Elliott Wave PrincipleElliott Wave Principle

Steven W. Poser

Managing Director, Research

New York Stock Exchange

212-656-4512

sposer@nyse.com

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Today’s ObjectivesToday’s Objectives

Review fundamentals of the Elliott Review fundamentals of the Elliott Wave Principle (EWP)Wave Principle (EWP)

Preparation for CMT II&III Preparation for CMT II&III

Text: Text: Elliott Wave Principle: Key to Elliott Wave Principle: Key to Market BehaviorMarket Behavior (A.J. Frost, Robert (A.J. Frost, Robert Prechter Jr.)Prechter Jr.)

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OverviewOverview

EWP’s primary value is as a description of EWP’s primary value is as a description of how markets behave.how markets behave.

Provides context for market analysis.Provides context for market analysis.

Prechter and Frost state EWP “Prechter and Frost state EWP “is not is not primarily a forecasting tool”primarily a forecasting tool”

EWP patterns also visible in economic data EWP patterns also visible in economic data and in general human behaviorand in general human behavior

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Basic TenetsBasic Tenets EWP is governed by man’s social nature, EWP is governed by man’s social nature,

which is expressed in repetitive form.which is expressed in repetitive form.

In markets, this is shown as progressions In markets, this is shown as progressions of five waves, followed by three waves.of five waves, followed by three waves.

Three rulesThree rules• Wave-2 never moves beyond start of wave-1Wave-2 never moves beyond start of wave-1• Wave-3 never the shortestWave-3 never the shortest• Wave-4 never overlaps wave-1, except in a Wave-4 never overlaps wave-1, except in a

diagonal trianglediagonal triangle

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Elliott Wave Theory BasicsElliott Wave Theory Basics

• Developed by Ralph Nelson Elliott, mostly Developed by Ralph Nelson Elliott, mostly in the 1930sin the 1930s

• Related specific price patterns in the stock Related specific price patterns in the stock market as being nature’s law – in essence, market as being nature’s law – in essence, price patterns were deterministicprice patterns were deterministic

• Although most reasonable Elliotticians Although most reasonable Elliotticians would not call EW deterministic, it does would not call EW deterministic, it does give us deep insight into market behavior give us deep insight into market behavior

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Elliott Wave Theory BasicsElliott Wave Theory Basics

• Classic patterns are based deeply in Classic patterns are based deeply in market psychologymarket psychology

• Each wave and sub-wave has a Each wave and sub-wave has a characteristic market psyche characteristic market psyche attached to itattached to it

• This improves forecasting capabilityThis improves forecasting capability

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The Basic Wave PatternThe Basic Wave Pattern

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AA

BB

CC

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Elliott Wave BasicsElliott Wave Basics• Wave modesWave modes

• Motive waves – subdivide into five wavesMotive waves – subdivide into five waves• Corrective waves – subdivide into a three wave Corrective waves – subdivide into a three wave

structure or a trianglestructure or a triangle

• A complete cycle is eight waves:A complete cycle is eight waves:• Five wave motive (1-2-3-4-5)Five wave motive (1-2-3-4-5)• Three wave corrective (a-b-c)Three wave corrective (a-b-c)

• Even numbered waves are also corrective Even numbered waves are also corrective within a motive movewithin a motive move

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Elliott Wave BasicsElliott Wave Basics• Waves are fractalWaves are fractal

• Wave-1 breaks into five smaller wavesWave-1 breaks into five smaller waves• Wave-2 subdivides into a three wave move, etc.Wave-2 subdivides into a three wave move, etc.• Wave-a is motive against the trend of one larger degreeWave-a is motive against the trend of one larger degree

• Any cycle of five waves forms a larger cycle of one degree Any cycle of five waves forms a larger cycle of one degree higher than the individual waves. Degree is based on form, higher than the individual waves. Degree is based on form, not price and time (despite nomenclature discussed later).not price and time (despite nomenclature discussed later).

• Even numbered waves are also corrective within a motive Even numbered waves are also corrective within a motive movemove

• Five wave moves have nothing to do with bull or bear Five wave moves have nothing to do with bull or bear markets: they can be in either direction. Action in the same markets: they can be in either direction. Action in the same direction as the larger trend is five waves, and countertrend direction as the larger trend is five waves, and countertrend action develops in three waves.action develops in three waves.

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Elliott Wave BasicsElliott Wave Basics

• Actionary moves are motive cycles that Actionary moves are motive cycles that are not diagonal triangles (no overlapping are not diagonal triangles (no overlapping between wave-1 and wave-4). Also known between wave-1 and wave-4). Also known as impulse moves.as impulse moves.

• A diagonal triangle is also known as a A diagonal triangle is also known as a wedge in classic TA and usually shows up wedge in classic TA and usually shows up in wave-5 or wave-C, rarely wave-1.in wave-5 or wave-C, rarely wave-1.

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Elliott Wave NotationElliott Wave Notation• Elliott created names for cycles of varying sizes and time. Frost Elliott created names for cycles of varying sizes and time. Frost

and Prechter revised the names and notationsand Prechter revised the names and notations1.1. Supermillenium Supermillenium 11 AA2.2. Millenium Millenium (1)(1) (A)(A)3.3. Submillenium Submillenium 11 AA4.4. Grand SupercycleGrand Supercycle II aa5.5. Supercycle Supercycle (I)(I) (a)(a)6.6. Cycle Cycle II aa7.7. Primary Primary 11 AA8.8. Intermediate Intermediate (1)(1) (A)(A)9.9. Minor Minor 11 AA10.10. MinuteMinute ii aa11.11. Minuette Minuette (i)(i) (a)(a)12.12. Subminuette Subminuette ii aa13.13. Micro Micro 11 AA14.14. Submicro Submicro (1)(1) (A)(A)15.15. Miniscule Miniscule 11 AA

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ExtensionsExtensions

• Usually, one wave in an impulse move extends – Usually, one wave in an impulse move extends – breaks into a larger five wave move. This is breaks into a larger five wave move. This is typically the third wave in the stock market and typically the third wave in the stock market and is often the fifth wave in the commodity is often the fifth wave in the commodity markets.markets.

