A few weeks ago, a friend asked me outright: How in the world does Elliott Wave analysis work anyway? To which I replied: It’s a little like the game "Wheel of Fortune" -- minus the wheel.
Both contain a set number of solutions. In Elliott Wave Analysis, there are a total of 13 corrective and impulsive wave patterns to choose from.
Next comes the "board": a price chart of a certain financial market. Right away, a few "letters" are "turned over," to start the thinking process. As more time passes, more clues about the wave pattern begin to unfold. Soon, the semblance of a specific shape emerges on a chart. Knowing the guidelines and rules that apply to each of the 13 Elliott wave configurations, the analyst can then narrow down the likely "phrases" (i.e., patterns) at work.
Now, here's the trick: Sometimes, an analyst thinks he has the puzzle figured out in the first few moments. The board reads: saw _ _ _ _; so, he rings his buzzer and blurts out: "Saw Mill."
A red "X" appears. His first answer is incorrect. The next letter is turned over: "D." "Saw Dust" – the analyst tries again, and is right.
Other times, said analyst solves the wave pattern puzzle on the first try. For this, I turn to Elliott Wave International's chief commodity expert Jeffrey Kennedy and his recent interpretation of the near-term trend changes in store for COFFEE.
Here's the gist: At their 26-month low in late-December (just above 106.00) coffee prices staged a powerful rally to five-week highs into January 9 before turning down.
One week BEFORE the market's upturn, Jeffrey Kennedy presented the following close-up of coffee in the December 19 Daily Futures Junctures "Weekly Wrap-up."
According to Jeffrey's labeling on December 19, Primary wave B was unfolding as a triangle -- a five-wave, overlapping pattern. Knowing that triangles always precede the final wave within a sequence and appear in waves 4, B or X (in this case, a wave B), Jeffrey knew that the next move in coffee should be wave C, to complete the simplest Elliott wave correction known as a ABC zigzag.
With the latest rally in coffee likely completing that wave C – and thus solving the puzzle of coffee's past price action – now the question is: Where will the market go next?