The Yelnick thread has new members, so I thought it worthwhile to give a brief intro to ewaves. A better tutorial is available for free at Club EWI.
Ellliott developed his theory in the 30s. Prechter picked it up in the 70s and made a killing calling the 1982-87 period correctly. (Typical wave 1, many people were skeptical of the bull.) Then, Prechter called the top multiple times in the 90s and his cachet faded - until the real top in 2000. Now Prechter is back!
The Elliott religion has split into several sects, the most popular being Neely, whose work is being improved on by Zoran Gayer, often mentioned here. The Yelnick thread looks at multiple Elliott sites and derives a consensus opinion. The STU from the Prechter camp is usually the best source; also very good in the orthodox Elliott camp is Ryan Henry, whose work is available under the name Wavespeak online here. Some of the more active Yelnick readers share their views either with me or the group, and that is encouraged.
The basic ewave is either a 5-wave impulse or a 3-wave correction. Impulses travel in the direction of the trend, corrections counter. The impulse is counted as waves 1 - 2 - 3 - 4 - 5, where the odd waves go in the direction of the trend and the even waves go opposite. The correction is counted as A - B - C, where A and C go in the corrective direction and B goes the other way. You can count the bull market this way:
> wave 1 from 82-87
> wave 2 correction from 87-91 (the Crash of 87 plus the Gulf War)
> wave 3 from 91-97 (includes the first Internet mania in 95-96)
> wave 4 correction from 97-98 (the Asian Flu)
> wave 5 to the manic peak in 2000 (dot-com fever!)
Impulses only have two basic forms: the standard five wave and an overly enthusiastic variant of 9 waves where one of the segments 'extends' or breaks into a mini-5 wave of its own. Corrections come in 11 variants, including:
> Flat, an ABC in a trading range, which subdivides as 3 - 3 - 5 waves
> ZigZag, an ABC which goes deeply down, which subdivides as 5 - 3 - 5 waves
> Extended flats and zigzags, where you get double or triple ABC moves
> Triangle, a very extended series of five ABCs that have lower highs and higher lows
The ewave is a fractal, meaning it has the same form at all degrees (minutes, days, decades, etc.). Within a impulse pattern, each wave itself breaks into subwaves. The odd waves in the direction of trend, waves 1 - 3 - 5, subdivide into impulse patterns. The even waves, 2 - 4, subdivide into corrective patterns. So after a 5-wave wave 1 up, we see an ABC wave down, then the wave 3 starts, etc.
The waves follow certain rules, the most important of which are:
> fives waves in the direction of trend, three waves counter
> wave 4 cannot go lower than the start of wave 2 (the top of wave 1)
> wave 2 cannot go below the start of wave 1 - if it did, the pattern would be counted as 3 and not 5 waves
> wave 3 is never the shortest wave - indeed, it usually is the most intense
> waves 2 and 4 alternate in form - so if 2 is a Flat, 4 is a ZigZag or Triangle
The rules as stated are for a bull trend; the rules reverse if the trend is down (eg. wave 4 cannot go above wave 2)
These rules are in play right now. At the top on Monday, we reversed and came down in a 5-wave pattern. This suggests the trend has changed. Today we corrected that 5 wave move in 3-wave pattern. The first 5 waves make a wave 1, the second 3 waves make a wave 2. Tomorrow will be very interesting. The wave 2 correction may not be over yet; futures are up overnight. If the market breaks its Monday highs, then the rule about wave 2's not breaching the start of wave 1 fails, and we know we have not yet changed trend. if the market turns down again, it would have entered wave 3, which is usually the most intense.
It is easy to get lost in numbers. Also, watching the ewave theory over the past two decades, it doesn't seem to work as well during corrections. This is where Zoran may be about to improve on the theory, since he has been developing a way of fixing the Bifurcation Point when the correction ends.
One way to understand the waves is that the market does not recognize a change in trend until wave 3. That is why wave 3 is the most intense. Everyone piles on! This lack of recognition of trend is what is happening right now. Everyone is eager to call a bottom and get back on the Bull. We have come down in a wave 1 to the low in October. Was that the end of the Bear? We have now come back in a wave 2. Bullishness is at levels not seen since 1987! This is extreme, but typical of wave 2s. When wave 2s fail to exceed the prior level, then the herd begins to recognize the trend and a wave 3 starts.
Another way to understand this is the difference between stock distribution and stock accumulation. After a peak, the waves A and B down (if corrective) or 1 and 2 down (if trend change) can look the same. Often they will mirror the waves 4 down and 5 up from the prior trend. This pattern forms a classic Head and Shoulders pattern. The traders who bought during the wave 5 up but didn't sell at the peak will try to get out during wave B or 2. If the stock is being distributed not accumulated, wave 2 will fail, and we turn down into wave C or 3. At some point wave 3 reverses in wave 4. If at that time stock is accumulated, wave 4 could exceed the start of wave 3. This changes the count from 1 - 2 - 3 - 4 down to A - B - C down followed by wave 1 up. If wave 4 fails to exceed wave 3, then the final wave 5 down will follow.
Final part of the basics is fibonacci numbers. Prechter believes what separates Elliott Wave Theory from Ptolemaic epicycles is that it reflects underlying social mood, which follows certain biological patterns based on mass psychology. Many aspects of biology show fibonacci relationships. The ratio of fib numbers is the very interesting number Phi, which is more irrational than Pi or e. Often Elliott Waves show numeric relationships based on Phi ratios. Phi is approxiamtely 1.618, and the inverse of Phi is 0.618. The square of 0.618 is 0.382. Often waves 2 reverse 61.8% of wave 1, often wave 3s are 1.618 the length of wave 1, and often waves 4 reverse 38.2% of wave 3, which happens to also be 61.8% of wave 1 if wave 3 goes 1.618 times wave 1.
This relationships can be used to predict both reversal levels and durations of waves. A full 5 wave pattern often runs 2.4x its first leg, for example, which can be calculated from those fib relationships. Usually wave 2s do not exceed 61.8% reversal of wave 1. And usually in ABC corrections wave C equals wave A. The current wave 2 is running into a number of these relationships. It topped on Monday at close to 61.8% of wave 1 and also where its A wave = its C wave.
Thus the next few days are extremely interesting. The wave pattern strongly suggests we have or are about to end wave 2 and start wave 3. Yet bullishness is rampant. One of these two perspectives will have to break, shortly.
Comments