• A full five wave impulse therefore breaks into a A full five wave impulse therefore breaks into a nine leg cycle. For example: (1)-(2)-1-2-3-4-5(3)-nine leg cycle. For example: (1)-(2)-1-2-3-4-5(3)-4-5 where wave-(3) extended into 1-2-3-4-5.4-5 where wave-(3) extended into 1-2-3-4-5.

• Extensions can extend as well: 1-2-3-4-(1)-(2)-Extensions can extend as well: 1-2-3-4-(1)-(2)-(3)-(4)-1-2-3-4-5(5)5(3)-(4)-1-2-3-4-5(5)5

• The circled waves are primary, the ones in parentheses The circled waves are primary, the ones in parentheses are intermediate and the last are minor degree.are intermediate and the last are minor degree.

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TruncationsTruncations

• More commonly known as failures, More commonly known as failures, but Frost/Prechter changed the name but Frost/Prechter changed the name to truncation.to truncation.

• When the fifth wave does not move When the fifth wave does not move beyond the end of the third wave. beyond the end of the third wave.

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DiagonalsDiagonals• Motive, but not actionary (impulsive)Motive, but not actionary (impulsive)

• Each leg is three waves. One exception is that a diagonal Each leg is three waves. One exception is that a diagonal can appear in wave-a of a zigzag or wave-1 of an impulse. can appear in wave-a of a zigzag or wave-1 of an impulse. In those cases, the subdivisions can – but do not have to – In those cases, the subdivisions can – but do not have to – develop as 5-3-5-3-5.develop as 5-3-5-3-5.

• Third wave still never the shortestThird wave still never the shortest

• Usually in fifth and sometimes in c-wave. If in a double Usually in fifth and sometimes in c-wave. If in a double three, can only be in wave-c of the second of the doubles.three, can only be in wave-c of the second of the doubles.

• Looks like wedge, with 5Looks like wedge, with 5thth sometimes over shooting, sometimes over shooting, sometimes undershooting. Frost/Prechter mentions one sometimes undershooting. Frost/Prechter mentions one case of expanding diagonal.case of expanding diagonal.

• Fifth wave extensions, truncated fifths and ending Fifth wave extensions, truncated fifths and ending diagonals often result in dramatic reversals.diagonals often result in dramatic reversals.

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Corrections - CategoriesCorrections - Categories• Three basic types:Three basic types:

• Zig-zags – 5-3-5 pattern. Also double zig-zag and triple zig-Zig-zags – 5-3-5 pattern. Also double zig-zag and triple zig-zag, which represent multiple zig-zag patterns joined zag, which represent multiple zig-zag patterns joined together. These are usually the sharpest corrections.together. These are usually the sharpest corrections.

• Flats – 3-3-5 pattern. Includes regular, expanded Flats – 3-3-5 pattern. Includes regular, expanded (Frost/Prechter term for irregular) and running. These (Frost/Prechter term for irregular) and running. These corrections are usually horizontal.corrections are usually horizontal.

• Triangle – Actually have five legs (3-3-3-3-3). Divided into Triangle – Actually have five legs (3-3-3-3-3). Divided into symmetrical, ascending, descending and expanding symmetrical, ascending, descending and expanding (reverse symmetrical). Always in last correction of an (reverse symmetrical). Always in last correction of an actionary wave of one larger degree (but can also be part of actionary wave of one larger degree (but can also be part of a combination). Frost/Prechter then says in very rare cases a combination). Frost/Prechter then says in very rare cases it can be a second wave, but usually as part of combination.it can be a second wave, but usually as part of combination.

• Combination – Double or triple, combining flats, zig-zags Combination – Double or triple, combining flats, zig-zags and trianglesand triangles

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Corrections – LabelingCorrections – Labeling• If you see a five wave move after a motive cycle, then there If you see a five wave move after a motive cycle, then there

will be another five wave move to come, forming a will be another five wave move to come, forming a correction (ie, a zig-zag). Five wave moves never stand correction (ie, a zig-zag). Five wave moves never stand alone.alone.

• Labels for a zig-zag or flat are of the A-B-C variety.Labels for a zig-zag or flat are of the A-B-C variety.

• For combinations (double three and triple three), each For combinations (double three and triple three), each individual “three” is labeled as W, then Y and then Z. The individual “three” is labeled as W, then Y and then Z. The overall labeling then would be: a-b-c(W), a-b-c(X), a-b-c(Y), overall labeling then would be: a-b-c(W), a-b-c(X), a-b-c(Y), a-b-c(X), a-b-c(Z). The waves between the W,Y and Z are a-b-c(X), a-b-c(Z). The waves between the W,Y and Z are called X-waves and can be any kind of corrective pattern, called X-waves and can be any kind of corrective pattern, but it is usually a zig-zag.but it is usually a zig-zag.

• If part of a combination is a triangle, that is labeled a-b-c-d-If part of a combination is a triangle, that is labeled a-b-c-d-e instead of a-b-c.e instead of a-b-c.

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Corrections – Zig-ZagsCorrections – Zig-Zags• Both waves are 5-wave motive moves. Both waves are 5-wave motive moves.

• Wave-A is rarely a diagonal triangle.Wave-A is rarely a diagonal triangle.

• Wave-B can be a triangle, or any other type of correction.Wave-B can be a triangle, or any other type of correction.

