Basic Tenets of
the Elliott Wave Principle

Since the Elliott Wave Principle was discovered by its founder, R.N. Elliott, in the 1930’s and 1940’s, it has since gained wide acceptance as a legitimate market analysis and forecasting tool.

The Wave Principle, as it is sometimes called, is a detailed description of how groups of people behave. It shows that mass psychology swings from pessimism to optimism, and back again, in a natural sequence, creating specific measurable patterns.

One of the most obvious places to see this phenomenon in action is in the financial markets, where changing investor psychology is recorded in the form of price movement. Using stock market data as his main research tool, R. N. Elliott isolated eleven patterns of movement, or “waves,” that recur in market price data.

He named, defined and illustrated those patterns. He then described how these patterns link together to form larger versions of those same patterns, how those in turn link to form identical patterns of the next
larger size, and so on.

The Wave Principle is a catalog of price patterns and an explanation of where they are likely to occur in the overall path of market development.

The markets often undergo periods of growth, alternating with phases of non-growth or decline, building fractally into similar patterns of increasing size.

The Elliott Wave Principle shows that the markets move in five wave patterns with the larger trend, then pull back in three - or five - wave corrections, before continuing with the larger trend.

The market moves
up in five waves, then pulls back, before continuing with the larger trend.

Patterns moving with the larger trend are always five wave patterns, and are labeled with the numbers 1-2-3-4-5. Patterns moving against the larger trend are generally three-wave patterns, but can be either three -
or five - wave patterns, and are labelled with letters.

An impulsive wave is composed of five sub-waves and moves in the same direction as the trend of the next larger size.

A corrective wave is usually composed of three sub-waves and moves against the trend of the next larger size.

As the diagram shows, these basic patterns link to form five-wave and three-wave structures of increasingly larger size (larger “degree” in Elliott terminology).

The first small sequence is an impulsive wave ending at the peak labeled 1.

This pattern signals that the movement of one larger degree is also upward. It also signals the start of a three-wave corrective sequence, labeled Wave 2. Waves 3, 4 and 5 complete a larger impulsive sequence, labeled Wave (1). Exactly as with Wave 1, the impulsive structure of Wave (1) tells us that the movement at the next larger degree is upward and signals the start of a three-wave corrective downtrend of the same degree as Wave (1).

This correction, Wave (2), is followed by Waves (3), (4) and (5) to complete an impulsive sequence of the next larger degree labelled Wave [1].

Once again, a three-wave correction of the same degree occurs, labeled Wave [2]. Note that at each “Wave one” peak, the implications are the same regardless of the size of the wave. Waves come in degrees, the smaller being the building blocks of the larger. Within a corrective wave, Waves A and C may be smaller-degree impulsive waves, consisting of five sub-waves.

This is because they move in the same direction as the next larger trend, i.e., Waves (2) and (4) in the illustration. Wave B, however, is always a corrective wave, consisting of three sub-waves, because it moves
against the larger downtrend.

Variations in corrective patterns involve repetitions of the three wave theme, creating more complex structures with names such as, “Zigzag,” “Flat,” “Triangle” and “Double Sideways.”

Each type of market pattern has a name and a structure that is specific under Elliott Wave rules and guidelines, yet variable enough in other aspects to allow for limited diversity within patterns of the same type.

For a particular pattern to be verified as an Elliott Wave, all its rules must be obeyed precisely. In contrast, its guidelines do not have to be strictly obeyed. However, when market movement can be interpreted in two or more ways according to the rules, the pattern obeying the most guidelines, or most important guidelines, is preferred. This pattern becomes known as the preferred count and has the highest probability of being correct.

It is important to understand that patterns of all degrees are operating in the market at the same time. Because they interact continually, they will never appear exactly as they did in the past.

The Elliott technician is concerned with probabilities. The Wave Principle does not show us the future with absolute certainty; it allows us to see what is likely to happen. As the market unfolds, waves can distort,
probabilities can change and target ranges will need to be altered. This is a normal day at the office for an Elliott technician.

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