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The Elliott Wave Principle not only proves
the validity of chart analysis, but it can help the technician decide
which formations are most likely of real significance. As in the Wave
Principle, technical analysis (as described by Robert D. Edwards and
John Magee in their book, Technical Analysis of Stock Trends)
recognizes the "triangle" formation as generally an
intra-trend phenomenon. The concept of a "wedge" is the same
as that for Elliott's diagonal triangle and has the same implications.
Flags and pennants are zigzags and triangles. "Rectangles"
are usually double or triple threes. Double tops are generally caused
by flats, double bottoms by truncated fifths.
The famous "head and
shoulders" pattern can be discerned in a normal Elliott top (see
Figure 7-3), while a head and shoulders pattern that "doesn't
work out" might involve an expanded flat correction under Elliott
(see Figure 7-4). Note that in both patterns, the decreasing volume
that usually accompanies a head and shoulders formation is a
characteristic fully compatible with the Wave Principle. In Figure
7-3, wave 3 will have the heaviest volume, wave 5 somewhat lighter,
and wave b usually lighter still when the wave is of Intermediate
degree or lower. In Figure 7-4, the impulse wave will have the highest
volume, wave b usually somewhat less, and wave four of c the least.
Figure 7-3
Figure 7-4
Trendlines and trend channels are used
similarly in both approaches. Support and resistance phenomena are
evident in normal wave progression and in the limits of bear markets
(the congestion of wave four is support for a subsequent decline).
High volume and volatility (gaps) are recognized characteristics of
"breakouts," which generally accompany third waves, whose
personality, as discussed in Lesson 14, fills the bill.
Despite this compatibility, after years
of working with the Wave Principle we find that applying classical
technical analysis to stock market averages gives us the feeling that
we are restricting ourselves to the use of stone tools in an age of
modern technology.
The technical analytic tools known as
"indicators" are often extremely useful in judging and
confirming the momentum status of the market or the psychological
background that usually accompanies waves of each type. For instance,
indicators of investor psychology, such as those that track short
selling, option transactions and market opinion polls, reach extreme
levels at the end of "C" waves, second waves and fifth
waves. Momentum indicators reveal an ebbing of the market's power
(i.e., speed of price change, breadth and in lower degrees, volume) in
fifth waves and in "B" waves in expanded flats, creating
"momentum divergences." Since the utility of an individual
indicator can change or evaporate over time due to changes in market
mechanics, we strongly suggest their use as tools to aid in correctly
counting Elliott waves but would not rely on them so strongly as to
ignore wave counts of obvious portent. Indeed, the associated
guidelines within the Wave Principle at times have suggested a market
environment that made the temporary alteration or impotence of some
market indicators predictable.
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