ASX Charting Course

Chapter 32

The Elliot Wave Principle

Background & History

R N Elliot postulated his wave theory in the 1920’s. It was forgotten by the investment community for some years following his death in 1948, his students thought it best to keep his discovery secret. A book called “Elliot Wave Principle – Key to Stock Market Profits” by A J Frost & Robert Prechter revived the theory and saw a new breed of chartists attempt to apply the theory to the futures markets in the 1970’s.

The Elliot Wave Theory suggested that markets traded according to some sort of universal natural order rather than the result of a conflicting random walk theory.

The Broad Concept

The basic rhythm of the market unfolds as five waves up and three waves down. Each advancing wave (1, 3 and 5) is called an impulse wave and each down wave (2 and 4) is referred to as a corrective wave.

Diagram 44

The diagram below shows how the basic cycle can be further dissected to reveal each impulse wave containing five waves, including the bear market impulse moves.

Diagram 45

The basic tenets of the theory are:

1. Action is followed by reaction

2. Movements in the direction of the trend divide into five waves and moves against the trend corrective waves divide into three waves

3. The cycle keeps repeating it self in ever expanding magnitude from Sub-minuette through nine categories to the Grand Super-cycle

4. The wave pattern exists irrespective of time. Waves may be stretched or compressed, but the underlying pattern is constant.

As a result of Prechter’s work in the 1970’s two more tenets emerged. They are:

Wave three is never the shortest.

Wave four never overlaps wave 1.

If wave four does overlap wave 1 then the move is probably not an impulse move, but an ABC correction.