Elliott Wave Theory

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 evidence of his discovery by making a number of accurate stock market forecasts. What appears random and unrelated, Elliott said, is actually tracing out a recognizable pattern once you learn what to look for. Elliott called his discovery “The 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 located copies of R.N. Elliott’s books in the New York Public 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 the late 1970s, gloom was pervasive, but in Elliott Wave Principle, Prechter and Frost called for a roaring bull market akin to that of the 1920s, to be followed by a record bear market. As the stock market rose, knowledge of the Wave Principle among private and professional investors grew dramatically.
When investors and traders first discover the Elliott Wave Principle, there are several reactions:

  • Disbelief that markets are patterned and largely predictable
  • Joy at having found a “crystal ball” to foretell the future
  • And finally the correct, and useful response – “Wow, here is a valuable model I should learn to use.”

Just like any system 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, such as roads, residential subdivisions… and – as recent discoveries have confirmed – in market prices. 
The first step in Elliott wave analysis is to identify patterns in market prices. At their core, wave patterns are simple; there are only two types: “impulse waves,” and “corrective waves.”
Elliott Wave Principle
Impulse waves are composed of five subwaves (labeled as 1, 2, 3, 4, 5) and move in the same direction as the trend of the next larger size. Impulse waves are so named because they powerfully impel the market.
A corrective wave follows, composed of three subwaves (labeled as a, b, c), and it moves against the trend of the next larger size. Corrective waves accomplish only a partial retracement, or “correction,” of the progress achieved by any preceding impulse wave.
As the figure above shows, one complete Elliott wave consists of eight waves and two phases: five-wave impulse phase, whose subwaves are denoted by numbers, and the three-wave corrective phase, whose subwaves are denoted by letters.
R.N. Elliott was not an ivory tower theorist. He set out to observe and then describe how the market actually behaves. Later he realized that his model had an important theme of self-similarity and a relationship to nature. There are a number of specific variations on the underlying pattern, which Elliott meticulously described and illustrated. He also noted the important fact that each pattern has identifiable certainties 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 helpful in understanding what a market can do, and at least as important, what it will not do.
You have just begun to learn the power and complexity of the Elliott Wave Principle. So, don’t let your Elliott wave education end here. Join Elliott Wave International’s free 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.

How the waves of social mood led to an investment method worth looking into

Have you ever been at the ocean body surfing, just waiting for that perfect wave? When you begin to truly feel it, your adrenaline starts pumping.
I came to work for Elliott Wave International in the late 1980s — before the Internet, before ETFs, before smartphones. Part of my job was to review the many publications that came to our offices, in search of articles that spoke to the “mood” of the markets.
It was a task that constantly searched for an answer to the question, Is there a large cluster of articles in print right now to indicate that people are extremely “bullish” or “bearish”? At that time my searches related mostly to the commodities markets, but I also kept close tabs on stock market news.
At first it was tedious. When I found groups of articles that reflected a certain mood, I would clip and save them to a file for our analysts to review. Yet after several months, I actually began to develop a feel for the mood patterns in the articles. I started to use this to see if I could anticipate where the price trend would go over the next several days or weeks.
The idea was simple: When the mood in the news articles got extremely bullish – and our Elliott wave counts suggested that a rally was completed — it would often represent a downside opportunity; when that mood became deeply gloomy, it was usually time to get bullish.
I was amazed — my adrenaline was pumping. I actually started to get a feel for the waves — a feeling for the direction of the market! I was hooked, so I took it to the next level.
I had read Prechter and Frost’s Elliott Wave Principle – Key to Market Behavior before I interviewed for my position. It was interesting, but it didn’t really speak to me. But after I had personally experienced and understood what it means to feel the mood of the markets, I read it again. The second time took on a whole new meaning.
If you read Elliott Wave Principle a long time ago, or wish to read it for the first time, Elliott Wave International has just released an online edition of this investment classic, free to members of Elliott Wave International’s Club EWI. Membership is free. This is your chance to learn how the waves of social mood can change the way you invest forever.
Follow this link to become a member, and to receive FREE online access to Elliott Wave Principle, and the many other free investment and trading reports available to Club EWI members.

What advantages does the Wave Principle offer to traders?

Here’s one of the big advantages of using the Wave Principle when trading: you can increase your understanding of how current price action relates to the market’s larger trend.
Other tools fall short in this regard. Several trend-following indicators such as oscillators and sentiment measures have their strong points, yet they generally fail to reveal the maturity of a trend. Moreover, these technical approaches to trading are not as useful in establishing price targets as the Wave Principle.
Here’s another big advantage of using the Wave Principle in your trading, which comes directly from the free eBook “How the Wave Principle Can Improve Your Trading”

“Technical studies can pick out many trading opportunities, but the Wave Principle helps traders discern which ones have the highest probability of being successful.” 