• Wave-C is often like wave-3, very powerful, but can occasionally Wave-C is often like wave-3, very powerful, but can occasionally be a diagonal triangle.be a diagonal triangle.

• Zig-zags are usually faster and correct more price territory than Zig-zags are usually faster and correct more price territory than flats.flats.

• You should look for a double zig-zag if a zig-zag completes that You should look for a double zig-zag if a zig-zag completes that has ended too quickly and more importantly has not retraced has ended too quickly and more importantly has not retraced enough price territory.enough price territory.

• A zig-zag can appear, usually as a Y or Z as part of a combination.A zig-zag can appear, usually as a Y or Z as part of a combination.

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Corrections – FlatsCorrections – Flats• Usually retraces less ground than a zig-Usually retraces less ground than a zig-

zag.zag.

• If a flat ends too quickly, although much of If a flat ends too quickly, although much of the price retracement may have taken the price retracement may have taken place, look for a double-three or triple-place, look for a double-three or triple-three to allow for more time (range three to allow for more time (range trading).trading).

• Wave-B can retrace more than 100% of Wave-B can retrace more than 100% of wave-A. This is known as an expanded flat wave-A. This is known as an expanded flat (Elliott called it an “irregular”, and that (Elliott called it an “irregular”, and that term is used by many Elliotticians).term is used by many Elliotticians).

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Corrections – Flats (con’t)Corrections – Flats (con’t)• Wave-C typically ends near the end of Wave-C typically ends near the end of

wave-A.wave-A.

• In expanded flats, wave-C may end well In expanded flats, wave-C may end well beyond the end of wave-A.beyond the end of wave-A.

• In a running flat, wave-B ends far beyond In a running flat, wave-B ends far beyond the start of wave-A. This implies strength the start of wave-A. This implies strength in the trend of one larger degree. Wave-C in the trend of one larger degree. Wave-C usually ends well before the end of wave-A usually ends well before the end of wave-A in these cases. in these cases. These types of These types of corrections are very rare!corrections are very rare!

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Corrections – TrianglesCorrections – Triangles• Possibly the single most important thing you can Possibly the single most important thing you can

learn from triangles is that the classic technical learn from triangles is that the classic technical analysis books have triangles all wrong:analysis books have triangles all wrong:• You can always predict which direction a triangle will You can always predict which direction a triangle will

break.break.• Although an ascending triangle is more likely to appear Although an ascending triangle is more likely to appear

as a correction in an up trend, the direction it breaks is as a correction in an up trend, the direction it breaks is based on the prior wave pattern. They are not inherently based on the prior wave pattern. They are not inherently bullish. The same is true of descending triangles.bullish. The same is true of descending triangles.

• Triangles, in this terminology are always Triangles, in this terminology are always corrective. If a triangle appears elsewhere in a corrective. If a triangle appears elsewhere in a trend, in Elliott terms, it is something different, trend, in Elliott terms, it is something different, even if classic technicians call it a triangle. In all even if classic technicians call it a triangle. In all likelihood, these triangles are less perfect likelihood, these triangles are less perfect triangles in standard TA terms.triangles in standard TA terms.

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Corrections – Triangles (con’t)Corrections – Triangles (con’t)• Triangles are virtually never in wave-2. Triangles are virtually never in wave-2.

• Running triangle – When wave-b of the Running triangle – When wave-b of the triangle moves past the starting point of triangle moves past the starting point of wave-a.wave-a.

• Fifth waves after triangles are usually fast Fifth waves after triangles are usually fast and the reversals are sharp. The size of and the reversals are sharp. The size of wave-5 is then often about the same as wave-5 is then often about the same as the width of the triangle (similar to the the width of the triangle (similar to the classic TA projection measure).classic TA projection measure).

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TerminologyTerminology• Frost/Prechter state that stocks are Frost/Prechter state that stocks are

directionally progressive. That is, that the directionally progressive. That is, that the general direction of stock prices is higher. general direction of stock prices is higher.

• In other words, stocks are upwardly In other words, stocks are upwardly directional, due to man’s general progress.directional, due to man’s general progress.

• Waves denoted by numbers are called Waves denoted by numbers are called cardinal waves. Waves denoted by letters cardinal waves. Waves denoted by letters are called consonant or sub-cardinal. We are called consonant or sub-cardinal. We can always says we are in a cardinal wave can always says we are in a cardinal wave of whatever is the current largest degree.of whatever is the current largest degree.

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Irregular TopsIrregular Tops• Frost/Prechter disagree with Elliott’s irregular top idea. Frost/Prechter disagree with Elliott’s irregular top idea.

• Elliott stated that major cycle highs were often irregular. Elliott stated that major cycle highs were often irregular. This would result in a tiny wave-a and an enormous wave-c.This would result in a tiny wave-a and an enormous wave-c.

• The authors state this is because Elliott favored extended The authors state this is because Elliott favored extended fifth waves, leaving an extra leg at the end of the cycle. fifth waves, leaving an extra leg at the end of the cycle. Frost and Prechter prefer using an extended third wave, Frost and Prechter prefer using an extended third wave, which often removes this requirement.which often removes this requirement.

• They note that the Elliott counting often had a strange They note that the Elliott counting often had a strange second wave which combined an expanded flat with a short second wave which combined an expanded flat with a short c-wave. (See figure 1-50 in Frost/Prechter).c-wave. (See figure 1-50 in Frost/Prechter).

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AlternationAlternation• This is not a rule, but it is a strong tendency.This is not a rule, but it is a strong tendency.

• It states that wave-2 and wave-4 do not usually develop in a It states that wave-2 and wave-4 do not usually develop in a similar fashion. The definition is vague, but examples may similar fashion. The definition is vague, but examples may include:include:

• Flat versus zig-zagFlat versus zig-zag• Expanded versus regular flatExpanded versus regular flat• Combination versus triangleCombination versus triangle• Fast versus slowFast versus slow• Deep versus shallow retracementDeep versus shallow retracement

• In other words, alternation may be in any dimension: size, time In other words, alternation may be in any dimension: size, time or form.or form.

