Elliott Wave Introduction – How Markets Move in
Recognisable Patterns
Ralph Nelson Elliott discovered that stock market charts move in a series of
recognisable patterns back in the 1950’s, publishing his findings in his book, The
Wave Principle. Elliott believed that the patterns reflected mass market psychology, (made
up of hundreds of thousands of collective investors’ opinions) and was a barometer of
man’s valuation of productive capability.
He described 13 patterns, or waves, that recur and are repetitive, whereby the
structures link together to form larger versions of the same patterns.
As the patterns repeat, the waves have a predictive quality, although I prefer to use
them to label what situation a market is in, rather than use them as a
predictive tool.
I use Elliott as a way of anticipating probable ensuing formations. And I mainly
focus on using my other techniques to trade the markets and ride trends.
Elliott Waves help to avoid trading some false signals and corrective, reactionary
waves and congestion areas. And I believe it is a great help to have some idea why a
market is moving how it is, in a pattern that you can label.
The Basic Wave Formation
The basic Elliott Wave formation is made up of 5 sub-waves that propel the market in
a trending direction – called a Motive Wave.
Every one of the 5 sub-waves serves one of two functions: action or reaction.
Actionary Wave: Promotes the cause of the wave of a larger degree.
Reactionary Wave: Interrupts the progress of the wave of one larger degree.
The 5-pulse, motive wave is labelled with numbers (1, 2, 3, 4 and 5), with the
actionary waves being labelled with odd numbers, 1, 3 and 5; and the reactionary waves
being labelled with even numbers 2 and 4.
Figure 56: Basic 5-wave structure that propels the market in the direction of the
trend. Sub-waves 1, 3 and 5 are actionary waves. Sub-waves 2 and 4 are reactionary waves.
These 5 sub-waves complete ONE wave of a larger degree.
This 5-wave structure completes the movement that advances the trend. We can label the
whole Motive Wave pattern above as Wave (1) of a larger degree.
It is then followed by a Corrective Wave, which most often takes the form of 3
sub-waves. It is labelled with letters a, b and c. This 3-wave pattern, we can label as
Wave (2) of a larger degree.
Figure 57: After a 5-wave move in the direction of the main trend – Wave (1) of a
larger degree – the wave is corrected by what is usually a 3 wave pattern, which is
labelled with letters: a, b, and c. This 3-wave correction forms a complete formation that
we can label Wave (2) of a larger degree. Therefore, the diagram above now shows 8
sub-waves that form Wave (1) and Wave (2) of a larger degree.
This complete 8 sub-wave pattern is what typically makes up the Elliott Wave structure.
It is important to realise that the pattern can be ascending (a bull market) or descending
(a bear market). If the main trend is up – then we will see 5 waves moving up,
followed by 3 waves moving down. If the main trend is down, we will see 5 waves moving
down, followed by 3 waves moving up – correcting the main trend.
I have spoken of the complete pattern forming one or two waves of a LARGER DEGREE. This
is another important point of Elliott Wave Principle:
That the main pattern is prevalent in all markets of all time frames…
If the chart above was a based on a daily price chart, then one could zoom in on the
market and look at, say, an hourly or 30-minute chart and see the same patterns (5’s
and 3’s) of a smaller degree.
For example:
