PART I – ELLIOTT THEORY
Chapter 1: THE BROAD CONCEPT
·
The Wave Principle is not primarily a
forecasting tool; it is a detailed description of how markets behave.
·
Many areas of human activities display the Wave
Principle.
·
Basic tenets
o Wave
Principle is governed by man’s social nature. Its expression generates forms.
As the forms are repetitive, they have predictive value.
o The
5-wave pattern
§ In
markets, progress takes the form of 5 waves. Three waves are labeled as 1,3,
& 5. Separated by 2 countertrend interruptions, 2 & 4.
§ The
wave 2 never moves beyond the start of wave 1
§ Wave
3 is never the shortest wave.
§ Wave
4 never enters the price territory of wave 1.
§ This
is the overriding form and all other patterns are subsumed by it.
o Wave
modes
§ Motive
– 5-wave structure; powerfully impel the market
§ Corrective
– 3-wave structure; partial retracement or correction
o The
complete cycle
§ Consists
of 8 waves (5 motive + 3 corrective)
§ The
big set of 8 waves comprises within itself, smaller sets of 8 waves and so
forth.
o The
Essential Design
§ Motive
waves do not always point upwards and corrective wave do not always point
downwards.
§ Mode
of wave is determined not by its absolute direction, but primarily by its
relative direction.
§ In
summary- “action” in the same direction as the one larger trend develops in
5-waves, while “reaction” against the one larger trend develops in 3-waves, at
all degrees of trend.
o Why
5-3?
§ Elliott
didn’t speculate on the form, but that’s what he observed.
§ Logically
it would make sense; 5 forward and 3 backward will allow for progression.
o Wave
degree: notation and nomenclature
§ Elliott
named 9 degrees of waves: Grand Supercycle, Super Cycle, Cycle, Primary,
Intermediate, Minor, Minute, Minuette, Subminuette.
·
Detailed Analytics
o Motive
Waves
§ Subdivided
into 5 waves and always move in the same direction of trend of one larger
degree.
§ The
goal of the motive is to make progression.
§ Two
types: impulse & diagonal
§ Impulse
·
Extension - Most impulses contain an extension.
An extension is an elongated impulse with exaggerated subdivisions.
·
Truncation – a situation in which the 5th
wave does not move beyond the 3rd wave.
§ Diagonal
·
A motive pattern, yet not an impulse.
·
A 5-wave structure in the direction of the main
trend.
·
Wave 4 moves into the price territory of wave 1.
·
Ending diagonal – happens mostly in the 5th
wave when the preceding move has gone “too far too fast”
·
5th wave extensions, truncated 5ths
and ending diagonals all imply the same thing: dramatic reversal ahead.
·
Leading diagonal – appears in wave 1 or in the
wave A of zigzags.
o Corrective
Waves
§ Difficult
to fit into recognizable patterns until they are completely behind us.
§ Two
styles: Sharp correction & Sideways correction
§ Three
categories: 1. Zigzag, 2. Flat, 3. Triangle
§ Zigzag
(5-3-5)
·
A single zigzag in a bull market is a simple
3-wave declining pattern labeled as A-B-C.
·
May occur 2-times or at most 3 times.
§ Flat
(3-3-5)
·
It occurs when the larger trend is strong.
·
Wave B terminates near the start of Wave A.
·
Wave C terminates slightly beyond the end of
Wave A
·
Variations:
o Expanded
Flat – price extreme beyond that of the preceding impulse wave
o Running
Flat – (rare) Wave B terminates well beyond the beginning of Wave A.
§ Triangle
·
Sideways movement associated with decreasing
volume and volatility
·
Three variations: Contracting, Barrier, &
Expanding.
Chapter 2: GUIDELINES OF WAVE FORMATION
·
Alternation
o Alternation
within an impulse
§ If
wave 2 of an impulse is a sharp correction, expect wave 4 to be a sideways
correction and vice versa.
o Alternation
within correction wave
§ If
wave A has flat a-b-c construction, expect wave B to have zigzag a-b-c-
formation and vice-versa.
·
Channeling – parallel trend channel typically
marks the upper and lower boundaries of an impulse wave.
·
Throw-over – within a parallel channel, if the 5th
wave approaches its upper trendline on declining volume, it is an indication
that the end of the wave will meet or fall short of it.
o If
the volume is heavy, it indicates a possible penetration of the upper line.