• Alternation also exists in correctionsAlternation also exists in corrections• If wave-a is a flat, expect a zig-zag for wave-bIf wave-a is a flat, expect a zig-zag for wave-b• If wave-a is simple, wave-b may be complex and wave-c even more If wave-a is simple, wave-b may be complex and wave-c even more

complex.complex.

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Depth of CorrectionDepth of Correction• Fourth waves usually end near the terminus of Fourth waves usually end near the terminus of

the fourth wave of the prior wave of one lesser the fourth wave of the prior wave of one lesser degree, especially if the current corrective wave degree, especially if the current corrective wave is a fourth wave itself.is a fourth wave itself.

• For example, wave-4 will typically terminate near For example, wave-4 will typically terminate near the end of the fourth wave of the just completed the end of the fourth wave of the just completed wave-3.wave-3.

• When wave-5 extends, the next correction will When wave-5 extends, the next correction will often end near the end of the second wave of often end near the end of the second wave of wave-5, though it could end as far as the end of wave-5, though it could end as far as the end of the prior fourth wave.the prior fourth wave.

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SymmetrySymmetry• In an impulse move, the two non-extended waves tend to In an impulse move, the two non-extended waves tend to

be about equal in size.be about equal in size.

• The best measurement tool for equality, for all but very The best measurement tool for equality, for all but very minor cycles (ie, above minor) is percentage, not price minor cycles (ie, above minor) is percentage, not price points.points.

• If equality does not happen, a Fibonacci ration between the If equality does not happen, a Fibonacci ration between the two (say wave-5 = 61.8% of wave-1) often occurs.two (say wave-5 = 61.8% of wave-1) often occurs.

• The extended wave will tend to be at least 1.618 times the The extended wave will tend to be at least 1.618 times the size of the non-extended waves.size of the non-extended waves.

• Note: The book talks about how you cannot use intraday Note: The book talks about how you cannot use intraday highs and lows in the Dow. This is no longer true, although highs and lows in the Dow. This is no longer true, although it was correct at the time the book was first published.it was correct at the time the book was first published.

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ChannelsChannels• A whole impulse cycle often develops in a channel.A whole impulse cycle often develops in a channel.

• Alternately, you may be able to draw a channel by connecting Alternately, you may be able to draw a channel by connecting the lows of waves 2&4 and projecting from the extreme of the lows of waves 2&4 and projecting from the extreme of wave-3 to provide you with a fifth wave target area.wave-3 to provide you with a fifth wave target area.

• If a fifth wave approaches its resistance line on lower volume, If a fifth wave approaches its resistance line on lower volume, it may fail to reach that resistance line.it may fail to reach that resistance line.

• A move above the resistance line in wave-5, known as a throw A move above the resistance line in wave-5, known as a throw over, is often preceded by a throw under for wave-4. A throw over, is often preceded by a throw under for wave-4. A throw under is when wave-4 briefly falls below channel support.under is when wave-4 briefly falls below channel support.

• If volume in a fifth of less than Primary degree is seen, you are If volume in a fifth of less than Primary degree is seen, you are probably in a fifth wave extension.probably in a fifth wave extension.

• Volume tends to be higher if fifths of Primary degree and Volume tends to be higher if fifths of Primary degree and higher (capitulation or blow-off in classic TA terms of major higher (capitulation or blow-off in classic TA terms of major cycles).cycles).

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WaveWave CharacteristicsCharacteristics Wave-1 Wave-1 (I am writing this from the perspective of (I am writing this from the perspective of

a bullish first wave. It can also be bearish, just a bullish first wave. It can also be bearish, just reverse bull for bear and bear for bull in all reverse bull for bear and bear for bull in all sentences)sentences)

• Start of bull moveStart of bull move• Almost everybody still bearishAlmost everybody still bearish• Rally seen as selling opportunityRally seen as selling opportunity• Volume may not be very high, but usually there is a Volume may not be very high, but usually there is a

small increase in volume and improved market breadth.small increase in volume and improved market breadth.• About half of first waves have very deep retracements.About half of first waves have very deep retracements.• Fundamental news probably still badFundamental news probably still bad• In futures, open interest might fallIn futures, open interest might fall• In stocks, A/D line may have already been improving In stocks, A/D line may have already been improving

before bottom.before bottom.

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WaveWave CharacteristicsCharacteristics Wave-2Wave-2

Correction of first leg of bull moveCorrection of first leg of bull move Fundamentals still mostly negativeFundamentals still mostly negative Drop seen as resumption of bear trendDrop seen as resumption of bear trend Bears tell bulls, “I told you so!”Bears tell bulls, “I told you so!” But, volume weaker on dropBut, volume weaker on drop In futures, open interest fallsIn futures, open interest falls Most sentiment surveys still bearishMost sentiment surveys still bearish

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A Diversion: Behavioral FinanceA Diversion: Behavioral Finance

Studies how human emotion and Studies how human emotion and crowd psychology can cause crowd psychology can cause inefficiencies in the marketsinefficiencies in the markets

Can be used to support both Can be used to support both fundamental and technical analysis fundamental and technical analysis as being able to offer positive alphaas being able to offer positive alpha

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Behavioral FinanceBehavioral Finance

Some academics in behavioral Some academics in behavioral finance have embraced technical finance have embraced technical analysis as a tool in their cadre. analysis as a tool in their cadre.

