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In addition to the concept of symmetry in descending magnitude with each of the larger waves divisible into smaller waves and still smaller waves still, ad infinitum, Elliott discovered that the individual components of the cycles of similar magnitude revealed specific behaviour patterns. While these behaviour patterns did not lend themselves to a fixed periodicity or repetitive patterns there was a distinct relationship to the various movements. Elliott concluded that, regardless of the magnitude of a cycle, a complete cycle consisted of eight distinct movements. Beginning with an upward cycle, Elliott discovered three basic ascending waves which he called “impulse” waves. Each of the first two “impulse” waves was followed by a wave which acted in correction of the entire upward cycle, and this correction wave itself consisted of two downward “impulse” waves interspersed by one upward corrective wave. In essence, we thus have an upward move consisting of five waves, three up and two down. Naturally the two down waves are of smaller magnitude than either of the preceding up waves. When we get to the fifth and final wave of the pattern we then have a major down move consisting of three waves; two downward waves interspersed by an upward wave, such upward wave being smaller in magnitude than the preceding down wave. This, in a nutshell, is Elliott’s basic form. As we go on we will see certain behavioural characteristics of the various impulse waves and corrective waves, the relationships between which will establish targets, and help to serve in formulating an investment strategy.

The successful modern advocates of Elliott’s work rank its precepts as comparable in importance to the work of Charles Dow, the grand-daddy of all technical market theory. It has been said that Elliott’s work begins where Dow left off. Charles Dow also discovered the vast cyclical forces which govern share price movements but was very limited in his classification. According to Dow, the basic force of the market was the primary bull trend which contained intermediate moves categorised as “secondary corrections” with the bull trend. The minor moves of the market were of little concern to Dow. Elliott’s thesis of “three upward impulse moves” comprising each bull market would appear to be compatible with the three phase bull market concept developed by Dow. However, as has already been established, Elliott takes the work much further.

Figure 1

Some eminent technical analysts believe that the Elliott Wave Principle offers the only significant explanation of stock market history, accurately describing the upwards sweeps of share prices from 1857 to 1929, the corrective tidal wave from 1929 to 1949 then the great upsurge from 1949 to 1973 followed by the characteristic “Wave IV” plunge in Wall Street between 1973 and 1974.

In my view, the most astute of all technical analysts and probably the most pragmatic, is John W. Schultz, one of the few stock market technicians to develop a keen understanding of the Elliott Wave Principle. In his most excellent book, The Intelligence Chartist, Shcultz makes the following observations:

“The man who – so to speak – formally opened up Dow’s trend structure was Ralph Nelson Elliott. He wrote very little about what he called the ‘Wave Principle’, and what he did write has long been out of print. He died in 1948. So far as I am aware, the only description of his theories currently available is one written by A. Hamilton Bolton.”

“In formulating his wave principle, Elliott opened up not only Dow’s trend structure, but a Pandora’s box as well. He was willing to recognise four trend categories smaller than intermediate, and four larger than intermediate, nine in all including the intermediate category itself. And – to use our terminology – he instead that no trend category could have more than three components of the next-lower order running in its dominant direction. The idea must have been to set up a rigid standard of definition. But the fact is that trends develop more than three thrusts.”

“Elliott got around this problem by permitting third legs to become very complex – that is, more thoroughly articulated than second and first legs. But, whether the rigidity of his theory yields a practical benefit or not is debatable. Attempts to implement Elliott’s principle quickly run into mind-wrenching frustrations as multiple alternatives of definition suggest themselves.”

Schultz’s observations are quite correct. One of the most difficult aspects of The Elliott Wave Principle is magnitudinal classification of the waves and correct identification within the cycle. As mentioned previously the Elliott Wave Principle does not offer absolutes but alternatives. Anyone who seeks an absolute will find the Wave Principle quite unsatisfactory. But, equally, those who seek absolutes will ultimately find all stock market methods unsatisfactory simply because absolutes do not exist in the stock market.