The basis of our accurate and reliable forecasting techniques lies in applying Elliott Wave Theory to assess where the markets are short- to (very) long-term in their cycles. Elliott wave tracks in essence investor sentiment which comes and goes in waves. These waves occur from the minute time-frame to the century and beyond time frame. In essence it is a three steps forward, two steps back process. Since markets are never certain, but instead are non-linear, stochastic and probabilistic in nature, we then use classic technical analysis as well as market breadth tools to assess the most likely path the markets will take.
If you are new to Elliott Wave, below you can find a brief description of what it is.
The Impulse Wave is shown above as to illustrate how the structure of Elliott Wave is put together. It is the most common motive wave and the easiest to spot. Like all motive waves, it consists of 5 sub-waves; three of them are also motive waves, and two corrective waves. This is labeled as a 5-3-5-3-5 structure, which was shown above. However, it has three rules that define its formation. These rules are unbreakable. If one of these rules is violated, then the structure is not an impulse wave and one would need to re-label the suspected impulse wave.
The three rules are:
Wave 2 cannot retrace more than 100% of Wave 1.
Wave 3 can never be the shortest of waves 1, 3, and 5.
Wave 4 can never overlap Wave 1.
Notice that in the above ideal impulse structure Wave 4 does not cross into the price territory of Wave 1, and that Wave 2 does not correct below the beginning of Wave 1. Also see that Wave 3 is not the shortest.
Although Wave 3 cannot be the shortest wave, it is typically the longest of Waves 1, 3, and 5 (and of all the 5 waves). It is the wave that is most likely to extend (covered in the next section).
Sub-wave 3 of an impulse wave will always be another impulse type motive wave.
Wave 2 cannot move below the beginning of Wave 1. Wave 2 is often known to retrace much of Wave 1, but if it retraces it completely, it is not a Wave 2. A break in price below the low of Wave 1 would invalidate the suspected wave-count and imply that one should look for an alternative way to label the pattern.
In the majority of cases, impulse waves will exhibit what is called an “extension” to their normal pattern. This means that one of the impulse wave’s three motive sub-waves will be an elongated impulse with exaggerated subdivisions. This can happen in either Wave 1, 3, or 5, and it typically happens in only one of the waves.
At times, the subdivisions of the extended sub-wave look almost the same in amplitude and time duration as the four other waves in the higher degree impulse wave of which they are a part. Instead of having a wave-count of 5 for the impulse, it is tempting to count 9 waves, as it may not be clear as to which wave is the extended wave. However, it does not really matter in the long run as the technical significance would be the same, even if one had assigned the wrong count.
If you run into difficulty seeing the extended wave, try your best to label the overall impulse and move on. A small guideline may help in this situation: if the potential Wave 1 and Wave 5 of the larger degree impulse look equal in length, then most likely it is Wave 3 that is extended. Wave 3 is the most common wave of an impulse to extend.
Extensions can also occur within extensions. This is because the extended wave is also an impulse. You may have a few degrees of extensions within one impulse wave.
Impulse Wave Truncation (Truncated Fifth):
There are times when the market has become so over extended in Wave 3 that there is not much force left for the impulse wave to come to a proper completion. When this happens, there is a chance that the last wave of the impulse, Wave 5, will not reach then end of Wave 3 before the market starts correcting in the opposite direction. At this point the market is just too exhausted. This condition is often called a “failure” or a “Truncation.”
A Truncation, or truncated fifth, consists of 5 sub-waves, like all motive waves. It often occurs after a particularly strong third wave, although there is also a chance that sentiment, for whatever reason, has become so strong in the opposite direction of the trend that a Wave 5 will not terminate beyond the price of Wave 3.
A Diagonal Wave is the second type of motive wave. It is not an impulse wave. However, like all motive waves, its goal is to move the market in the direction of the trend. Also, like all motive waves, it consists of five sub-waves. The difference is that the diagonal looks like a wedge – either expanding or contracting. Also, the sub-waves of the diagonal may not have a count of five, depending on what type of diagonal is being observed. This is explained below.
As with the motive wave, each sub-wave of the diagonal never fully retraces the previous sub-wave, and sub-wave 3 of the diagonal may not be the shortest wave. A diagonal is also called a “Wedge”. Once a diagonal ends, the price action will move swiftly to the opposite direction of the diagonal and often move back to the wedge’s start.
The ending diagonal is a special type of wave that occurs in Wave 5 of an impulse, or the last wave of a correction pattern – Wave C of an A, B, C correction. This wave often occurs when the preceding move of the trend has gone too far, too fast and has run out of steam. In all cases, they are found at the end of the higher degree motive or corrective wave. This wave pattern indicates the termination of the previous trend of one higher degree.
The wave-structure of an ending diagonal is different from the impulse wave. Where the impulse wave had a general structure count of 5-3-5-3-5, the ending diagonal has a structure count of 3-3-3-3-3. All five of the waves of an ending diagonal break down to only three waves each, indicating exhaustion of the larger degree trend. Also, Wave 2 and Wave 4 may overlap each other.
Most ending diagonals have a wedge shape to them where they fit within two converging lines. However, there are cases where the wedge is expanding (though it is rare).
Please keep in mind that the sub-waves of the ending diagonal, consisting of three waves each, are corrective in nature. See the section on corrective waves for more detail on their formation.
Leading diagonals are rare, and are found in either the Wave 1 position of an impulse wave, or in the Wave A position of a zigzag correction. They have a 5-3-5-3-5 wave structure like an impulse, but in this case, Wave 2 and Wave 4 overlap, and they form a wedge pattern with converging boundary lines.
