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Lesson 6

6.1 Wave Personality

 

The idea of wave personality is a substantial expansion of the Wave Principle. It has the advantages of bringing human behavior more personally into the equation and even more important, of enhancing the utility of standard technical analysis.

 

The personality of each wave in the Elliott sequence is an integral part of the reflection of the mass psychology it embodies. The progression of mass emotions from pessimism to optimism and back again tends to follow a similar path each time around, producing similar circumstances at corresponding points in the wave structure. The personality of each wave type is usually manifest whether the wave is of Grand Supercycle degree or Subminuette. These properties not only forewarn the analyst about what to expect in the next sequence but at times can help determine one's present location in the progression of waves, when for other reasons the count is unclear or open to differing interpretations. As waves are in the process of unfolding, there are times when several different wave counts are perfectly admissible under all known Elliott rules. It is at these junctures that a knowledge of wave personality can be invaluable. If the analyst recognizes the character of a single wave, he can often correctly interpret the complexities of the larger pattern. The following discussions relate to an underlying bull market picture, as illustrated in Figures 2-14 and 2-15. These observations apply in reverse when the actionary waves are downward and the reactionary waves are upward. 

Figure 2-14

6.2 Wave Personality

 

1) First waves — As a rough estimate, about half of first waves are part of the "basing" process and thus tend to be heavily corrected by wave two. In contrast to the bear market rallies within the previous decline, however, this first wave rise is technically more constructive, often displaying a subtle increase in volume and breadth. Plenty of short selling is in evidence as the majority has finally become convinced that the overall trend is down. Investors have finally gotten "one more rally to sell on," and they take advantage of it. The other fifty percent of first waves rise from either large bases formed by the previous correction, as in 1949, from downside failures, as in 1962, or from extreme compression, as in both 1962 and 1974. From such beginnings, first waves are dynamic and only moderately retraced.

 

2) Second waves — Second waves often retrace so much of wave one that most of the advancement up to that time is eroded away by the time it ends. This is especially true of call option purchases, as premiums sink drastically in the environment of fear during second waves. At this point, investors are thoroughly convinced that the bear market is back to stay. Second waves often produce downside non-confirmations and Dow Theory "buy spots," when low volume and volatility indicate a drying up of selling pressure.

 

3) Third waves — Third waves are wonders to behold. They are strong and broad, and the trend at this point is unmistakable. Increasingly favorable fundamentals enter the picture as confidence returns. Third waves usually generate the greatest volume and price movement and are most often the extended wave in a series. It follows, of course, that the third wave of a third wave, and so on, will be the most volatile point of strength in any wave sequence. Such points invariably produce breakouts, "continuation" gaps, volume expansions, exceptional breadth, major Dow Theory trend confirmations and runaway price movement, creating large hourly, daily, weekly, monthly or yearly gains in the market, depending on the degree of the wave. Virtually all stocks participate in third waves. Besides the personality of "B" waves, that of third waves produces the most valuable clues to the wave count as it unfolds.

 

4) Fourth waves — Fourth waves are predictable in both depth (see Lesson 11) and form, because by alternation they should differ from the previous second wave of the same degree. More often than not they trend sideways, building the base for the final fifth wave move. Lagging stocks build their tops and begin declining during this wave, since only the strength of a third wave was able to generate any motion in them in the first place. This initial deterioration in the market sets the stage for non-confirmations and subtle signs of weakness during the fifth wave.

 

5) Fifth waves — Fifth waves in stocks are always less dynamic than third waves in terms of breadth. They usually display a slower maximum speed of price change as well, although if a fifth wave is an extension, speed of price change in the third of the fifth can exceed that of the third wave. Similarly, while it is common for volume to increase through successive impulse waves at Cycle degree or larger, it usually happens below Primary degree only if the fifth wave extends. Otherwise, look for lesser volume as a rule in a fifth wave as opposed to the third. Market dabblers sometimes call for "blowoffs" at the end of long trends, but the stock market has no history of reaching maximum acceleration at a peak. Even if a fifth wave extends, the fifth of the fifth will lack the dynamism of what preceded it. During fifth advancing waves, optimism runs extremely high, despite a narrowing of breadth. Nevertheless, market action does improve relative to prior corrective wave rallies. For example, the year-end rally in 1976 was unexciting in the Dow, but it was nevertheless a motive wave as opposed to the preceding corrective wave advances in April, July and September, which, by contrast, had even less influence on the secondary indexes and the cumulative advance-decline line. As a monument to the optimism that fifth waves can produce, the market forecasting services polled two weeks after the conclusion of that rally turned in the lowest percentage of "bears," 4.5%, in the history of the recorded figures despite that fifth wave's failure to make a new high!

