Elliott Wave Principle : Chapter 1.2

In a rare variation on the 3-3-5 pattern, which we call a running flat, wave B terminates well beyond the beginning of wave A as in an expanded flat, but wave C fails to travel its full distance, falling short of the level at which wave A ended, as in Figures 1-38 through 1-41. Apparently in this case, the forces in the direction of the larger trend are so powerful that the pattern is skewed in that direction. The result is akin to the truncation of an impulse.

It is always important, but particularly when concluding that a running flat has taken place, that the internal subdivisions adhere to Elliott’s rules. If the supposed B wave, for instance, breaks down into five waves rather than three, it is more likely the first wave up of the impulse of next higher degree. The power of adjacent impulse waves is important in recognizing running corrections, which tend to occur only in strong and fast markets.

We must issue a warning, however. There are hardly any examples of this type of correction in the price record. Never label a correction prematurely this way, or you’ll find yourself wrong nine times out of ten. A running triangle, in contrast, is much more common (see next section).

Triangle

A triangle appears to reflect a balance of forces, causing a sideways movement that is usually associated with decreasing volume and volatility. The triangle pattern contains five overlapping waves that subdivide 3-3-3-3-3 and are labeled A-B-C-D-E. A triangle is delineated by connecting the termination points of waves A and C, and B and D. Wave E can undershoot or overshoot the A-C line, and in fact, our experience tells us that it happens more often than not.

There are three varieties of triangles: contracting, barrier and expanding, as illustrated in Figure 1-42. Elliott contended that the horizontal line of a barrier triangle could occur on either side of the triangle, but such is not the case; it always occurs on the side that the next wave will exceed. Elliott’s terms, "ascending" and "descending," are nevertheless useful shorthand in communicating whether the barrier triangle occurs in a bull or bear market, respectively.

Figure 1-42 depicts contracting and barrier triangles as taking place entirely within the area of preceding price action, which may be termed a regular triangle. Yet, it is extremely common for wave B of a contracting triangle to exceed the start of wave A in what may be termed a running triangle, as shown in Figure 1-43. Despite their sideways appearance, all triangles, including running triangles, effect a net retracement of the preceding wave at wave E’s end.

There are several real life examples of triangles in the charts in this book (see Figures 1-27, 3-15, 5-5, 6-9, 6-10 and 6-12). As you will notice, most of the sub waves in a triangle are zigzags, but sometimes one of the sub waves (usually wave C) is more complex than the others and can take the shape of a multiple zigzag. In rare cases, one of the sub-waves (usually wave E) is itself a triangle, so that the entire pattern protracts into nine waves. Thus, triangles, like zigzags, occasionally display a development that is analogous to an extension. One example occurred in silver from 1973 through 1977 (see Figure 1-44).

Figure 1-42

Figure 1-43

Figure 1-44

A triangle always occurs in a position prior to the final actionary wave in the pattern of one larger degree, i.e., as wave four in an impulse, wave B in an A-B-C, or the final wave X in a double or triple zigzag or combination (see next section). A triangle may also occur as the final actionary pattern in a corrective combination, as discussed in the next section, although even then it usually precedes the final actionary wave in the pattern of one larger degree than the corrective combination. Although upon extremely rare occasions a second wave in an impulse appears to take the form of a triangle, it is usually due to the fact that a triangle is part of the correction, which is in fact a double three (for example, see Figure 3-12).

In the stock market, when a triangle occurs in the fourth wave position, wave five is sometimes swift and travels approximately the distance of the widest part of the triangle. Elliott used the word "thrust" in referring to this swift, short motive wave following a triangle. The thrust is usually an impulse but can be an ending diagonal. In powerful markets, there is no thrust, but instead a prolonged fifth wave. So if a fifth wave following a triangle pushes past a normal thrust movement, it is signaling a likely protracted wave. Post-triangle advancing impulses in commodities at degrees above Intermediate are usually the longest wave in the sequence, as explained in Chapter 6.

Many analysts are fooled into labeling a completed triangle way too early. Triangles take time and go sideways. If you examine Figure 1-44 closely, you will see that one could have jumped the gun in the middle of wave b, pronouncing the end of five contracting waves. But the boundary lines of triangles almost never collapse so quickly. Sub wave C is typically a complex wave, though wave B or D can fulfill that role. Give triangles time to develop.