·
Scale – its better to analyze the parallel
channel using both arithmetic scale as well as semilog scale. Sometime, one
scale a wave point may fall short, while in another scale, it may fit perfectly
·
The “Right Look” – the “right look” may not be
evident at all degrees of trend simultaneously. The solution is to focus on the
degrees that are clearest. If hourly chart is confusing, step back and look at
daily or weekly, and so forth.
·
Wave
Personality
o Wave
1
§ About
half of 1st waves are part of “basing” process that tend to be
heavily corrected by wave 2.
o Wave
2
§ Often
retrace so much of wave 1. Often end on very low volume and volatility.
o Wave
3
§ Strong
and broad. Generate greatest volume and price movement and are often extended.
o Wave
4
§ Predictable
in depth and form, because by alternation they should differ from the previous
wave 2.
§ More
often, they trend sideways, building a base for 5th wave.
o Wave
5
§ Less
dynamic than wave 3 in terms of breadth.
o Wave
A
§ The
public is generally convinced that this is just a pull back, despite the first
really technically damaging cracks appear.
§ Sets
the tone for wave B.
o Wave
B
§ They
are phonies, sucker plays, bull traps, speculator’s paradise.
§ B
waves of Intermediate degree and lower usually show a diminution of volume,
while B waves of primary degree and greater can display heavier volume.
o Wave
C
§ Usually
devastating. Is it during these declines that there is virtually no place to
hide except cash.
o Wave
D
§ D
waves, being advances within corrective waves, are as phony as B waves.
o Wave
E
§ E
waves in triangles appear to be a dramatic kickoff of a new downtrend after the
top has been built. Almost always accompanied by supportive news.
§ Being
ending waves, are attended by psychology as that of 5th waves.
o Rules
and Guidelines – comprehensive list of rules and guidelines for all wave types
are summarized. This is a reference guide for the wave principles.
·
Learning the basics
o Best
learning procedure is using an hourly chart and trying to fit all the wiggles
into Elliott wave patterns.
o After
you have acquired the “Elliott touch”, it will be forever with you, just as a
child who learns to ride a bicycle never forgets.
·
Practical Applications
o Without
Elliott, there appear to be an infinite number of possibilities for the market
action.
o Wave
Principles help limiting the possibilities and then ordering the relative
probabilities of future market paths.
o the
ongoing maintenance of alternative wave counts is an essential part of using it
correctly.
Chapter 3: HISTORICAL AND MATHEMATICAL BACKGROUND OF
THE WAVE PRINCIPLE
·
Leonardo Fibonacci da Pisa
o During
the Middle Ages, (after 1000 AD), Pisa became a strongly walled city-state and
flourishing commercial center.
o Born
between 1170-80, Leonardo was the son of a prominent merchant.
o During
his lifetime, the bell tower known as the Leaning Tower of Pisa was under
construction.
o His
father was appointed a customs official in Bogia, North Africa. Leonardo
travelled with his father. After one of his trips to Egypt, he published Liber
Abaci (Book of Calculation)
o He
introduced decimal system and positioning 0 as the 1st digit in the
number scale system which originated from Hindu-Arabic system.
o In
all, he wrote 3 major mathematical works:
§ Liber
Abaco, 1202
§ Practica
Geometriae, 1220
§ Liber
Quadratorum
·
The Fibonacci Sequence
o Originated
from a problem posed – “How many pairs of rabbits placed in an enclosed area
can be produced in a single year from 1 pair of rabbits if each pair gives
birth to a new pair each month starting with the second month?”
o The
Rabbit Family Tree
·
The Golden Ratio
o After
several numbers in the sequence, the ratio of any number to the next higher is
approximately 0.618 to 1.
o Besides
1 and 2, any Fib number multiplied by 4, when added to a selected Fib number,
gives another Fib number.
o 1.618
(or 0.618) appears through biology, music, art and architecture
o 10
phenomena relating to Fib sequence are presented
·
The Golden Section
o Occurs
throughout nature. Human body is a tapestry of Golden Sections
·
The Golden Rectangle
o The
sides are proportional to 1.618 to 1.
·
The Golden Spiral
o The
golden rectangle can be used to construct golden spiral
o The
dotted lines, which are themselves in golden proportion to each other,
diagonally bisect the rectangles and pinpoint the theoretical center of the
whirling squares. From near this point, we can draw the spiral.
o The
spiral proceeds infinitely in both the outward and inward directions. The
center is never met and the outward reach is unlimited.
o At
any point in the evolution of the Golden spiral, the ratio of the length of the
arc to its diameter is 1.618. the diameter and radius, in turn, are related by
1.618 to the diameter and radius 90 degrees away.