6.3 Ideal Wave Personality

Figure 2-15

6) "A" waves — During "A" waves of bear markets, the investment world is generally convinced that this reaction is just a pullback pursuant to the next leg of advance. The public surges to the buy side despite the first really technically damaging cracks in individual stock patterns. The "A" wave sets the tone for the "B" wave to follow. A five-wave A indicates a zigzag for wave B, while a three-wave A indicates a flat or triangle.

 

7) "B" waves — "B" waves are phonies. They are sucker plays, bull traps, speculators' paradise, orgies of odd-lotter mentality or expressions of dumb institutional complacency (or both). They often involve a focus on a narrow list of stocks, are often "unconfirmed" (Dow Theory is covered in Lesson 28) by other averages, are rarely technically strong, and are virtually always doomed to complete retracement by wave C. If the analyst can easily say to himself, "There is something wrong with this market," chances are it's a "B" wave. "X" waves and "D" waves in expanding triangles, both of which are corrective wave advances, have the same characteristics. Several examples will suffice to illustrate the point.

 

— The upward correction of 1930 was wave B within the 1929-1932 A-B-C zigzag decline. Robert Rhea describes the emotional climate well in his opus, The Story of the Averages (1934):

 

...many observers took it to be a bull market signal. I can remember having shorted stocks early in December, 1929, after having completed a satisfactory short position in October. When the slow but steady advance of January and February carried above [the previous high], I became panicky and covered at considerable loss. ...I forgot that the rally might normally be expected to retrace possibly 66 percent or more of the 1929 downswing. Nearly everyone was proclaiming a new bull market. Services were extremely bullish, and the upside volume was running higher than at the peak in 1929.

 

— The 1961-1962 rise was wave (b) in an (a)-(b)-(c) expanded flat correction. At the top in early 1962, stocks were selling at unheard of price/earnings multiples that had not been seen up to that time and have not been seen since. Cumulative breadth had already peaked along with the top of the third wave in 1959.

 

— The rise from 1966 to 1968 was wave [B]* in a corrective pattern of Cycle degree. Emotionalism had gripped the public and "cheapies" were skyrocketing in the speculative fever, unlike the orderly and usually fundamentally justifiable participation of the secondaries within first and third waves. The Dow Industrials struggled unconvincingly higher throughout the advance and finally refused to confirm the phenomenal new highs in the secondary indexes.

 

— In 1977, the Dow Jones Transportation Average climbed to new highs in a "B" wave, miserably unconfirmed by the Industrials. Airlines and truckers were sluggish. Only the coal-carrying rails were participating as part of the energy play. Thus, breadth within the index was conspicuously lacking, confirming again that good breadth is generally a property of impulse waves, not corrections.

 

As a general observation, "B" waves of Intermediate degree and lower usually show a diminution of volume, while "B" waves of Primary degree and greater can display volume heavier than that which accompanied the preceding bull market, usually indicating wide public participation.

 

8) "C" waves — Declining "C" waves are usually devastating in their destruction. They are third waves and have most of the properties of third waves. It is during this decline that there is virtually no place to hide except cash. The illusions held throughout waves A and B tend to evaporate and fear takes over. "C" waves are persistent and broad. 1930-1932 was a "C" wave. 1962 was a "C" wave. 1969-1970 and 1973-1974 can be classified as "C" waves. Advancing "C" waves within upward corrections in larger bear markets are just as dynamic and can be mistaken for the start of a new upswing, especially since they unfold in five waves. The October 1973 rally (see Figure 1-37), for instance, was a "C" wave in an inverted expanded flat correction.

 

9) "D" waves — "D" waves in all but expanding triangles are often accompanied by increased volume. This is true probably because "D" waves in non-expanding triangles are hybrids, part corrective, yet having some characteristics of first waves since they follow "C" waves and are not fully retraced. "D" waves, being advances within corrective waves, are as phony as "B" waves. The rise from 1970 to 1973 was wave [D] within the large wave IV of Cycle degree. The "one-decision" complacency that characterized the attitude of the average institutional fund manager at the time is well documented. The area of participation again was narrow, this time the "nifty fifty" growth and glamour issues. Breadth, as well as the Transportation Average, topped early, in 1972, and refused to confirm the extremely high multiples bestowed upon the favorite fifty. Washington was inflating at full steam to sustain the illusory prosperity during the entire advance in preparation for the election. As with the preceding wave [B], "phony" was an apt description.

 

10) "E" waves — "E" waves in triangles appear to most market observers to be the dramatic kickoff of a new downtrend after a top has been built. They almost always are accompanied by strongly supportive news. That, in conjunction with the tendency of "E" waves to stage a false breakdown through the triangle boundary line, intensifies the bearish conviction of market participants at precisely the time that they should be preparing for a substantial move in the opposite direction. Thus, "E" waves, being ending waves, are attended by a psychology as emotional as that of fifth waves.

6.4 Wave Tendencies

 

Because the tendencies discussed here are not inevitable, they are stated not as rules, but as guidelines. Their lack of inevitability nevertheless detracts little from their utility. For example, take a look at Figure 2-16, an hourly chart showing the first four Minor waves in the DJIA rally off the March 1, 1978 low. The waves are textbook Elliott from beginning to end, from the length of waves to the volume pattern (not shown) to the trend channels to the guideline of equality to the retracement by the "a" wave following the extension to the expected low for the fourth wave to the perfect internal counts to alternation to the Fibonacci time sequences to the Fibonacci ratio relationships embodied within. It might be worth noting that 914 would be a reasonable target in that it would mark a .618 retracement of the 1976-1978 decline.


Figure 2-16 (Click Image To Enlarge)

There are exceptions to guidelines, but without those, market analysis would be a science of exactitude, not one of probability. Nevertheless, with a thorough knowledge of the guide lines of wave structure, you can be quite confident of your wave count. In effect, you can use the market action to confirm the wave count as well as use the wave count to predict market action.

 

Notice also that Elliott wave guidelines cover most aspects of traditional technical analysis, such as market momentum and investor sentiment. The result is that traditional technical analysis now has a greatly increased value in that it serves to aid the identification of the market's exact position in the Elliott wave structure. To that end, using such tools is by all means encouraged.

6.5 A Summary of Rules and Guidelines for Waves

 

From a theoretical standpoint, we must be careful not to confuse Elliott waves with their measures, which are as a thermometer is to heat. A thermometer is not designed to gauge rapid short-term fluctuations in air temperature and neither is an index of 30 stocks constructed so as to be able to record every short-term fluctuation in social mood. While we fully believe that the listed rules govern Elliott waves as a collective mental phe- nomenon, recordings of actions that Elliott waves induce — such as buying and selling certain lists of stocks — may not perfectly reflect those waves. Therefore recordings of such actions could deviate from a perfect expression of the rules simply because of the imperfection of the chosen gauge. That being said, we have found that the Dow Jones Industrial Average has followed Elliott's rules impeccably at Minor degree and above and almost always at lesser degrees as well. Below is a summary of the rules and known guidelines (excepting Fibonacci relationships) for the five main wave patterns, variations and combinations.

MOTIVE WAVES


Impulse

 

Rules

 

  • An impulse always subdivides into five waves. 
  • Wave 1 always subdivides into an impulse or (rarely) a diagonal. 
  • Wave 3 always subdivides into an impulse. 
  • Wave 5 always subdivides into an impulse or a diagonal. 
  • Wave 2 always subdivides into a zigzag, flat or combination. 
  • Wave 4 always subdivides into a zigzag, flat, triangle or combination. 
  • Wave 2 never moves beyond the start of wave 1. 
  • Wave 3 always moves beyond the end of wave 1. 
  • Wave 3 is never the shortest wave. 
  • Wave 4 never moves beyond the end of wave 1. 
  • Never are waves 1, 3 and 5 all extended. 