Indeed, this valuable free eBook shows you how to identify and exploit the market’s price pattern, as shown in the Elliott wave structure below:

The Wave Principle also helps you to identify price levels where you may want to place protective stops.

“…although the Wave Principle is highly regarded as an analytical tool, many traders abandon it when they trade in real-time — mainly because they don’t think it provides the defined rules and guidelines of a typical trading system.
But not so fast — although the Wave Principle isn’t a trading “system,” its built-in rules do show you where to place protective stops in real-time trading.”
“How the Wave Principle Can Improve Your Trading”

Before you attempt to identify price levels for protective or trailing stops, you should first become familiar with these three rules of the Wave Principle:

  • Wave 2 can never retrace more than 100 percent of wave 1
  • Wave 4 may never end in the price territory of wave 1
  • Wave 3 may never be the shortest impulse wave of waves 1, 3, and 5 

The details and specific instructions for placing protective and trailing stops are in the BONUS section of the free eBook, “How the Wave Principle Can Improve Your Trading.”

Here’s what you’ll learn:
  • How the Wave Principle provides you with price targets
  • How it gives you specific “points of ruin”: At what point does a trade fail?
  • What specific trading opportunities the Wave Principle offers you
  • How to use the Wave Principle to set protective stops

Keep reading this free lesson now.

Everything You Ever Wanted to Know About the Elliott Wave Principle, Free
Club EWI’s free introductory tutorial on the Wave Principle is the key to unlocking the mystery of market behavior

Okay. There can be only two reasons why you are reading this article right now:

  1. You thought “Elliott wave” was a surfing term for a wicked breaker, dude.

— OR —

  1. You’re tired of fundamental analysis of financial markets leaving you behind the trend-moving curve, AND you’re ready for an alternative.

If you answered the second choice, then you’re in the right place. Fact is, you can probably count on all hands — of a millipede — the number of times the mainstream financial media has provided conflicting reports on how a certain news event “moves” a particular market. Case in point, the recent headlines below on the Dow Jones Industrial Average:

  • March 31 at 8:44 AM: “US Stocks Edge Lower After Jobless Claims Data” (International Business Times)
  • March 31 at 9:53 AM: “US Stocks Slightly Higher After Jobless Claims Data” (Wall Street Journal)

The Elliott Wave Principle resets the stage from an entirely different starting point. Wave analysis asserts that while certain news events can have a temporary, near-term effect on market prices, the larger trend is governed by one consistent force: social mood, or collective investor psychology.
This source of markets’ trending power unfolds in calculable wave patterns visible on a market’s price chart. Elliotticians know of 13 such patterns, each of which adheres to specific rules and guidelines. Ultimately, if you can identify one of these patterns, you can project what direction the pattern will move prices AND how far into that direction prices may go.
The best part is, Club EWI has recently re-released our most comprehensive Wave Principle tutorial ever, at no monetary cost. This 10-lesson course leaves no stone unturned and no question unanswered about the basic recognition of all Elliott patterns and their practical application in real-world markets.
In the end, the difference comes down to this simple reality: Before taking the Wave Principle tutorial, the price chart of a major financial market looked like this:

After taking the tutorial, that same chart comes into breathtaking being as the clearly labeled blue print to opportunity we see below: 

Join the rapidly expanding Club EWI community today and get the complete, free Wave Principle Tutorial.

What Does a Fractal Look Like?
And What Does It Have to Do with the Stock Market?