Two examples are be Blake LeBaron Two examples are be Blake LeBaron (Brandeis) and Andrew Lo (MIT)(Brandeis) and Andrew Lo (MIT)

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Back to Elliott – Wave-3 Back to Elliott – Wave-3 CharacteristicsCharacteristics

Elliotticians dream of third waves (they don’t Elliotticians dream of third waves (they don’t have much of a life, do they?)have much of a life, do they?)

Usually most powerful and largest price moveUsually most powerful and largest price move The public jumps on board during this moveThe public jumps on board during this move High volume, momentum confirmsHigh volume, momentum confirms Typically at least 1.618 times as large as wave-1Typically at least 1.618 times as large as wave-1 Fundamentals (finally) confirm the positive price Fundamentals (finally) confirm the positive price

actionaction Breakouts, continuation gaps are common.Breakouts, continuation gaps are common. Excellent market breadth with Dow Theory Excellent market breadth with Dow Theory

confirmation for higher degree stock market bull confirmation for higher degree stock market bull cycles.cycles.

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Wave-3 and Behavioral FinanceWave-3 and Behavioral Finance

Sentiment should be at highest level Sentiment should be at highest level during this moveduring this move

Forecasts should show revisions to extend Forecasts should show revisions to extend earlier expectationsearlier expectations

Recognition that this is a bull market is Recognition that this is a bull market is likelylikely

While should be easy to get in, some will While should be easy to get in, some will want to wait for a pull back to get a want to wait for a pull back to get a bargain, and they will miss the boatbargain, and they will miss the boat

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Wave-4 CharacteristicsWave-4 Characteristics Often the most difficult wave to tradeOften the most difficult wave to trade

Trend is still upTrend is still up

Extended range trading possible, and irregulars very Extended range trading possible, and irregulars very commoncommon

Seen as buying opportunity.Seen as buying opportunity.

Forms first support in head and shoulders necklineForms first support in head and shoulders neckline

Preferably, trend line drawn from start of wave-1 through Preferably, trend line drawn from start of wave-1 through bottom of wave-2 is not breachedbottom of wave-2 is not breached

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Wave-5 CharacteristicsWave-5 Characteristics

Everybody is bullish; it is a true bull Everybody is bullish; it is a true bull love festlove fest

Bears are regularly ridiculed in the Bears are regularly ridiculed in the financial mediafinancial media

The news is all goodThe news is all good Prices make new highsPrices make new highs

BUT....BUT....

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Wave-5 CharacteristicsWave-5 Characteristics Volume probably lower than at end of third wave, except in Volume probably lower than at end of third wave, except in

Primary degree and higher where there can be a blow-off Primary degree and higher where there can be a blow-off type situation. Also, volume is high in a fifth wave type situation. Also, volume is high in a fifth wave extension.extension.

Open interest (in futures) might not confirm gainsOpen interest (in futures) might not confirm gains

Usually see momentum divergencesUsually see momentum divergences

COT reports may show growing short positions held by COT reports may show growing short positions held by hedgershedgers

Optimism is extreme. The bull market will never end!Optimism is extreme. The bull market will never end!

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Wave-5 Behavioral CluesWave-5 Behavioral Clues Forecast targets extended to allow for new Forecast targets extended to allow for new

paradigmsparadigms

Your friendly neighborhood plumber is talking Your friendly neighborhood plumber is talking about the investmentabout the investment

Cover stories in mass media magazines such as Cover stories in mass media magazines such as TimeTime and and NewsweekNewsweek

Nobody will talk to all of the famous bearish Nobody will talk to all of the famous bearish gurus, except to ridicule them. Remember how gurus, except to ridicule them. Remember how technical analysts were treated in early 2000 by technical analysts were treated in early 2000 by the mainstream financial media?the mainstream financial media?

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Wave-A CharacteristicsWave-A Characteristics

At the start of the bear market, At the start of the bear market, people still think they should be people still think they should be buying dips.buying dips.

Sentiment is still bullish.Sentiment is still bullish. If Wave-A is five waves, it means that If Wave-A is five waves, it means that

the bear market will be a zig-zagthe bear market will be a zig-zag

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Wave-B CharacteristicsWave-B Characteristics A wolf in sheep’s clothing.A wolf in sheep’s clothing. Market participants still following the bullish Market participants still following the bullish

mantra and see the just completed wave-A as mantra and see the just completed wave-A as corrective.corrective.

Everything is going to be okay.Everything is going to be okay. But, volume probably not very strong (except in But, volume probably not very strong (except in

Primary Degree and higher) and market breadth Primary Degree and higher) and market breadth is poor even if sentiment is still strong and is poor even if sentiment is still strong and fundamentals, which tend to be trailing, still look fundamentals, which tend to be trailing, still look constructive.constructive.

Wave-B is the right shoulder of the classic head Wave-B is the right shoulder of the classic head and shoulders reversal pattern.and shoulders reversal pattern.

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Wave-C CharacteristicsWave-C Characteristics Cousins of third waves.Cousins of third waves. Usually impulsive, but can be diagonal Usually impulsive, but can be diagonal

triangles.triangles. High volume as end of wave is reached (at High volume as end of wave is reached (at

the end of a bear, this would be termed a the end of a bear, this would be termed a capitulation)capitulation)

Everybody finally buys into the bear Everybody finally buys into the bear market.market.

However, as the end approaches, there However, as the end approaches, there might even be some technical lights at the might even be some technical lights at the end of the tunnel (which are not an end of the tunnel (which are not an oncoming train).oncoming train).

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Waves D&E (Triangles)Waves D&E (Triangles) Wave-D might see higher volume in non-Wave-D might see higher volume in non-

expanding triangles.expanding triangles. This may be due to the fact that they This may be due to the fact that they

follow c-waves and can be initially follow c-waves and can be initially believed to be the start of the next cycle believed to be the start of the next cycle and the end of the correction.and the end of the correction.