Guidelines

 

  • Wave 4 will almost always be a different corrective pattern than wave 2. 
  • Wave 2 is usually a zigzag or zigzag combination. 
  • Wave 4 is usually a flat, triangle or flat combination. 
  • Sometimes wave 5 does not move beyond the end of wave 3 (in which case it is called a truncation). 
  • Wave 5 often ends when meeting or slightly exceeding a line drawn from the end of wave 3 that is parallel to the      line connecting the ends of waves 2  and 4, on either arithmetic or semilog scale. 
  • The center of wave 3 almost always has the steepest slope of any equal period within the parent impulse except      that sometimes an early portion of wave 1 (the "kickoff") will be steeper. 
  • Wave 1, 3 or 5 is usually extended. (An extension appears "stretched" because its corrective waves are small            compared to its impulse waves. It is substantially longer, and contains larger sub- divisions, than the non-                  extended waves).                    
  • Often, the extended subwave is the same number (1, 3 or 5) as the parent wave. 
  • Rarely do two subwaves extend, although it is typical for waves 3 and 5 both to extend when they are of Cycle or      Supercycle degree and within a fifth  wave of one degree higher.        
  • Wave 1 is the least commonly extended wave. 
  • When wave 3 is extended, waves 1 and 5 tend to have gains related by equality or the Fibonacci ratio. 
  • When wave 5 is extended, it is often in Fibonacci proportion to the net travel of waves 1 through 3. 
  • When wave 1 is extended, it is often in Fibonacci proportion to the net travel of waves 3 thorough 5. 
  • Wave 4 typically ends when it is within the price range of subwave four of 3. 
  • Wave 4 often subdivides the entire impulse into Fibonacci proportion in time and/or price.

Diagonal

Rules

 

  • A diagonal always subdivides into five waves.
  • An ending diagonal always appears as wave 5 of an impulse or wave C of a zigzag or flat.
  • A leading diagonal always appears as wave 1 of an impulse or wave A of a zigzag.
  • Waves 1, 2, 3, 4 and 5 of an ending diagonal, and waves 2 and 4 of a leading diagonal, always subdivide into              zigzags. 
  • Wave 2 never goes beyond the start of wave 1. 
  • Wave 3 always goes beyond the end of wave 1. 
  • Wave 4 never moves beyond the end of wave 2. 
  • Wave 4 always ends within the price territory of wave 1.* 
  • Going forward in time, a line connecting the ends of waves 2 and 4 converges towards (in the contracting                  variety) or diverges from (in the expanding variety) a line connecting the ends of waves 1 and 3. 
  • In a leading diagonal, wave 5 always ends beyond the end of wave 3. 
  • In the contracting variety, wave 3 is always shorter than wave 1, wave 4 is always shorter than wave 2, and wave      5 is always shorter than wave 3. 
  • In the expanding variety, wave 3 is always longer than wave 1, wave 4 is always longer than wave 2, and wave 5        is always longer than wave 3. 
  • In the expanding variety, wave 5 always ends beyond the end of wave 3.

Guidelines

  • Waves 2 and 4 each usually retrace .66 to .81 of the preceding wave. 
  • Waves 1, 3 and 5 of a leading diagonal usually subdivide into zig- zags but sometimes appear to be impulses. 
  • Within an impulse, if wave 1 is a diagonal, wave 3 is likely to be extended. 
  • Within an impulse, wave 5 is unlikely to be a diagonal if wave 3 is not extended.In the contracting variety, wave 5      usually ends beyond the end of wave 3. (Failure to do so is called a truncation.) 
  • In the contracting variety, wave 5 usually ends at or slightly beyond a line that connects the ends of waves 1 and      3. (Ending beyond that line is called a throw-over.) 
  • In the expanding variety, wave 5 usually ends slightly before reach- ing a line that connects the ends of waves 1        and 3.

* We have found one diagonal in the Dow in which wave four did not reach the price territory of wave one. See Figure 1-18 in Lesson 3

CORRECTIVE WAVES

Zigzag

Rules

  • A zigzag always subdivides into three waves. 
  • Wave A always subdivides into an impulse or leading diagonal. 
  • Wave C always subdivides into an impulse or diagonal. 
  • Wave B always subdivides into a zigzag, flat, triangle or combination thereof. 
  • Wave B never moves beyond the start of wave A.