On the basis of our experience with triangles, as the examples in Figures 1-27 and later in 3-11 and 3-12 illustrate, we propose that often the time at which the boundary lines of a contracting triangle reach an apex coincides with a turning point in the market. Perhaps the frequency of this occurrence would justify its inclusion among the guidelines associated with the Wave Principle.

Combination (Double and Triple Three)

Elliott called a sideways combination of two corrective patterns a "double three" and three patterns a "triple three." While a single three is any zigzag or flat, a triangle is an allowable final component of such combinations and in this context is called a "three." A combination is composed of simpler types of corrections, including zigzags, flats and triangles. Their occurrence appears to be the flat correction’s way of extending sideways action. As with double and triple zigzags, the simple corrective pattern components are labeled W, Y and Z. Each reactionary wave, labeled X, can take the shape of any corrective pattern but is most commonly a zigzag. As with multiple zigzags, three patterns appear to be the limit, and even those are rare compared to the more common double three.

Combinations of threes were labeled differently by Elliott at different times, although the illustrative pattern always took the shape of two or three juxtaposed flats, as shown in Figures 1-45 and 1-46. However, the component patterns more commonly alternate in form. For example, a flat followed by a triangle is a more typical type of double three (which we now know as of 1983; see Appendix), as illustrated in Figure 1-47.

A flat followed by a zigzag is another example, as shown in Figure 1-48. Naturally, since the figures in this section depict corrections in bull markets, they need only be inverted to observe them as upward corrections in bear markets.

Figure 1-47

Figure 1-48

For the most part, a combination is horizontal in character. Elliott indicated that the entire formation could slant against the larger trend, although we have never found this to be the case. One reason is that there never appears to be more than one zigzag in a combination. Neither is there more than one triangle. Recall that triangles occurring alone precede the final movement of a larger trend. Combinations appear to recognize this character and sport triangles only as the final wave in a double or triple three.

Although different in that their angle of trend is sharper than the sideways trend of combinations (see the guideline of alternation in Chapter 2), double and triple zigzags (see Figure 1-26) can be characterized as non-horizontal combinations, as Elliott seemed to suggest in Nature’s Law. But double and triple threes are different from double and triple zigzags not only in their angle but in their goal. In a double or triple zigzag, the first zigzag is rarely large enough to constitute an adequate price correction of the preceding wave. The doubling or tripling of the initial form is usually necessary to create an adequately sized price retracement. In a combination, however, the first simple pattern often constitutes an adequate price correction. The doubling or tripling appears to occur mainly to extend the duration of the corrective process after price targets have been substantially met. Sometimes additional time is needed to reach a channel line or achieve a stronger kinship with the other correction in an impulse. As the consolidation continues, the attendant psychology and fundamentals extend their trends accordingly.

As this section makes clear, there is a qualitative difference between the series 3 + 4 + 4 + 4, etc., and the series 5 + 4 + 4 + 4, etc. Notice that while an impulse wave has a total count of 5, with extensions leading to 9 or 13 waves, and so on, a corrective wave has a count of 3, with combinations leading to 7 or 11 waves, and so on. The triangle appears to be an exception, although it can be counted as one would a triple three, totaling 11 waves. Thus, if an internal count is unclear, you can sometimes reach a reasonable conclusion merely by counting waves. A count of 9, 13 or 17 with few overlaps, for instance, is likely motive, while a count of 7, 11 or 15 with numerous overlaps is likely corrective. The main exceptions are diagonals of both types, which are hybrids of motive and corrective forces.

Orthodox Tops and Bottoms

Sometimes a pattern’s end differs from the associated price extreme. In such cases, the end of the pattern is called the "orthodox" top or bottom in order to differentiate it from the actual price high or low that occurs intra-pattern or after the end of the pattern. For example, in Figure 1-14, the end of wave (5) is the orthodox top despite the fact that wave (3) registered a higher price. In Figure 1-13, the end of wave 5 is the orthodox bottom. In Figures 1-33 and 1-34, the starting point of wave A is the orthodox top of the preceding bull market despite the higher high of wave B. In Figures 1-35 and 1-36, the start of wave A is the orthodox bottom. In Figure 1-47, the end of wave Y is the orthodox bottom of the bear market even though the price low occurs at the end of wave W.

This concept is important primarily because a successful analysis always depends upon a proper labeling of the patterns. Assuming falsely that a particular price extreme is the correct starting point for wave labeling can throw analysis off for some time, while being aware of the requirements of wave form will keep you on track. Further, when applying the forecasting concepts that will be introduced in Chapter 4, the length and duration of a wave are typically determined by measuring from and projecting orthodox ending points.