·
The meaning of Phi (Φ = 0.618)
o Many
great men in history used phi. Pythagoras, Bernoulli, Newton, etc.
o Egyptian
engineers used this to construct the Pyramids of Gizeh.
o The
pharaonic Egyptians considered phi not as a number, but a symbol of creative
function, or of reproduction in an endless series. To them, it represented “the
fire of life”, the male action of sperm.
o The
stock market is not a random, formless mess reacting to current news and events,
but a remarkably precise recording of the formal structure of the progress of
man.
·
Fibonacci in the Spiraling stock market
o Stock
market reflects Fib-based spiral growth.
·
Phi and the Additive Growth
o If
you take any two randomly selected number, add them to produce the third, and
continuing in this manner to produce additional numbers. By the time you reach
the 8th iteration, you will hit the 0.618 (or 1.618 when inversed)
o Fib
ratio is a fundamental law of geometric progression in which two preceding units
are summed to create the next.
o Wave
Principle suggests that the idea that the same law that shapes living creatures
and galaxies is inherent in the spirit and activities of men en masse. Because
the stock market is the most meticulously tabulated reflector of mass
psychology in the world, its data produce an excellent recording of man’s
psychological states and trends.
PART II – ELLIOTT APPLIED
Chapter 4 – RATIO ANALYSIS AND FIBONACCI TIME
SEQUENCES
·
Ratio Analysis
o Assessment
of the proportionate relationship, in time and amplitude, of one wave to
another.
o Dow
theorist, Robert Rhea, in his book, in 1934, compiled a summary of market data
covering 9 bull and 9 bear markets spanning 36 year time period from 1896 to
1932.
o This
review extended over 13,115 calendar days. Bull markets were in progress for
8,143 days, while the remaining 4,972 days were in bear markets. The
relationship between these figures tends to show bear market run was 61.1% of
time of bull period.
o Two
categories of ratio relationships: 1) Retracements 2) Multiples
o Retracements
§ Sharp
corrections often tend to retrace 61.8% or 50% of previous wave.
§ A
leading diagonal in the wave 1 position is typically followed by a zigzag
retracement of 78.6% (sqrt of phi)
§ Sideways
corrections tend to retrace 38.2%, particularly when they occur as wave 4.
o Motive
Wave Multiples
§ If
wave 3 is extended, wave 1 and 5 likely to be of same length
§ If
wave 5 is extended, wave 5 may be 1.618 of wave 1
§ If
wave 1 is extended, wave 5 may be 1.618 of wave 1
§ In
a normal impulse without extensions, wave 5 usually is 1.618 of wave 1
§ When
wave 5 is extended, it is 1.618 of total span from start of wave 1 to end of
wave 5
o Corrective
Wave Multiples
§ In
a zigzag, the length of wave C is usually equal to wave A (or 1.618 or 0.618)
§ In
a double zigzag, the same relationship applied to the 2nd zigzag
§ In
a regular flat, waves A, B and C are approximately equal. Sometimes C is 0.618
of A. in rare cases, C is 2.618
§ In
a triangle, at least 2 of the alternating waves are typically related by 0.618
(contracting) and 1.618 (expanding)
·
Applied Ratio Analysis – several examples of
ratios of retracement from the Dow industrial Avg is illustrated
·
Multiple Wave Relationships
o All
degrees of trend are always operating in the market at the same time.
·
Fibonacci Time Sequences
o Frequently,
durations and time relationships themselves reflect Fibonacci measurements
o E.g.
there are 52.18 weeks in a year, shy of 55 and based on 4-week months, there
are 13 of them. 55/13 = 4.23, which is a Fib number in the table Figure 3-2
o There
are 365.24 days in a year, shy of 377 Fib number. 12.37 lunar cycles, shy of 13
Fib number. 365/12 gives 0.34, which is a Fib number.
·
Benner’s Theory
o Samuel
T Benner, an iron workers manufacturer, in his book, Business Prophecies of the
Future Ups and Downs in Prices, noted that highs of business trends follow a
repeating 8-9-10 yearly pattern.
o If
we add 8,9,10 repetitions cumulatively, we get numbers that are Fib number or a
number that is off by just + or – 1 to the Fib number.
Chapter 5: LONG TERM WAVES AND AN UP-TO-DATE
COMPOSITE
·
The stock market’s patterns are the same at all
degrees.
·
Several long-term wave cycles are presented
o 1.
The millennium wave from the Dark ages
o 2.
The Grand Supercycle wave from 1789 to Present
o 3.
