Wave Counting in Financial Markets
R. N. Elliott was the first to discover the wave structure of markets and put together a framework of rules to count waveforms and attempt to predict the outcome.
This method has been used with success, most notably by R. Prechter, but in its original form it is ambiguous and has been extended by many in an attempt to improve it.
After observing the ambiguity and complexity of patterns in Elliott's method, I developed a fresh set of simpler non-ambiguous rules to assist in the use of Wave Counting.
Defining a Wave
The first step is always definition and we need an unambiguous way of defining a wave. Since a wave is a trend of some length, we can
use the familiar trendline and/or parallel channel to define trends in the Transport index chart below. We can see an uptrend wave
broken in 1998, a downtrend wave broken in 2003, and as of mid 2007 we have not broken the uptrend yet. We can see that this method
works quite well, and is further confirmed by adding time cycles to reveal that the changes of trend do match and are not occuring
randomly. We can see why trendlines are the most popular form of technical analysis, since when placed properly they can detect a
change of trend.
Wave Myth #1 exposed
The first wave counting myth we must dispel is that impulsive waves are always made up of 5 sub-waves where corrective waves are always
made up of 3 sub-waves. Waves can only be made up of an odd number of sub-waves and as the Pascal Law of Probability predicts they get
progresssively less common as we go from 1, 3, 5, 7, 9, etc... We can see an example of 3 and 7 sub-waves in both impulsive and corrective
waves in the Transport index chart below. I am sure many ways of labeling the obvious 7 sub-waves into a 5 sub-wave structure exists
on the web, but we are trying to remove this wave ambiguity, and a child would count it as 7 waves. While the number of sub-waves
reveals clues about the trend, it is really irrelevant in the task of identifying waves. The use of a trendline helps us to recognize
a developing wave, and most importantly knowing when it ends. The price/time travelled and cycles make sure we are measuring waves of
similar degrees.
Charts courtesy of StockCharts.com
Charts courtesy of StockCharts.com
Parallel Channels
A wave with 5 or more sub-waves will often evolve between two trendlines forming a parallel channel or an expanding or constricting triangle.
These structures can have good predictive abilities when positioned properly. The parallel channel is the most common and can be seen in both
impulsive and corrective waves in the Transport index chart above.
Symmetrical Triangles
Symmetrical Triangles are usually found near the end of trends as they represent indecision and testing of the boundaries of previous
price trends. An equally constricting triangle results in an accumulation of trades near the apex price, which results in a good trend
developing in the direction of the break. The indecision often means the break is the last move in the trend and it will be fully
retraced before another attempt.
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Charts courtesy of StockCharts.com
Ascending or Descending Triangles
If the triangle is a constricting triangle slanted towards the previous trend, then it often but not always
predicts a reversal of trend and is usually fully retraced. The large descending triangle built over the 80's led to the major low in Silver
in the early 90's and should lead to a full retrace of that 1980's decline. The same could be seen in the chart of Palladium as far back as
2005.
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Charts courtesy of StockCharts.com
Alternation and Inversions
Alternations and Inversions are probably caused by too many traders expecting the previous behavior to repeat causing the inverse to
happen as their anticipatory trades affect the natural path until it reverts to normal. We can see alternation clearly in the Gold
chart and Inversion in the chart of the Yen below.
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Charts courtesy of StockCharts.com
Fibonacci and the Laws of Growth
later...
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Charts courtesy of StockCharts.com
Wave Counting and Determinism
later...
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Charts courtesy of StockCharts.com
SPX Elliott Wave Counts
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Charts courtesy of StockCharts.com
Nasdaq Elliott Wave Counts
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Long-term SPX/Dow Chart
The Dow long-term wave count is pretty clear when contained by parallel channels.
The rally from 1932 has turned at the channel boundaries in 1938 (Wave 1), 1942 (Wave 2), 1966 (Wave 3), 1974 (wave 4),
and wave 5 has taken us out of the upper boundary in 2000, indicating that we should break the lower channel on the correction.
This implies a quick move to the lower channel at 3000, once we break the upper channel at 7500, and most likely by 2010.
The final target for this bear market is indicated by the parallel channel formed by the 1929 and 2000 highs, and now points to 1500.
Looking at the huge consolidation at the 1000 level, this level will be a huge attractor and support should we ever get close to it.
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Charts courtesy of StockCharts.com