Because of the five wave subdivisions of Waves 1, 3, and 5, this pattern indicates continuation of the trend where the ending diagonal pattern of 3-3-3-3-3 indicates termination of the trend. After the market corrects – and does not correct beyond the beginning of the leading diagonal – one can expect the trend to continue in the direction of the leading diagonal.
Types of Corrective Waves
When markets move against the trend of one higher degree, they do so with an apparent struggle. This resistance prevents the pattern that forms from developing a motive type of structure, and the patterns that form are more varied than in the motive wave type. An analyst must exercise patience and flexibility when dealing with corrective waves.
There are two styles of corrective waves, the “sharp” correction and the “sideways” correction. The sharp corrections move steeply against the trend of one higher degree and the sideways correction appears to form a flat type of structure that often goes back to the price of where it began before ending the correction. More details on these are given below, broken down into four main categories.
Please keep in mind that although corrections are often seen as declining in price, the reality is that the market can correct up or down, depending on the trend of higher degree.
A single zigzag is a three wave corrective structure that is labeled as A-B-C. The sub-wave sequence is 5-3-5. We have seen this above in our expanded corrective wave pattern. The A and C waves are motive waves (with 5 sub-waves), while the B wave is corrective (often with 3 sub-waves). The zigzag is known to form a sharp style of correction, and in an impulse wave, usually shows up in the second wave position.
Zigzags may also form in combination and form what is called a double zigzag or even a triple zigzag, where two or three zigzags form connected by another corrective wave between them. More detail on the rules for these are given below when we talk about combination corrections.
The flat correction is another three wave correction where the sub-waves form a 3-3-5 structure. Like the zigzag, it is also labeled as an A-B-C structure. In this case, both Waves A and B are of the corrective variety and Wave C is motive (with 5 sub-waves). It is called a “flat” because the pattern moves in a sideways direction. Within an impulse wave, the fourth wave often has a flat while the second wave rarely does.
Most flats, however, don’t look as neat as this. They are variations on the theme. A flat that has the B wave terminate beyond the start of the A wave and the C wave terminate beyond the start of the B wave is called an expanded flat. This is actually more common in markets than the normal flat shown above.
A running flat, which often occurs in strong trends of one higher degree, will have Wave B terminate beyond the beginning of Wave A, but Wave C will fail to reach the beginning of Wave A. This is a rare case, but it has been known to happen and usually forms in strong trends.
The horizontal triangle is a pattern that consists of five sub-waves that form a 3-3-3-3-3 structure labeled as A-BC, A-B-C-D-E (most common) or even as complex as AB-C-D-E-F (see correction combination section). Unlike the motive wave, which also has five waves, this pattern reflects a balance of forces and travels in a sideways pattern. The sub-waves are corrective and form patterns of threes.
The horizontal triangle can either be expanding, where each following sub-wave gets bigger in amplitude, or contracting, forming a wedge. The triangles may also be categorized as symmetrical, descending, or ascending, depending on whether they seem to be pointing sideways (as in the example above), or up with a flat top and rising bottoms (ascending), or down with descending tops and a flat bottom.
The sub-waves may be composed of complex combinations, and not just of zigzags or flats. Although it may look easy in theory to spot a triangle, it make take a little practice to become familiar with them in the market.
A triangle may extend by having its fifth wave also be a triangle of lesser degree. Instead of Wave E being a three structure, it will be another horizontal triangle. This just demonstrates the level of complexity that Elliott Wave Theory can reach.
One thing to remember about horizontal triangles is that they always appear in the position prior to the final move of the pattern, or as the final pattern in a combination (described below). This means that they will appear as Wave 4 in an impulse wave, or as Wave B in a zigzag. Not in a Wave 2. This one fact can help alert an analyst to a change in trend.
Markets do not always form the relatively simple patterns seen above. The structure is most often complex and (very) confusing. The way Elliott Wave categorizes these structures is what is called a combination.
A combination is composed of the corrective waves seen above and seems to be a corrective waves’ way of extending sideways for the most part. Combinations are mostly sideways types of corrections, but can be sharp in the case of the double or triple zigzag. The structure is officially labeled as W-X-Y, for a double combination, or as W-X-Y-X-Z for a triple combination. However, I find that labeling to complex, confusing and not-fitting with all the other labels and thus rather simple use smaller degree a, b, c labels since corrections are always a, b, c, (d, e)’s anyway. So why confuse us poor souls with more letters!? The diagram below shows the theoretical breakdown of the wave structure of a double zigzag.
Wave a is a zigzag, Wave b is also a zigzag. But both can be flat corrections as well! (except in the case where a triangle forms indicating that the next wave will be the last of the combination), and the rest of the waves may be any corrective type. The only thing to watch out for is the horizontal triangle, which can be either in the last position or the next to the last position – the last Wave.
Grand Super Cycle (GSC): (I), (II), (III), (IV), (V); (A), (B), (C)
Super Cycle (SC): I, II, III, IV, V; A, B, C
Cycle (C): 1, 2, 3, 4, 5; A, B, C
Primary (P): I, II, III, IV, V; A, B, C
Major (M): 1, 2, 3, 4, 5; a, b, c
Intermediate (Int): i, ii, iii, iv, v; a, b, c
Minor: 1, 2, 3, 4, 5; a, b, c
Minute: i, ii, iii, iv, v; a, b, c