If the word ‘fractal’ comes up at all in conversation, that conversation is probably being held in a mathematics department. However, anyone who is interested in the Wave Principle and how it applies to the stock market may have stumbled across the phrase “robust fractal.” If you want to know more about what it means in that context, here’s an excerpt from Elliott Wave International’s primer on fractals that explains the connection.
* * * * *
Excerpted from The Human Social Experience Forms a Fractal
by Robert R. Prechter
In the 1930s, Ralph Nelson Elliott discovered that aggregate stock market prices trend and reverse in recognizable patterns. In a series of books and articles published from 1938 to 1946, he described the stock market as a fractal. A fractal is an object that is similarly shaped at different scales.
Although Elliott came to his conclusions fifty years before the new science of fractals blossomed, he took a step that current observers of natural processes have yet to take. He explained not only that the progress of the market was fractal in nature but discovered and described the component patterns. The patterns that Elliott discerned are repetitive in form but not necessarily in time or amplitude. Elliott isolated and defined a number of patterns, or “waves,” that recur in market price data. He named and illustrated the patterns. He then described how they link together to form larger versions of themselves, how they in turn link to form the same patterns at the next larger size, and so on, producing a structured progression. He called this phenomenon The Wave Principle….
The Stock Market as a Robust Fractal
A classic example of a self-identical fractal is nested squares. One square is surrounded by eight squares of the same size, which forms a larger square, which is surrounded by eight squares of that larger size, and so on.
A classic example of an indefinite fractal is the line that delineates a seacoast. When viewed from space, a seacoast has a certain irregularity of contour. If we were to drop to ten miles above the earth, we would see only a portion of the seacoast, but the irregularity of contour of that portion would resemble that of the whole. From a hundred feet up in a balloon, the same thing would be true.
Photo of Madeira coastline, near Sao Jorge, by Plane Person (source: Wikimedia Commons)
Scientists today recognize financial markets’ price records as fractals, but they presume them to be of the indefinite variety. Elliott undertook a meticulous investigation of financial market behavior and found something different. He described the record of stock market prices as a specifically patterned fractal yet with variations in its quantitative expression. I call this type of fractal, which has properties of both self-identical and indefinite fractals, a robust fractal. Robust fractals permeate life forms. Trees, for example, are branching robust fractals, as are animals, circulatory systems, bronchial systems and nervous systems. The stock market record belongs in the category of life forms since it is a product of human social interaction.
How Is the Stock Market Patterned?
Idealized Wave Development and Subdivisions
Figure 1 shows Elliott’s idea of how the stock market is patterned. If you study this depiction, you will see that each component, or “wave,” within the overall structure subdivides in a specific way by one simple rule: If the wave is heading in the same direction as the wave of one larger degree, then it subdivides into five waves. If the wave is heading in the opposite direction as the wave of one larger degree, then it subdivides into three waves (or a variation). These are called motive and corrective waves, respectively. Each of these waves adheres to specific traits and tendencies of construction, as described in Elliott Wave Principle (1978).
Waves subdivide this way down to the smallest observable scale, and the entire process continues to develop larger and larger waves as time progresses. Each wave’s degree may be identified numerically by relative size on a sort of social Richter scale.
Want to Know More About Fractals and the Stock Market? Then read the whole special report, called “The Human Social Experience Forms a Fractal.” It’s free of charge, so long as you are a member of Club EWI, which gives you access to many free reports that explain Elliott wave analysis and the Wave Principle.

5 Ways the Wave Principle Can Improve Your Trading

Jeffrey Kennedy brings more than 15 years of experience to his position as Elliott Wave International’s Senior Analyst and trading instructor. He knows firsthand how hard it can be to get simple explanations of a trading method that works — so he shares his knowledge with his subscribers each month in the Trader’s Classroom lessons.
Here’s an excerpt from The Best of Trader’s Classroom, a free 45-page eBook that gives you the 14 most critical lessons every trader should know. Download the full eBook free here.