E-waves look like the resumption of the E-waves look like the resumption of the bear market and news can be very bear market and news can be very negative. They often break below triangle negative. They often break below triangle support. But, they are a fake-out as the support. But, they are a fake-out as the market is then ripe for a return to the prior market is then ripe for a return to the prior up trend.up trend.

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Da Rules!Da Rules! It is not worth going through all of the guidelines It is not worth going through all of the guidelines

and rules noted in the 2005 edition on pages 86-and rules noted in the 2005 edition on pages 86-91, but you should be familiar with most of them.91, but you should be familiar with most of them.

Note that most of these guidelines have been Note that most of these guidelines have been discussed in prior slides.discussed in prior slides.

Here are a few of the less obvious but more Here are a few of the less obvious but more important rules and guidelines:important rules and guidelines:• Usually, only one motive wave extends, but two might in Usually, only one motive wave extends, but two might in

Cycle or Supercycle degree.Cycle or Supercycle degree.• When wave-5 extends, it is typically in a Fibonacci When wave-5 extends, it is typically in a Fibonacci

proportion to the distance traveled by waves 1-3proportion to the distance traveled by waves 1-3• Wave-4 usually ends in the area of the fourth of wave-3Wave-4 usually ends in the area of the fourth of wave-3• Wave-4 often subdivides the entire impulse in a Wave-4 often subdivides the entire impulse in a

Fibonacci price or time proportionFibonacci price or time proportion

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Da Rules! (con’t)Da Rules! (con’t) An ending diagonal always appears as wave-5 of An ending diagonal always appears as wave-5 of

an impulse or wave-c of a zig-zag or flat.an impulse or wave-c of a zig-zag or flat. A leading diagonal always appears as wave-1 of A leading diagonal always appears as wave-1 of

an impulse or wave-A of a zig-zag or flat.an impulse or wave-A of a zig-zag or flat. All waves of an ending diagonal and waves 2&4 All waves of an ending diagonal and waves 2&4

of a leading diagonal always divide into a zig-zag.of a leading diagonal always divide into a zig-zag. Wave-4 of a diagonal always overlaps wave-1.Wave-4 of a diagonal always overlaps wave-1. Diagonals look like classic TA wedges.Diagonals look like classic TA wedges. Wave-3 is still never the shortest wave and in an Wave-3 is still never the shortest wave and in an

expanding diagonal wave-5 always ends beyond expanding diagonal wave-5 always ends beyond the terminus of wave-3.the terminus of wave-3.

Waves 2&4 usually retrace 66% to 81% of the Waves 2&4 usually retrace 66% to 81% of the prior wave.prior wave.

4444

Da Rules! (con’t)Da Rules! (con’t) In an impulse, a diagonal is unlikely unless wave-3 is In an impulse, a diagonal is unlikely unless wave-3 is

extended.extended. In a zig-zag, wave-B never retraces more than 100% of In a zig-zag, wave-B never retraces more than 100% of

wave-Awave-A If wave-B is a running triangle, it will typically retrace 10-If wave-B is a running triangle, it will typically retrace 10-

40% of wave-A40% of wave-A Wave-B usually retraces 38-79% of wave-A if it isn’t a Wave-B usually retraces 38-79% of wave-A if it isn’t a

running triangle.running triangle. If wave-B is a zig-zag, it typically retraces 50-70% of wave-If wave-B is a zig-zag, it typically retraces 50-70% of wave-

A.A. Wave-A is never a triangle in a flat (or a zig-zag).Wave-A is never a triangle in a flat (or a zig-zag). Wave-B always retraces at least 90% of wave-A and usually Wave-B always retraces at least 90% of wave-A and usually

retraces 100-138% of wave-A in a flat.retraces 100-138% of wave-A in a flat. In a flat, wave-C is typically 100-162% of wave-A.In a flat, wave-C is typically 100-162% of wave-A. Wave-C usually ends beyond the end of wave-A in a flat.Wave-C usually ends beyond the end of wave-A in a flat.

4545

Da Rules! (con’t)Da Rules! (con’t) An expanded flat is when wave-B is more than 105% of An expanded flat is when wave-B is more than 105% of

wave-A and wave-C ends beyond the end of wave-A.wave-A and wave-C ends beyond the end of wave-A. If wave-B is more than 100% of wave-A, but wave-C does If wave-B is more than 100% of wave-A, but wave-C does

not move past the end of wave-A, then the flat is called a not move past the end of wave-A, then the flat is called a running flat.running flat.

In a contracting triangle, at least four of the waves must In a contracting triangle, at least four of the waves must divide into a zig-zag or a zig-zag combination.divide into a zig-zag or a zig-zag combination.

Except for wave-E, a wave in a contracting triangle never Except for wave-E, a wave in a contracting triangle never retraces more than 100% of the prior wave.retraces more than 100% of the prior wave.

A triangle never has more than one complex wave and if it A triangle never has more than one complex wave and if it does, it is either a zig-zag combination or a triangle itself.does, it is either a zig-zag combination or a triangle itself.

About 60% of the time, wave-B does not end beyond the About 60% of the time, wave-B does not end beyond the end of wave-A. This is a running triangle.end of wave-A. This is a running triangle.

Wave-5 following a triangle is typically either brief or an Wave-5 following a triangle is typically either brief or an exceptionally long extension.exceptionally long extension.

4646

Da Rules! (con’t)Da Rules! (con’t) In an expanding triangle, waves c,d and e retrace at least In an expanding triangle, waves c,d and e retrace at least

100%, but not more than 150% of the prior subwave. They 100%, but not more than 150% of the prior subwave. They usually retrace 105-125% of the previous subwave.usually retrace 105-125% of the previous subwave.

