Anyone Can Learn the Wave Principle

The Elliott Wave model of financial markets might seem intimidating, but I think you’ll find that if you take a look, it’s core concepts can be understood even by a child. So today we’re going to introduce you to Elliott Wave analysis at three levels. We’ll start with a nine year old and then move on to a college student and finish with an expert. So if you’ve been curious about exactly what Elliott Waves are and how they can help you to get an edge in the markets, then come on board to discover a way of looking at the market that’s totally different from what most people are used to, but it’s an approach that’s hacked with helpful insights that you can use to understand markets better than even most professional traders out there. So let’s get started.

Hey Seth, I’m Matt. Nice to meet you. How you doing? Awesome. Me too. Now today we’re going to talk about financial markets. Have you heard of the stock market before? Awesome. Well, we’re going to talk all about financial markets, particularly the Elliott Wave model of financial market price fluctuation. That’s kind of a big mouthful, but we’re going to break it all down and it’s really at its core about patterns. Now Seth, have you seen a pattern before? Yes, of course you have, right? What’s an example of a pattern that you’ve seen? Like square, square, triangle, triangle, square, square, triangle. That’s perfect, right? Just some repeating shapes. Yeah all in a row and what’s cool about patterns is that if you can recognize a pattern, then you know what comes next. Yeah, you can predict. So we’re going to take a look at some patterns together. Are you up for that?

Yes. Alright, let’s get the big board in here and take a look. Okay, Seth, let’s take a look at a pattern here. And this is pretty familiar cause it’s kind of like the pattern that you talked about earlier. So we’ve got a series of shapes. Now, what’s this first shape here? A square. Of course, and it’s followed by a circle. Alright, now let’s take a look at this second line here. Looks quite a bit like the first we’ve got a square, then a circle, then a square, then a circle. And then there are two shapes that are missing. So if you’d like, I’m going to hand this iPad to you Seth and have you draw in the shapes that come next in this pattern. Go for it. Alright, we’ve got a square and then a circle. Alright, let’s see if you got it right.

Okay. Seth. Can you do a little drum roll on your pants there? Perfect. Alright, here we go. And the correct answer is a square and a circle. You nailed it. Now Seth, how did you know that the next items were a square? A circle? Because every single pattern is a square. And then a circle square circle. Square circle. Yeah. And once you identify that pattern, then you know what comes next. You can predict. So patterns can lead to predictability, just like that prediction you made there. Alright, let’s take a look at a different kind of pattern. So here we have a series of numbers and then a series of letters on the bottom. Again, we’ve got a pattern. We’ve got one, two, three, four, but we’ve got some missing items yet again. So Seth, I’m going to ask you to take the iPad back and fill in those missing items.

Got a five then A, B and C. Awesome. Well, thank you very much, Seth. Now you wrote that up pretty quickly. You’re pretty confident with your answer here. Okay? And you should be doggone it. Well, I tell you what, Seth, we can make this a little bit more interesting. In financial markets, people invest and if they’re right, they have a chance to make some money. Now, we don’t have any money for you to invest today, Seth, but we’ve got something that might be even better. Would you like to know what it is? Yes. Okay. Do you know what this is? AA peep. This is a peep. Now I understand you like these? Yeah. Awesome. Well, Seth, this is yours. We don’t want to eat it just yet. Hang on to it. Here’s the deal Seth. If you want, you can invest that peep. Now, financial markets always involve risks. So if you’ve gotten this wrong, you’re going to lose your peep. But if you get it right, you get an additional peep. So what would you like to do, Seth?

You want to take a risk? Yes. Awesome. Let’s do it. Alright, so you say that the next item in the sequence is a five followed by an A, B, and C. Alright. The stakes are pretty high. Let’s see, what do we have a five followed by an A, B, and C. So Seth, you have a pattern you can predict and if you can predict while you’ve got a chance to make some profit. So hold on to that profit right now. I think we need to raise the stakes. You are doing great, right? This is kind of easy. Yeah. And I saw that this up here, just the same thing and this same thing. Absolutely. You saw the pattern, you knew it repeated and so you knew what came next. Let’s do one that’s a little harder. Alright. Now Seth this is an idealized version of a financial market price chart. Okay. So we see prices going up, prices going down, up, down and so on. Now South, I told you that the pattern, we just saw that one, two, three, four, five ABC was actually depicted on this screen somehow. Any idea how we might do that? It’s kind of tricky, right? Yeah. Okay. Well let me give you a hint. Okay. What if I told you that this first wave up was one? Yeah.

The second wave down was two. Kind of picking up on how this goes. Alright. I’ll tell you why don’t you put your peeps down there? I’m going to give the iPad to you. Where would three go? Alright. You’ve put three there. I think you’ve got the hang of this. So let’s really raise the stakes. You’ve got two peeps, but if you’re able to label the rest of this chart, you can have an entire box of peeps sound pretty good? Alright, let’s take the risk. What comes after the three, four and after four comes five up there. And then what came after the one, two, three, four, five. We had an A followed by B. Followed by C Seth, that is exactly right. Now before I give these to you, let’s wrap things up. What have you learned today about patterns?