Every trader, every analyst and every technician has favorite techniques to use when trading. But where traditional technical studies fall short, the Wave Principle kicks in to show high-probability price targets. Just as important, it can distinguish high-probability trade setups from the ones that traders should ignore.
Where Technical Studies Fall Short
There are three categories of technical studies: trend-following indicators, oscillators and sentiment indicators. Trend-following indicators include moving averages, Moving Average Convergence-Divergence (MACD) and Directional Movement Index (ADX). A few of the more popular oscillators many traders use today are Stochastics, Rate-of-Change and the Commodity Channel Index (CCI). Sentiment indicators include Put-Call ratios and Commitment of Traders report data.
Technical studies like these do a good job of illuminating the way for traders, yet they each fall short for one major reason: they limit the scope of a trader’s understanding of current price action and how it relates to the overall picture of a market. For example, let’s say the MACD reading in XYZ stock is positive, indicating the trend is up. That’s useful information, but wouldn’t it be more useful if it could also help to answer these questions: Is this a new trend or an old trend? If the trend is up, how far will it go? Most technical studies simply don’t reveal pertinent information such as the maturity of a trend and a definable price target — but the Wave Principle does.
How Does the Wave Principle Improve Trading?
Here are five ways the Wave Principle improves trading:
1. Identifies Trend
The Wave Principle identifies the direction of the dominant trend. A five-wave advance identifies the overall trend as up. Conversely, a five-wave decline determines that the larger trend is down. Why is this information important? Because it is easier to trade in the direction of the dominant trend, since it is the path of least resistance and undoubtedly explains the saying, “the trend is your friend.”
2. Identifies Countertrend
The Wave Principle also identifies countertrend moves. The three-wave pattern is a corrective response to the preceding impulse wave. Knowing that a recent move in price is merely a correction within a larger trending market is especially important for traders because corrections are opportunities for traders to position themselves in the direction of the larger trend of a market.
3. Determines Maturity of a Trend
As Elliott observed, wave patterns form larger and smaller versions of themselves. This repetition in form means that price activity is fractal, as illustrated in Figure 2-1. Wave (1) subdivides into five small waves, yet is part of a larger five-wave pattern. How is this information useful? It helps traders recognize the maturity of a trend. If prices are advancing in wave 5 of a five-wave advance for example, and wave 5 has already completed three or four smaller waves, a trader knows this is not the time to add long positions. Instead, it may be time to take profits or at least to raise protective stops.
Figure 2-1
4. Provides Price Targets
What traditional technical studies simply don’t offer — high-probability price targets — the Wave Principle again provides. When R.N. Elliott wrote about the Wave Principle in Nature’s Law, he stated that the Fibonacci sequence was the mathematical basis for the Wave Principle. Elliott waves, both impulsive and corrective, adhere to specific Fibonacci proportions, as illustrated in Figure 2-2. For example, common objectives for wave 3 are 1.618 and 2.618 multiples of wave 1. In corrections, wave 2 typically ends near the .618 retracement of wave 1, and wave 4 often tests the .382 retracement of wave 3. These high-probability price targets allow traders to set profit-taking objectives or identify regions where the next turn in prices will occur.
Figure 2-2
5. Provides Specific Points of Ruin
At what point does a trade fail? Many traders use money management rules to determine the answer to this question, because technical studies simply don’t offer one. Yet the Wave Principle does — in the form of Elliott wave rules.
Rule 1: Wave 2 can never retrace more than 100% of wave 1.
Rule 2: Wave 4 may never end in the price territory of wave 1.
Rule 3: Out of the three impulse waves — 1, 3 and 5 — wave 3 can never be the shortest.
A violation of one or more of these rules implies that the operative wave count is incorrect. How can traders use this information? If a technical study warns of an upturn in prices, and the wave pattern is a second wave pullback, the trader knows specifically at what point the trade will fail — a move beyond the origin of wave 1. That kind of guidance is difficult to come by without a framework like the Wave Principle.
Technical studies can pick out many trading opportunities, but the Wave Principle helps traders discern which ones have the highest probability of being successful. This is because the Wave Principle is the framework that provides history, current information and a peek at the future. When traders place their technical studies within this strong framework, they have a better basis for understanding current price action.

Don’t miss the rest of the 14 most critical lessons that every trader should know. Download the free 45-page eBook The Best of Trader’s Classroom.

Learn Elliott Wave Analysis — Free
Often, basics is all you need to know.

Understand the basics of the subject matter, break it down to its smallest parts — and you’ve laid a good foundation for proper application of… well, anything, really. That’s what we had in mind when we put together our free 10-lesson online Basic Elliott Wave Tutorial, based largely on Robert Prechter’s classic “Elliott Wave Principle — Key to Market Behavior.” Here’s an excerpt:

Successful market timing depends upon learning the patterns of crowd behavior. By anticipating the crowd, you can avoid becoming a part of it. …the Wave Principle is not primarily a forecasting tool; it is a detailed description of how markets behave. In markets, progress ultimately takes the form of five waves of a specific structure.
The personality of each wave in the Elliott sequence is an integral part of the reflection of the mass psychology it embodies. The progression of mass emotions from pessimism to optimism and back again tends to follow a similar path each time around, producing similar circumstances at corresponding points in the wave structure.
These properties not only forewarn the analyst about what to expect in the next sequence but at times can help determine one’s present location in the progression of waves, when for other reasons the count is unclear or open to differing interpretations.
As waves are in the process of unfolding, there are times when several different wave counts are perfectly admissible under all known Elliott rules. It is at these junctures that knowledge of wave personality can be invaluable. If the analyst recognizes the character of a single wave, he can often correctly interpret the complexities of the larger pattern.
The following discussions relate to an underlying bull market… These observations apply in reverse when the actionary waves are downward and the reactionary waves are upward.
Idealized Elliott Wave Pattern 
1) First waves — …about half of first waves are part of the “basing” process and thus tend to be heavily corrected by wave two. In contrast to the bear market rallies within the previous decline, however, this first wave rise is technically more constructive, often displaying a subtle increase in volume and breadth. Plenty of short selling is in evidence as the majority has finally become convinced that the overall trend is down. Investors have finally gotten “one more rally to sell on,” and they take advantage of it. The other half of first waves rise from either large bases formed by the previous correction, as in 1949, from downside failures, as in 1962, or from extreme compression, as in both 1962 and 1974. From such beginnings, first waves are dynamic and only moderately retraced. …

Read the rest of this 10-lesson Basic Elliott Wave Tutorial online now, free! Here’s what you’ll learn:

  • What the basic Elliott wave progression looks like
  • Difference between impulsive and corrective waves
  • How to estimate the length of waves
  • How Fibonacci numbers fit into wave analysis
  • Practical application tips for the method
  • More

Keep reading this free tutorial today.