Many traders know about the Elliott Wave Principle, but most do not understand how it works or how to apply it. The purpose of this article is provide you with enough of an understanding Elliott Wave to improve the accuracy of your trading.
I saw a headline a few days prior to writing this article that basically stated that U.S. investors are increasingly becoming concerned that the economic recovery is stalling. This struck me as odd because the U.S. economy remains in recovery and is getting stronger, right? The housing slump is “finally” behind us with real estate prices on the up swing and construction going “full tilt boogey” in most major metro areas in the country, right? Interest rates will remain low for the foreseeable future and thus, contain and control the “evil demon” inflation, right?
The analyst in me usually sees a top or bottom being put in place just about the time the majority is acknowledging the rally or decline. My expectations for the current recovery, to resemble in its intensity or dynamic nature the incredible finish to the last expansion in 1999 to 2000 did not exist. The previous recovery or economic expansion began in 1932 and included both a depression and recessions – housing booms and busts on a regional and national scale – periods of inflation and deflation – interest rates soaring and falling – world currencies experiencing hyperinflation and disastrous collapses with new currencies born to replace numerous others.
Despite the economic collapse and the probability that an even greater event on a larger scale is probable to begin within the next 5 to 10 years most people continue to choose denial over preparedness.
Elliott Wave Principle – Brief Explanation
The Elliott Wave Principle is a system of derived rules and guidelines first used to interpret the major stock market averages. As applied and used by R.N. Elliott it offers a precise road map of the “underlying” being analyzed. There are 4 rules and 9 guidelines that have stood well against the test of time. Don’t break the rules and apply the guidelines. Anything different is effectively not the Elliot Wave Principle and becomes the “John Doe” Principle.
The Wave Principle is a valuable tool, which is unique in nature due to its general characteristics and strong accuracy. When used correctly, the wave principle measures with striking precision market psychology and behavior.
The broad concept is as follows: within the context of direction the trend (bull or bear market) of the market will develop and build upon or within sequences of five-waves, three in the direction of the larger trend and two in a counter trend direction. Waves 1, 3 and 5 are termed impulse waves and waves 2 and 4 corrective waves. Wave 2 corrects wave 1, wave 4 corrects wave 3 and the entire sequence 1, 2, 3, 4, 5 is corrected by the sequence a, b, c. Therefore a complete sequence (cycle) consists of eight waves.
Magnitude (duration and size) was also discernible to Elliott and he precisely categorized them into nine different ranges: Grand Supercycle, Supercycle, Cycle, Primary, Intermediate, Minor, Minute, Minuette, Sub-Minuette. Correctly employing the principles gives the analyst valuable input with regards to where the market is within the larger trend in force which in turn provides a clear road map complete with directions.
Take a look at the chart of the DJIA below, which covers 1900 to 2013.