Reconciling Function and Mode

Earlier in this chapter, we described the two functions waves may perform (action and reaction), as well as the two modes of structural development (motive and corrective) that they undergo. Now that we have reviewed all types of waves, we can summarize their labels as follows:

—     The labels for actionary waves are 1, 3, 5, A, C, E, W, Y and Z.

—     The labels for reactionary waves are 2, 4, B, D and X.

As stated earlier, all reactionary waves develop in corrective mode, and most actionary waves develop in motive mode. The preceding sections have described which actionary waves develop in corrective mode. They are:

—     waves 1, 3 and 5 in an ending diagonal,

—     wave A in a flat correction,

—     waves A, C and E in a triangle,

—     waves W and Y in a double zigzag and a double three,

—     wave Z in a triple zigzag and a triple three.

Because the waves listed above are actionary in relative direction yet develop in corrective mode, we term them "actionary corrective" waves.

1.9 Additional Terminology (Optional)

Terms that Denote Purpose

Though action in five waves is followed by reaction in three waves at all degrees of trend regardless of direction, progress begins with an actionary impulse, which by convention is graphed in the upward direction. (Since all such graphs depict ratios, they could be depicted in the downward direction. Instead of dollars per share, for instance, one could plot shares per dollar.) Ultimately and most fundamentally, then, the long term trend of the stock market, which is a reflection of man’s progress, is upwardly directional. Progress is carried out by the development of impulse waves of ever larger degree. Motive waves downward are merely parts of corrections and therefore are not synonymous with progress. Similarly, corrective waves upward are still corrective and thus ultimately do not achieve progress. Therefore, three additional terms are required to denote the purpose of a wave, to differentiate conveniently among waves that result in progress and those that do not.

Any motive wave upward that is not within a corrective wave of any larger degree will be termed a progressive wave. It must be labeled 1, 3 or 5. Any declining wave, regardless of mode, will be termed a regressive wave. Finally, an upward wave, regardless of mode, that occurs within a corrective wave of any larger degree will be termed a progressive wave. Both regressive and progressive waves are part or all of corrections. Only a progressive wave is independent of countertrend forces.

The reader may recognize that the commonly used term "bull market" would apply to a progressive wave, the term "bear market" would apply to a regressive wave, and the term "bear market rally" would apply to a progressive wave. However, conventional definitions of terms such as "bull market," "bear market," "primary," "intermediate," "minor," "rally," "pullback" and "correction" attempt to include a quantitative element and are thus rendered useless because they are arbitrary. For instance, some people define a bear market as any decline of 20% or more. By this definition, a decline of 19.99% is not a bear market, just a "correction," while any decline of 20% is a bear market. Such terms are of questionable value. Although a whole list of quantitative terms could be developed (cub, mama bear, papa bear and grizzly, for instance), they cannot improve upon the simple use of a percentage. In contrast, Elliott wave terms are properly definitive because they are qualitative, i.e., they reflect concepts and pertain regardless of the size of the pattern. Thus, there are differing degrees of progressive, regressive and progressive waves under the Wave Principle. A Super Cycle B wave in a Grand Super cycle correction would be of sufficient amplitude and duration that it would be popularly identified as a "bull market." However, its proper label under the Wave Principle is a progressive wave, or using the conventional term as it should be used, a bear market rally.

Terms That Denote Relative Importance

There are two classes of waves, which differ in fundamental importance. Waves denoted by numbers we term cardinal waves because they compose the essential wave form, the five-wave impulse, as shown in Figure 1-1. The market can always be identified as being in a cardinal wave at the largest degree. Waves denoted by letters we term consonant or sub cardinal waves because they serve only as components of cardinal waves 2 and 4 and may not serve in any other capacity. A motive wave is composed, at one lesser degree, of cardinal waves, and a corrective wave is composed, at one lesser degree, of consonant waves. Our selection of these terms is due to their excellent double meanings. "Cardinal" means not only "of central or basic importance to any system, construction or framework of thought" but also denotes a primary number used in counting. "Consonant" means not only "harmonious with other parts [in] conforming to a pattern," but also is a type of letter in the alphabet. (Source: The Merriam-Webster Unabridged Dictionary.) There is little practical use for these terms, which is why this explanation has been relegated to the end of the chapter. However, they are useful in philosophical and theoretic discussions and so are presented to anchor the terminology.

