Lesson 1: Introduction to the
Wave Principle
In The Elliott Wave Principle — A
Critical Appraisal, Hamilton Bolton made this opening statement:
As we have advanced through some of the
most unpredictable economic climate imaginable, covering depression,
major war, and postwar reconstruction and boom, I have noted how
well Elliott's Wave Principle has fitted into the facts of life as
they have developed, and have accordingly gained more confidence
that this Principle has a good quotient of basic value.
"The Wave Principle" is Ralph Nelson
Elliott's discovery that social, or crowd, behavior trends and
reverses in recognizable patterns. Using stock market data 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. Elliott isolated
thirteen patterns of movement, or "waves," that recur in market
price data 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 those same patterns, how they in turn
link to form identical patterns of the next larger size, and so on.
In a nutshell, then, the Wave Principle is a catalog of price
patterns and an explanation of where these forms are likely to occur
in the overall path of market development. Elliott's descriptions
constitute a set of empirically derived rules and guidelines for
interpreting market action. Elliott claimed predictive value for The
Wave Principle, which now bears the name, "The Elliott Wave
Principle."
Although it is the best forecasting tool
in existence, the Wave Principle is not primarily a forecasting
tool; it is a detailed description of how markets behave.
Nevertheless, that description does impart an immense amount of
knowledge about the market's position within the behavioral
continuum and therefore about its probable ensuing path. The primary
value of the Wave Principle is that it provides a context for market
analysis. This context provides both a basis for disciplined
thinking and a perspective on the market's general position and
outlook. At times, its accuracy in identifying, and even
anticipating, changes in direction is almost unbelievable. Many
areas of mass human activity follow the Wave Principle, but the
stock market is where it is most popularly applied. Indeed, the
stock market considered alone is far more important than it seems to
casual observers. The level of aggregate stock prices is a direct
and immediate measure of the popular valuation of man's total
productive capability. That this valuation has form is a fact of
profound implications that will ultimately revolutionize the social
sciences. That, however, is a discussion for another time.
R.N. Elliott's genius consisted of a
wonderfully disciplined mental process, suited to studying charts of
the Dow Jones Industrial Average and its predecessors with such
thoroughness and precision that he could construct a network of
principles that covered all market action known to him up to the
mid-1940s. At that time, with the Dow in the 100s, Elliott predicted
a great bull market for the next several decades that would exceed
all expectations at a time when most investors felt it impossible
that the Dow could even better its 1929 peak. As we shall see,
phenomenal stock market forecasts, some of pinpoint accuracy years
in advance, have accompanied the history of the application of the
Elliott Wave approach.
Elliott had theories regarding the origin
and meaning of the patterns he discovered, which we will present and
expand upon in Lessons 16-19. Until then, suffice it to say that the
patterns described in Lessons 1-15 have stood the test of time.
Often one will hear several different
interpretations of the market's Elliott Wave status, especially when
cursory, off-the-cuff studies of the averages are made by latter day
experts.
However, most uncertainties can be
avoided by keeping charts on both arithmetic and semilogarithmic
scale and by taking care to follow the rules and guidelines as laid
down in this course. Welcome to the world of Elliott.
BASIC
TENETS
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.
Sometimes the market appears to reflect
outside conditions and events, but at other times it is entirely
detached from what most people assume are causal conditions. The
reason is that the market has a law of its own. It is not propelled
by the linear causality to which one becomes accustomed in the
everyday experiences of life. Nor is the market the cyclically
rhythmic machine that some declare it to be. Nevertheless, its
movement reflects a structured formal progression.
That progression unfolds in waves. Waves
are patterns of directional movement. More specifically, a wave is
any one of the patterns that naturally occur under the Wave
Principle, as described in Lessons 1-9 of this course.
The 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 1-1. The two
interruptions are apparently a requisite for overall directional
movement to occur.
Figure 1-1
R.N. Elliott did not specifically state
that there is only one overriding form, the "five wave" pattern, but
that is undeniably the case. 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.
Wave Mode
There are two modes of wave development:
motive and corrective. Motive waves have a five wave structure,
while corrective waves have a three wave structure or a variation
thereof. Motive mode is employed by both the five wave pattern of
Figure 1-1 and its same-directional components, i.e., waves 1, 3 and
5. Their structures are called "motive" because they powerfully
impel the market. Corrective mode is employed by all countertrend
interruptions, which include waves 2 and 4 in Figure 1-1. Their
structures are called "corrective" because they can accomplish only
a partial retracement, or "correction," of the progress achieved by
any preceding motive wave. Thus, the two modes are fundamentally
different, both in their roles and in their construction, as will be
detailed throughout this course.
Next Lesson: Details of the
Complete Cycle
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