The Supercycle wave from 1932
·
The theory of spiraling Wave Principle suggests
that there exist waves of larger degree, and a larger degree, and so forth up
to infinity.
Chapter 6: STOCKS AND COMMODITIES
·
Individual stocks
o When
to make a move is more important than what stock to choose.
o As
a mass psychological phenomenon, the market averages unfold in Elliott wave
patterns regardless of the price movements of individual stocks.
o “Elliott
will tell you if the track is fast, but not which horse is going to win”
o With
regards to individual stocks, other types of analysis are probably more
rewarding then trying to force the stock’s price action into an Elliott count
that may or may not exist.
o The
progress of general business activity is well reflected by the Wave Principle,
while each individual area of activity has its own essence.
o Despite
this important, distinction, many stocks tend to move more or less in harmony
with the general market.
o On
average, 75% of all stocks move up with the market and 90% of all stocks move
down with the market.
o The
best approach seems to be to avoid trying to analyze each issue on an Elliott
basis unless a clear, unmistakable wave pattern unfolds before your eyes.
·
Commodities
o Primary
bull and bear markers at times overlap each other.
o Most
commonly develop extensions in 5th wave in Primary or Cycle degree
bull markets.
o Commodities
have properties that reflect the universal order that Elliott discovered.
·
Gold
o One
commodity that is unalterable tied to the psyche of mass humanity is gold.
o In
the past, gold has often moved “contra-cyclically” to the stock market.
o Gold
is the time-honored store of value, and although the price of gold may flatten
for a long period, it is always good insurance to own some.
Chapter 7: OTHER APPROACHES TO THE STOCK MAKET &
THEIR RELATIONSHIP TO THE WAVE PRINCIPLE
·
Dow Theory
o Wave
Principle validates much of Dow Theory, but DT doesn’t validate Wave Principle,
since Elliott’s wave concept has mathematical basis.
o Both
approaches are based on empirical observations and complement each other in
theory and practice.
·
The “Kondratieff” Wave economic cycle
o Russian
economist Nikolai Kondratieff documented that the economic cycles of modern
capitalist countries tend to repeat a cycle of expansion and contraction
lasting a bit over half a century.
·
Cycles
o Cycle
theories have spawned a rigid adherence to the “four-year cycle” idea by many
analysts and investors.
o For
those who have found success using cyclic approach, the Wave Principle can be
an useful tool in predicting changes in lengths of cycles.
o The
Wave Principle reveals that the market reflects more of the properties of a spiral
than a circle, more the properties of nature than of a machine.
·
The Decennial Pattern
o The
DJIA chart, since its inception, shows a perfect Elliott wave pattern in the 10
decades.
·
News
o At
best, news is the tardy recognition of forces that have already been at work
for some time and is startling only to those unaware of the trend.
o People’s
emotional states and trends, as reflected by market prices, cause them to behave
in ways that ultimately affect economic statistics and politics, i.e., produce “news”.
In short, “the market, is the news”.
·
Random Walk Theory
o Theory
hold that stock prices move randomly and not in accord with predictable
patterns of behavior.
o On
this basis, stock market analysis is pointless.
o The
Elliott Wave Principle challenges the Random Walk theory at every turn.
·
Technical Analysis
o The
Wave Principle can help a technician decide which formulations are mot likely
of real significance.
o Examples:
§ A
triangle formation is an in-trend phenomenon
§ “wedge”
is the same as that for Elliott’s diagonal.
§ Flags
and pennants are zigzags and triangles
§ Rectangles
are usually double or triple threes
§ Double
tops are generally caused by flats
§ Double
bottoms are truncated fifths
§ Head
and shoulders can be discerned in a normal Elliott top.
·
The “Economic Analysis” approach
o Attempts
to forecast the market without listening to the market itself are doomed to
fail
o Market
is a far more reliable predictor of the economy than vice versa
o Elliott
waves, as a reflection of the mass psyche, extend their influence over all
categories of human behavior.
·
Exogeneous Forces
o External
forces may trigger cycles and patterns that man has yet to comprehend.
o Example,
some analysts suspected a connection between sunspot frequency and stock market
process on the basis that changes in magnetic radiation have an effect on the
mass psychology of people.
Chapter 8: ELLIOTT SPEAKS
·
Predictions for next 10 years from 1978, when
the book was published, is theorized in this chapter.
Book Mentions
·
An Inquiry into the Effect of Sunspot Activity
on the Stock Market, 1965, Charles J Collins
·
Blueprint for Survival – Dr. R. Burr
·
The Fibonacci Quarterly – by the Fibonacci Association,
Santa Clara University.
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