Tenets of the Elliott Wave Principle
“The Wave Principle” is Ralph Nelson
Elliott’s discovery that social, or crowd, behavior trends and
reverses in recognizable patterns. Using stock market data for the Dow
Jones Industrial Average (DJIA) as his main research tool, Elliott
discovered that the ever-changing path of stock market prices reveals a
structural design that in turn reflects a basic harmony found in nature.
From this discovery, he developed a rational system of market analysis.
Under the Wave Principle, every market
decision is both produced by meaningful information and produces meaningful
information. Each transaction, while at once an effect, enters
the fabric of the market and, by communicating transactional data to
investors, joins the chain of causes
of others’ behavior. This feedback loop is governed by man’s
social nature, and since he has
such a nature, the process generates forms. As the forms are
repetitive, they have predictive value.
Elliott isolated thirteen “waves,” or
patterns of directional movement, that recur in markets and are
repetitive in form, but are not necessarily repetitive in time or
amplitude. He named, defined and illustrated the patterns. He then
described how these structures link together to form larger versions of
the same patterns, how those in turn are the building blocks for
patterns of the next larger size, and so on. His descriptions constitute
a set of empirically derived rules and guidelines for interpreting
market action. The patterns that naturally occur under the Wave
Principle are described below.
Five Wave Pattern
In markets, progress
ultimately takes the form of five waves of a specific
structure. Three of these waves, which are labeled 1, 3
and 5, actually effect the directional movement. They are
separated by two countertrend interruptions, which are
labeled 2 and 4, as shown in Figure 1. The two
interruptions are apparently a requisite for overall
directional movement to occur.
At any time, the market
may be identified as being somewhere in the basic five
wave pattern at the largest degree of trend. Because the
five wave pattern is the overriding form of market
progress, all other patterns are subsumed by it.
There are two modes of wave development: impulsive and corrective.
Impulsive waves have a five wave structure, while corrective
waves have a three wave structure or a variation thereof.
Impulsive mode is employed by both the five wave pattern of Figure 1 and its
same-directional components, i.e., waves 1, 3 and 5. Their structures
are called “impulsive” because they powerfully impel the market.
Corrective mode is employed by all countertrend interruptions, which
include waves 2 and 4 in Figure 1. Their structures are called “corrective”
because they can accomplish only a partial retracement, or “correction,”
of the progress achieved by any preceding impulsive wave. Thus, the two
modes are fundamentally different, both in their roles and in their
construction, as will be detailed in an upcoming section.
A five-wave impulse (whose
subwaves are denoted by numbers) is followed by a
three-wave correction (whose subwaves are denoted by
letters) to form a complete cycle of eight waves. The
concept of five waves up followed by three waves down is
shown in Figure 2. The eight-wave cycle
shown in Figure 2 is a
component of a cycle of one degree larger, as shown in
Figure 3. As Figure 3 illustrates, each same-direction
component of an impulsive wave, and each full cycle
component (i.e., waves 1 + 2, or waves 3 + 4) of a
cycle, is a smaller version of itself.
It is crucial to understand an essential
point: Figure 3 not only illustrates a larger version of Figure
2, it also illustrates Figure 2 itself, in greater detail. In
Figure 2, each subwave 1, 3 and 5 is an impulsive wave that will
subdivide into a “five,” and each subwave 2 and 4 is a corrective
wave that will subdivide into an a, b, c. Waves (1) and (2) in Figure 3,
if examined under a “microscope,” would take the same form as waves
Thus, waves of any degree in any series always subdivide and
re-subdivide into waves of lesser degree and simultaneously are
components of waves of higher degree. We can use Figure 3 to illustrate
two waves, eight waves or thirty-four waves, depending upon the degree
to which we are referring.
Now observe that within
the corrective pattern illustrated as wave
in Figure 3, waves (a) and (c), which point
downward, are composed of five waves: 1, 2, 3, 4 and 5.
Similarly, wave (b), which points upward, is composed of
three waves: a, b and c. This construction discloses a
crucial point: that impulsive waves do not always point
upward, and corrective waves do not always point
downward. The mode of a wave is greatly determined not by
its absolute direction but by its relative direction.
Aside from four specific exceptions, which will be
discussed later in this booklet, waves divide in impulsive
mode (five waves) when trending in the same direction
as the wave of one larger degree of which it is a part,
and in corrective mode (three waves or a
variation) when trending in the opposite direction. Waves
(a) and (c) are impulsive, trending in the same
direction as wave . Wave (b) is
corrective because it corrects wave (a) and is countertrend
to wave . In summary, the essential
underlying tendency of the Wave Principle is that action
in the same direction as the one larger trend develops in
five waves, while reaction against the one larger trend
develops in three waves, at all degrees of trend.
Neither does Figure 3
imply finality. As before, the termination of yet another
eight wave movement (five up and three down) completes a
cycle that automatically becomes two subdivisions of the
wave of next higher degree. As long as progress
continues, the process of building to greater degrees
continues. The reverse process of subdividing into lesser
degrees apparently continues indefinitely as well. As far
as we can determine, then, all waves both have and
are component waves.
on the Basic Theme
The Wave Principle would
be simple to apply if the basic theme described above
were the complete description of market behavior.
However, the real world, fortunately or unfortunately, is
not so simple. The rest of this chapter fills out the
description of how the market behaves in reality.
All waves may be
categorized by relative size, or degree. Elliott
discerned nine degrees of waves, from the smallest wiggle
on an hourly chart to the largest wave he could assume
existed from the data then available. He chose the names
listed below to label these degrees, from largest to
Cycle waves subdivide into Primary waves
that subdivide into Intermediate waves that in turn subdivide into Minor
and sub-Minor waves. It is important to understand that these labels
refer to specifically identifiable degrees of waves. By using this
nomenclature, the analyst can identify precisely the position of a wave
in the overall progression of the market, much as longitude and latitude
are used to identify a geographical location. To say, “the Dow Jones
Industrial Average is in Minute wave v of Minor wave 1 of Intermediate
wave (3) of Primary wave
of Cycle wave I of Supercycle wave (V) of the current Grand Supercycle”
is to identify a specific point along the progression of market history.
When numbering and lettering waves, some
scheme such as the one shown below is recommended to differentiate the
degrees of waves in the stock market’s progression:
||5s With the Trend
||3s Against the Trend
(II) (III) (IV) (V)
III IV V
||A B C
(2) (3) (4) (5)
||1 2 3
||A B C
iii iv v
||a b c
||1 2 3
||a b c
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