Guidelines

  • Wave A almost always subdivides into an impulse. 
  • Wave C almost always subdivides into an impulse. 
  • Wave C is often about the same length as wave A. 
  • Wave C almost always ends beyond the end of wave A. 
  • Wave B typically retraces 38 to 79 percent of wave A. 
  • If wave B is a running triangle, it will typically retrace between 10 and 40 percent of wave A. 
  • If wave B is a zigzag, it will typically retrace 50 to 79 percent of wave A. 
  • If wave B is a triangle, it will typically retrace 38 to 50 percent of wave A. 
  • A line connecting the ends of waves A and C is often parallel to a line connecting the end of wave B and the              start of wave A. (Forecast- ing guideline: Wave C often ends upon reaching a line drawn from the end of wave A        that is parallel to a line connecting the start of wave A and the end of wave B.

Flat

Rules

 

  • A flat always subdivides into three waves. 
  • Wave A is never a triangle. 
  • Wave C is always an impulse or a diagonal. 
  • Wave B always retraces at least 90 percent of wave A.

Guidelines

 

  • Wave B usually retraces between 100 and 138 percent of wave A. 
  • Wave C is usually between 100 and 165 percent as long as wave A. 
  • Wave C usually ends beyond the end of wave A.

Notes

 

  • When wave B is more than 105 percent as long as wave A and wave C ends beyond the end of wave A, the entire      formation is called an expanded flat. 
  • When wave B is more than 100 percent as long as wave A and wave C does not end beyond the end of wave A,        the entire formation is called a running flat.

Contracting Triangle 

 

Rules

  • A triangle always subdivides into five waves. 
  • At least four waves among waves A, B, C, D and E each subdivide into a zigzag or zigzag combination. 
  • Wave C never moves beyond the end of wave A, wave D never moves beyond the end of wave B, and wave E              never moves beyond the end of wave C. The result is that going forward in time, a line connecting the ends of            waves B and D converges with a line con- necting the ends of waves A and C. 
  • A triangle never has more than one complex subwave, in which case it is always a zigzag combination or a                triangle.

Guidelines

 

  • Usually, wave C subdivides into a zigzag combination that is longer lasting and contains deeper percentage              retracements than each of the other subwaves. 
  • Sometimes, wave D subdivides into a zigzag combination that is longer lasting and contains deeper percentage      retracements than each of the other subwaves. 
  • Sometimes one of the waves, usually wave C, D or E, subdivides into a contracting or barrier triangle. Often the        effect is as if the entire triangle consisted of nine zigzags. 
  • About 60 percent of the time, wave B does not end beyond the start of wave A. When it does, the triangle is                called a running triangle.

Barrier Triangle

 

  • A barrier triangle has the same characteristics as a contracting triangle except that waves B and D end at                  essentially the same level. We have yet to observe a 9-wave barrier triangle, implying that this form may not              extend. 
  • When wave 5 follows a triangle, it is typically either a brief, rapid movement or an exceptionally long extension.

Expanding Triangle

Rules 

 

Most rules are the same as for contracting triangles, with these differences: 

 

  • Wave C, D and E each moves beyond the end of the preceding same-directional subwave. (The result is that              going forward in time, a line connecting the ends of waves B and D diverges from a line connecting the ends of        waves A and C.) 
  • Subwaves B, C and D each retrace at least 100 percent but no more than 150 percent of the preceding subwave.

Guidelines

 

  • Most guidelines are the same, with these differences: 
  • Subwaves B, C and D usually retrace 105 to 125 percent of the preceding subwave. 
  • No subwave has yet been observed to subdivide into a triangle.

Combinations

Rules

 

  • Combinations comprise two (or three) corrective patterns separated by one (or two) corrective pattern(s) in the        opposite direction, labeled X. (The first corrective pattern is labeled W, the second Y, and the third, if there is one,      Z.) 
  • A zigzag combination comprises two or three zigzags (in which case it is called a double or triple zigzag). 
  • A "double three" flat combination comprises (in order) a zigzag and a flat, a flat and a zigzag, a flat and a flat, a        zigzag and a triangle or a flat and a triangle. 
  • A rare "triple three" flat combination comprises three flats. 
  • Double and triple zigzags take the place of zigzags, and double and triple threes take the place of flats and                triangles.An expanding triangle has yet to be observed as a component of a combination.

Guidelines 

 

  • When a zigzag or flat appears too small to be the entire wave with respect to the preceding wave (or, if it is to be      wave 4, the preceding wave 2), a combination is likely.