Elliott Wave

According to Mr. Elliott, the markets move because of investors’ psychology, or crowd psychology. The most basic principle of this theory is that market movements are based on crowd behavior. The crowd’s mood swings from optimism to pessimism, and these changes in sentiment create repetitive patterns. After staring at 75 years’ worth of data on the charts and markets for days and nights, Mr. Elliott reached his aha moment.

Markets Trade in Repetitive Cycles

Elliott claims to have discovered that a trending market moves in what he calls a five-three wave pattern.

The first five waves are impulsive (moving either up or down).

The next three waves are corrective (generally moving in the opposite direction from the impulsive waves).

Here you can see how simple the Elliott wave pattern is. The first five waves are numbered from 1 to 5, as shown in Figure 15-1, and the corrective three waves are labeled a, b, and c. This is how they come together.

Elliott Wave in a Bull Market

So basically Mr. Elliott believes that every five impulsive waves are followed by three corrective ones. Just like all patterns, this one works for both bull and bear markets. This is how the same five-three wave pattern can look in a bear market.

Now comes the natural question: “Do the Elliott waves always appear as neat and pretty as the images shown here do?” And the anticipated answer is: “No!”

Normally, each Elliott wave is made up of subwaves(see figures below)

                                                           Elliott Wave Bull Market Subwaves

Elliott Wave Bear Market Subwaves

Each of the waves 1, 3, and 5 can be made up of a smaller five-wave impulse pattern, while waves 2 and 4 can be made up of smaller abc corrective patterns. This pattern can repeat itself—well, forever!