At some point after reading the basics of the Elliott Wave Principle, any beginner says to him or herself that it’s time to try and count some waves. Maybe it’s your favorite stock, or the DJIA, or those gold options you’ve been holding – the Wave Principle claims to work in any liquid market, so let’s see how it hangs.
And that’s where things get interesting. After you sit down in front of your computer and pull up a chart, the first question you’ll probably ask yourself is, where do I start? From what point on the chart do you actually start the wave count? Simple. Most Elliotticians use the lowest low and the highest high as measurement points for identifying waves.
Now comes the second question: Do you count every little wiggle in that chart, or just the major “bumps”? As one of my more experienced colleagues, a veteran Elliottician, says, “Everything that counts can be counted, but not everything that can be counted counts.” In other words, don’t force wave patterns onto a chart.
At its core, wave analysis is all about simple “fives and threes”: Just look for five-wave impulses followed by three-wave corrections, as this idealized diagram shows. (And don’t forget that “fives and threes” equally apply to up-trending AND down-trending markets.)
Found a structure that could be a five and a three? Great, but now you have to decide if it is, in fact, a proper pattern – meaning, does it satisfy the Three Rules of Elliott?
Rule #1: Wave 2 never goes past the origin of wave 1. If it does, it’s not a 1-2.
Rule #2: Wave 3 is never shorter than wave 1 AND wave 5. If wave 3 is the shortest, it’s not an impulse.
Rule #3: Wave 4 never enters the price territory of wave 1. If it does, it’s not a wave 4.
Remember that your ostensible “five-three” structure must satisfy ALL of these rules, not just one or two. And if it does – congratulations, you’ve just done your first proper wave count!
A little side note. You may ask – fine, I’m finding “fives and threes” all over the place, but so what? What does that actually tell me? A lot. Once you’ve found a five-wave impulse (followed by a three-wave correction), you can expect your market to continue moving in the direction of the impulse. In other words, you now know what the likely trend is, at least in that timeframe.
Elliott wave analysis is a highly visual method. You can only learn it if you actually label waves on a chart – maybe even physically, with a pencil. Placing wave labels on a chart mentally won’t get you there: You’ll forget where you started by the time you’re done labeling. So there is some elbow grease involved in learning this method.
Because Elliott is so visual, we have put together a series of DVDs that take you through the learning process step by step. In fact, if you liked what you’ve just read, after you've watched DVD #2 in the series, “Counting Waves Correctly,” wave analysis will make even more sense to you.