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Elliott Wave Principle and Detailed Analytics
Motive waves subdivide into five waves and always move in the same direction as the trend of one larger degree. They are straightforward and relatively easy to recognize and interpret.
Within motive waves, wave 2 always retraces less than 100% of wave 1, and wave 4 always retraces less than 100% of wave 3. Wave 3, moreover, always travels beyond the end of wave 1. The goal of a motive wave is to make progress, and these rules of formation assure that it will.
Elliott further discovered that in price terms, wave 3 is often the longest and never the shortest among the three actionary waves (1, 3 and 5) of a motive wave. As long as wave 3 undergoes a greater percentage movement than either wave 1 or 5, this rule is satisfied. It almost always holds on an arithmetic basis as well. There are two types of motive waves: impulse and diagonal.
The most common motive wave is an impulse, per Figure 1-1. In an impulse, wave 4 does not enter the price territory of (i.e., "overlap") wave 1. This rule holds for all non-leveraged "cash" markets. Futures markets, with their extreme leverage, can induce short term price extremes that would not occur in cash markets. Even so, overlapping is usually confined to daily and intraday price fluctuations and even then is rare. In addition, the actionarysubwaves (1, 3 and 5) of an impulse are themselves motive, and subwave 3 is always an impulse. Figures 1-2, 1-3 and 1-4 all depict impulses in the 1, 3, 5, A and C wave positions.
As detailed in the preceding three paragraphs, there are only a few simple rules for interpreting impulses properly. A rule is so called because it governs all waves to which it applies. Typical, yet not inevitable, characteristics of waves are called guidelines. Guidelines of impulse formation, including extension, truncation, alternation, equality, channeling, personality and ratio relationships are discussed below and throughout Chapters 2 and 4. A rule should never be disregarded. In many years of practice with countless patterns, the authors have found but one or two instances above Subminuette degree when all other rules and guidelines combined to suggest that a rule was broken. Analysts who routinely break any of the rules detailed in this section are practicing some form of analysis other than that guided by the Wave Principle. These rules have great practical utility in correct counting, which we will explore further in discussing extensions.
Most impulses contain what Elliott called an extension. An extension is an elongated impulse with exaggerated subdivisions. The vast majority of impulses contain an extension in one and only one of their three actionarysubwaves. The rest either contain no extension or an extension in both subwaves three and five. At times, the subdivisions of an extended wave are nearly the same amplitude and duration as the other four waves of the larger impulse, giving a total count of nine waves of similar size rather than the normal count of "five" for the sequence. In a nine-wave sequence, it is occasionally difficult to say which wave extended. However, it is usually irrelevant anyway, since under the Elliott system, a count of nine and a count of five have the same technical significance. The diagrams in Figure 1-5, illustrating extensions, will clarify this point.
The fact that an extension typically occurs in only one actionarysubwave provides a useful guide to the expected lengths of upcoming waves. For instance, if the first and third waves are of about equal length, the fifth wave will likely be a protracted surge. Conversely, if wave three extends, the fifth should be simply constructed and resemble wave one.
In the stock market, the most commonly extended wave is wave 3. This fact is of particular importance to real-time wave interpretation when considered in conjunction with two of the rules of impulse waves: Wave 3 is never the shortest actionary wave, and wave 4 may not overlap wave 1. To clarify, let us assume two situations involving an improper middle wave, as illustrated in Figures 1-6 and 1-7.
In Figure 1-6, wave 4 overlaps the top of wave 1. In Figure 1-7, wave 3 is shorter than wave 1 and shorter than wave 5. According to the rules, neither is an acceptable labeling. Once the apparent wave 3 is proved unacceptable, it must be relabeled in some way that is acceptable. In fact, it is almost always to be labeled as shown in Figure 1-8, implying an extended wave (3) in the making. Do not hesitate to get into the habit of labeling the early stages of a third wave extension. The exercise will prove highly rewarding, as you will understand from the discussion under Wave Personality (see Chapter 2). Figure 1-8 is perhaps the single most useful guide to real time impulse wave counting in this book.
Extensions may also occur within extensions. In the stock market, the third wave of an extended third wave is typically an extension as well, producing a profile such as shown in Figure 1-9. A real-life example is shown in Figure 5-5. Figure 1-10 illustrates a fifth wave extension of a fifth wave extension. Extended fifths are quite common in major bull markets in commodities (see Chapter 6).
Elliott used the word "failure" to describe a situation in which the fifth wave does not move beyond the end of the third. We prefer the less connotative term, "truncation," or "truncated fifth." A truncation can usually be verified by noting that the presumed fifth wave contains the necessary five subwaves, as illustrated in Figures 1-11 and 1-12. A truncation often occurs following a particularly strong third wave.
The U.S. stock market provides two examples of majordegree truncated fifths since 1932. The first occurred in October 1962 at the time of the Cuban crisis (see Figure 1-13). It followed the crash that occurred as wave 3. The second occurred at yearend in 1976 (see Figure 1-14). It followed the soaring and broad wave (3) that took place from October 1975 to March 1976.
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