figure EW2. The larger pattern in detail


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