Combinations are formed by two or three corrective Combinations are formed by two or three corrective patterns separated by corrective pattern(s) in the opposite patterns separated by corrective pattern(s) in the opposite direction.direction.

A double three flat is either a zig-zag&flat, a flat&zig-zag, A double three flat is either a zig-zag&flat, a flat&zig-zag, two flats, a zig-zag and triangle or a flat&triangle.two flats, a zig-zag and triangle or a flat&triangle.

A triple three flat comprises three flats.A triple three flat comprises three flats. Double and triple zig-zags take the place of zig-zags while Double and triple zig-zags take the place of zig-zags while

double and triple threes stand in for flats or triangles.double and triple threes stand in for flats or triangles. An expanding triangle has never been seen as part of a An expanding triangle has never been seen as part of a

combination.combination.

4747

Determining Your CountDetermining Your Count You should consider all factors discussed to this point in You should consider all factors discussed to this point in

developing a wave count.developing a wave count. More than one count may be possible. Frost&Prechter More than one count may be possible. Frost&Prechter

recommend always having an alternate count. Alternates recommend always having an alternate count. Alternates must also abide by these rules and guidelines.must also abide by these rules and guidelines.

Never forget that wave form is more important than Never forget that wave form is more important than volume, exact timing, price target calculations of non-Elliott volume, exact timing, price target calculations of non-Elliott indicators, be they technical or fundamental in developing indicators, be they technical or fundamental in developing your count.your count.

In the next section, we will cover in greater detail Fibonacci In the next section, we will cover in greater detail Fibonacci ratios to help you more closely compute potential time and ratios to help you more closely compute potential time and price targets. However, these calculations remain less price targets. However, these calculations remain less important than wave form.important than wave form.

Despite these admonitions, if several methods provide you Despite these admonitions, if several methods provide you with a good price target (such as equality between wave-1 with a good price target (such as equality between wave-1 and wave-5, a trend line, a day count, plus volume and and wave-5, a trend line, a day count, plus volume and indicators), the probability of your being correct is better.indicators), the probability of your being correct is better.

4848

Fibonacci - IntroductionFibonacci - Introduction Based on the work of the mathematician Based on the work of the mathematician

Leonardo da Pisa (later known as Fibonacci).Leonardo da Pisa (later known as Fibonacci). Many waves relate to prior subwaves and degrees Many waves relate to prior subwaves and degrees

based on comparisons using Fibonacci-based based on comparisons using Fibonacci-based ratios.ratios.

Ratios based on the series of numbers where SRatios based on the series of numbers where Snn = = SSn-1n-1 + S + Sn-2n-2• Example: 1,1,2,3,5,8,13,21,34Example: 1,1,2,3,5,8,13,21,34• Example: 6,11,17,28,45,73,118Example: 6,11,17,28,45,73,118

The ratio of number n in the series, to number n-The ratio of number n in the series, to number n-1, quickly approaches 1.618.1, quickly approaches 1.618.

The inverse of this is 0.618 and is known by the The inverse of this is 0.618 and is known by the Greek letter phi (Greek letter phi (ΦΦ).).

4949

Fibonacci - IntroductionFibonacci - Introduction There is a whole lot of numerology involved with There is a whole lot of numerology involved with ΦΦ, which is , which is

not all that relevant to Elliott.not all that relevant to Elliott. What is relevant are the main ratios and retracements that What is relevant are the main ratios and retracements that

Elliotticians use:Elliotticians use:• 0.382 (S0.382 (Snn/S/Sn-2n-2) ) 1.6181.618• 0.6180.618 2.618 = 1.618*1.6182.618 = 1.618*1.618• 0.236 (S0.236 (Snn/S/Sn-3n-3) ) 4.236 = 1.6184.236 = 1.61833

• 0.764 (1-0.236) or 0.786 (0.764 (1-0.236) or 0.786 (ΦΦ0.50.5)) The Golden Mean (or Golden Ratio) is 0.618 or 1.618 The Golden Mean (or Golden Ratio) is 0.618 or 1.618

according to Frost/Prechter.according to Frost/Prechter. The Golden Section: The point on a line where the ratio The Golden Section: The point on a line where the ratio

between the smaller part of the line and the larger part of between the smaller part of the line and the larger part of the line equals the ratio between the larger part of the line the line equals the ratio between the larger part of the line and the whole line. This is at the 0.618 point.and the whole line. This is at the 0.618 point.

The book covers the Golden Rectangle and Golden Spiral. The book covers the Golden Rectangle and Golden Spiral.

5050

Using FibonacciUsing Fibonacci Some basic tendencies were discussed in “Da Some basic tendencies were discussed in “Da

Rules” earlier.Rules” earlier. You can use Fibonacci ratios for determining You can use Fibonacci ratios for determining

possible targets for retracements and for current possible targets for retracements and for current and later wave termini.and later wave termini.

You can also use Fibonacci numbers and ratios to You can also use Fibonacci numbers and ratios to help you time when waves might end.help you time when waves might end.

On their own, a dependence on Fib numbers can On their own, a dependence on Fib numbers can be dangerous, but when combined with the be dangerous, but when combined with the principals of channeling as well as by using principals of channeling as well as by using volume and momentum, plus an understanding of volume and momentum, plus an understanding of Crowd Behavior, you can learn to apply Elliott Crowd Behavior, you can learn to apply Elliott Wave in a profitable and easy-to-understand Wave in a profitable and easy-to-understand manner.manner.