Figure 1-49

Erroneous Concepts and Patterns

In The Wave Principle and elsewhere, Elliott discussed what he called an "irregular top," an idea he developed with a great deal of specificity. He said that if an extended fifth wave terminates a fifth wave of one higher degree, the ensuing bear market will either begin with or be an expanded flat in which wave A is extremely (we would say impossibly) small relative to the size of wave C (see Figure 1-49). Wave B to a new high is the irregular top, "irregular" because it occurs after the end of the fifth wave. Elliott contended further that occurrences of irregular tops alternate with those of regular tops. His formulation is inaccurate, however, and complicates the description of phenomena that we describe accurately in the discussion of the behavior following fifth wave extensions and under "Depth of Corrective Waves" in Chapter 2.

The question is, how did Elliott end up with two extra waves that he had to explain away? The answer is that he was powerfully predisposed to marking a fifth wave extension when in fact the third wave had extended. Two impressive Primary degree fifth wave extensions occurred in the 1920s and 1930s, engendering that predisposition. In order to turn an extended third into an extended fifth, Elliott invented an A-B-C correction called an "irregular type 2." In this case, he said, wave B falls short of the level of the start of wave A, as in a zigzag, while wave C falls short of the level of the end of wave A, as in a running correction. He often asserted this labeling in the wave 2 position. These labels then left him with two extra waves at the peak. The "irregular type 2" idea got rid of an extension’s first two waves, while the "irregular top" idea handled the two left over at the top. Thus, these two erroneous concepts were born of the same tendency. In fact, one requires the other. As you can see by the count illustrated in Figure 1-50, the a-b-c "irregular type 2" in the wave 2 position necessitates the "irregular top" labeling at the peak. In fact, there is nothing irregular about the wave structure except its false labeling!

Figure 1-50

Elliott also contended that every fifth wave extension is "doubly retraced," i.e., followed by a "first retracement" to near the level of its beginning and a "second retracement" to above the level at which it began. Such movement happens naturally due to the guideline that corrections usually bottom in the area of the previous fourth wave (see Chapter 2); the "second retracement" is the next impulse wave. The term might apply reasonably well to waves A and B of an expanded flat following an extension, as per the discussion in Chapter 2 under "Behavior Following Fifth Wave Extensions." There is no point in giving this natural behavior a specific name.

In Nature's Law, Elliott referred to a shape called a "half-moon." It was not a separate pattern but merely a descriptive phrase of how a decline within a bear market occasionally begins slowly, accelerates, and ends in a panic spike. This shape is found more often when declining prices are plotted on semi log scale and when advancing prices in a multi-year trend are plotted on arithmetic scale.

Also in Nature’s Law, Elliott twice referred to a structure he called an "A-B base," in which after a decline ends on a satisfactory count, the market advances in three waves and then declines in three waves prior to the commencement of the true five-wave bull market. The fact is that Elliott invented this pattern during a period in which he was trying to force his Principle into the 13-year triangle concept, which no interpreter today accepts as valid under the rules of the Wave Principle. Indeed, it is clear that such a pattern, if it existed, would have the effect of invalidating the Wave Principle. The authors have never seen an "A-B base," and in fact it cannot exist. Its invention by Elliott merely goes to show that for all his meticulous study and profound discovery, he displayed a typical analyst’s weakness in (at least once) allowing an opinion already formed to affect adversely his objectivity in analyzing the market.

As far as we know, this chapter lists all wave formations that can occur in the price movement of the broad stock market averages. Under the Wave Principle, no other formations than those listed here will occur. The authors can find no examples of waves above Minor degree that we cannot count satisfactorily by the Elliott method. The hourly readings are a nearly perfectly matched filter for detailing waves of Sub minuette degree. Elliott waves of much smaller degree than Sub minuette are revealed by computer generated charts of minute-by-minute transactions. Even the few data points (transactions) per unit of time at this low a degree are often enough to reflect the Wave Principle accurately by recording the rapid shifts in psychology occurring in the "pits" and on the exchange floor.

All rules and guidelines of the Wave Principle fundamentally apply to actual market mood, not its recording per se or lack thereof. Its clear manifestation requires free market pricing. When prices are fixed by government edict, such as those for gold and silver for half of the twentieth century, waves restricted by the edict are not allowed to register. When the available price record differs from what might have existed in a free market, rules and guidelines must be considered in that light. In the long run, of course, markets always win out over edicts, and edict enforcement is only possible if the mood of the market allows it. All rules and guidelines presented in this book presume that your price record is accurate.