5151

Using Fibonacci (con’t)Using Fibonacci (con’t) When wave-3 extends, wave-1 and wave-5 end to When wave-3 extends, wave-1 and wave-5 end to

be equal in size.be equal in size. When wave-5 extends, it tends to travel about When wave-5 extends, it tends to travel about

1.618 times the distance traveled by waves 1-31.618 times the distance traveled by waves 1-3 When wave-1 extends, it will often travel 1.618 When wave-1 extends, it will often travel 1.618

times the distance of waves 3-5.times the distance of waves 3-5. Wave-4 often divides a whole move into the Wave-4 often divides a whole move into the

Golden mean (ie, wave-5 is 38.2% or 61.8% of the Golden mean (ie, wave-5 is 38.2% or 61.8% of the distance from the start of wave-1 to the bottom of distance from the start of wave-1 to the bottom of wave-4).wave-4).

In a contracting triangle each alternate wave In a contracting triangle each alternate wave tends to be 0.618 times the preceding alternate tends to be 0.618 times the preceding alternate wave (ie, wave-e = 0.618 times wave-a)wave (ie, wave-e = 0.618 times wave-a)

5252

Using Fibonacci (con’t)Using Fibonacci (con’t) You can also use Fibonacci numbers to look for You can also use Fibonacci numbers to look for

timing targets.timing targets. Waves will often take Fib ratios in terms of time Waves will often take Fib ratios in terms of time

as well. For example, if wave-1 takes eight days, as well. For example, if wave-1 takes eight days, wave-2 might take five, and wave-3 13.wave-2 might take five, and wave-3 13.

I have often found that daily cycles tend take I have often found that daily cycles tend take Fibonacci numbers of days.Fibonacci numbers of days.

My work has also shown that trading days works My work has also shown that trading days works better than calendar days. However, neither this better than calendar days. However, neither this or the previous point is noted in Prechter/Frost.or the previous point is noted in Prechter/Frost.

Frost/Prechter notes the Benner-Fibonacci cycle. Frost/Prechter notes the Benner-Fibonacci cycle. Although I doubt it will be on the exam, this 20-Although I doubt it will be on the exam, this 20-18-16 year cycle has done a very good job of 18-16 year cycle has done a very good job of forecasting panics and blow-offs.forecasting panics and blow-offs.

5353

Using FibonacciUsing Fibonacci When wave-3 extends, wave-1 and wave-5 end to When wave-3 extends, wave-1 and wave-5 end to

be equal in size.be equal in size. When wave-5 extends, it tends to travel about When wave-5 extends, it tends to travel about

1.618 times the distance traveled by waves 1-31.618 times the distance traveled by waves 1-3 When wave-1 extends, it will often travel 1.618 When wave-1 extends, it will often travel 1.618

times the distance of waves 3-5.times the distance of waves 3-5. Wave-4 often divides a whole move into the Wave-4 often divides a whole move into the

Golden mean (ie, wave-5 is 38.2% or 61.8% of the Golden mean (ie, wave-5 is 38.2% or 61.8% of the distance from the start of wave-1 to the bottom of distance from the start of wave-1 to the bottom of wave-4).wave-4).

In a contracting triangle each alternate wave In a contracting triangle each alternate wave tends to be 0.618 times the preceding alternate tends to be 0.618 times the preceding alternate wave (ie, wave-e = 0.618 times wave-a)wave (ie, wave-e = 0.618 times wave-a)

5454

Some Final ThoughtsSome Final Thoughts Frost and Prechter note that wave theory is applicable to Frost and Prechter note that wave theory is applicable to

business activity. Prechter has extended this to the new business activity. Prechter has extended this to the new science of Socioconomics. Socioconomics is not mentioned science of Socioconomics. Socioconomics is not mentioned in the book, and is not likely to be tested on, but the Elliott in the book, and is not likely to be tested on, but the Elliott Wave Principle is its basis.Wave Principle is its basis.

Note that this ties us back into the idea of Behavior Note that this ties us back into the idea of Behavior Finance. It is not the news that counts, but how the market Finance. It is not the news that counts, but how the market (or stock, or commodity) reacts to the news. In terms of (or stock, or commodity) reacts to the news. In terms of Elliott, it is how that reaction is represented in wave forms.Elliott, it is how that reaction is represented in wave forms.

Dow Theory has some minor overlaps with Elliott. They both Dow Theory has some minor overlaps with Elliott. They both recognize the behavioral and psychological differences recognize the behavioral and psychological differences between bull and bear cycles. between bull and bear cycles.

Dow Theory divergences (Industrials at new high, Dow Theory divergences (Industrials at new high, Transports not) couples well with momentum divergences Transports not) couples well with momentum divergences often noted at the top of fifth waves.often noted at the top of fifth waves.

Dow bull and bear markets are not directly tied to any Dow bull and bear markets are not directly tied to any specific degree and Elliott does not have a true bull or bear.specific degree and Elliott does not have a true bull or bear.

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Charts to DiscussCharts to Discuss

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Charts to DiscussCharts to Discuss

5757

Charts to DiscussCharts to Discuss

5858

Further Readings and SourcesFurther Readings and Sources Robert Prechter Jr.’s site: Robert Prechter Jr.’s site:

http://www.elliottwave.comhttp://www.elliottwave.com R.N. Elliott’s MasterworksR.N. Elliott’s Masterworks (edited by Robert (edited by Robert

Prechter Jr.)Prechter Jr.) Applying Elliott Wave Theory ProfitablyApplying Elliott Wave Theory Profitably (by (by

Steven W. Poser) – Note that my book does not Steven W. Poser) – Note that my book does not exactly follow Frost/Prechter. It should be useful exactly follow Frost/Prechter. It should be useful when you get beyond the exam and wish to start when you get beyond the exam and wish to start applying Elliott Wave in the real world.applying Elliott Wave in the real world.

Pioneering Studies in Socioconomics&The Wave Pioneering Studies in Socioconomics&The Wave Principle of Human Social BehaviorPrinciple of Human Social Behavior (by Robert (by Robert Prechter Jr.)Prechter Jr.)