That they have to be in order like by and it’s kind of hard to get sometimes if like, it’s like this.

Yeah, patterns can be tricky, but if you’re able to work it out and figure out what the pattern is, then you can predict as you’ve done here, and if you can predict, then you’ve got a chance to make some profits. So these profits are yours. Enjoy them. You’re welcome to take a bite of a peep if you want. And believe it or not, we just learned the basic building block of every financial market, price pattern on the planet. We’ll explain when we meet Danielle, a college student in our next segment. Alright, so you’ve got to take a bite of one of those. My goodness. They looked so delicious. It’s sitting there. Boom. Yeah. How does that taste? Pretty good. Oh man, I wish I had a market to invest in so I could get one of those.

Hey Danielle, nice to meet you. Nice to meet you. I understand you’re a college student. Yeah. Perfect. What year are you, I’m a freshmen. Freshmen in college now. Do you have a major picked out? Are you still deciding?

I’m currently an early childhood education major, but that may change. Absolutely.

Well, we’re going to do a little bit of education, a little bit of teaching today. Hopefully we’ll have a little bit of fun the way as well. Now, do you have some sort of interest in financial markets?

Honestly I haven’t really thought about it.

Yeah. Okay. But you’ve heard of the stock market before? Yes. Okay. You know, there’s this big exchange in New York where people trade stocks. Alright, great. Now when it comes to prices in the stock market, why do you think prices might go up and down? Any idea?

Things change. So some things become worth more or less, I’m assuming.

Yeah, and that’s pretty close to the conventional view of financial markets. I mean, people have all sorts of ideas about why prices might fluctuate. The argument that we’ve found that’s the most consistent with the data is that financial market prices pretty much march to the beat of their own drum. They do their own thing, they have their own rhythm, their own pattern, and we think we know what that pattern is. So if you’re up for it, we’ll get the big board in here and take a look at it. Sound good? Sounds good. So this is an idealized picture of a financial market. So we see prices going up than down than up and so on. Then they go up and down in a particular way. They move up and down in five what we call waves that make net progress in one direction, in this case up. Followed by three waves labeled ABC that make net progress in the opposite direction, down in this case. This is an Elliott Wave, it was discovered by an analyst named RN Elliott in the 1930s and one of the things that’s kind of cool about it is that this pattern repeats. So, even though we haven’t drawn it on the screen after this five wave advance in three wave correction, we’d have another five wave advance right after it. So let’s take a look at that, shall we? Okay. So here we’ve taken the same pattern that we saw before and we’ve just repeated it a few times. So if we were to start down here, for instance, we would have our wave one that’s the first wave up that would be followed by wave two. Then we move up in wave three and Danielle, your handwriting is probably a little bit better than mine.

So I’m going to hand the iPad over to you and ask you to label the rest of this chart. So we had wave three. So next would come wave four perfect. Followed by wave five and then after that five wave advance, we get our three wave correction. You’re doing great an A, B and C. Then after that three way of correction, exactly. That pattern just repeats all over again. So we’ve got our waves, one, two, three, four and five up, followed by that three wave correction. Which you’re labeling now, brilliant ABC. We’ve got one more leg up here. One, two, three, four and five. Brilliant. Okay. Perfectly done. Danielle. So we’ve got some five wave advances. We’ve got our three wave corrections and if we were to look at this, how many five wave advances do you see on the screen? So would it be three? Three, right?

Cause we’ve got this one here, then we’ve got this one after it, and then finally this final five wave advance here. Now what if I were to tell you there’s actually a fourth one? You see any way we might fit a fourth five wave advance in here? Can I have a hint? I can give you a hint. Absolutely. So what if I were to say that this first five wave advance forms wave one at the next larger degree. That three wave correction forms wave two are you picking up on a pattern here? Yes. Alright. So where would wave three go? So three would be up here. I absolutely after that next five wave advance that collectively would form wave three followed by wave four, which would go here. There, awesome. I’ll have you draw wave five cause that’s the most exciting wave.

Where would that fifth wave go? Perfect. That is wonderful. So you see we’ve got a five wave advance at a larger degree. Why don’t you connect some dots for us? Why don’t we draw a big wave one, a big wave two, a big wave three and so on. Perfect. Three, four and five. Brilliant. So if we were to make a forecast for this market, we’ve had our big five wave advance. So what came after the five wave advance A, B and C. That ABC correction, that three wave correction. So we don’t have to draw the whole thing. Let’s just draw an arrow in the direction that you would expect prices to go next.

Okay, brilliant. I’ll take that back from you. So it’s one thing Danielle, to label basically a textbook version of the model on this chart. And we can point out a couple of nuances here. For example, you’ll notice that wave three is a little bit longer, and the reason for that is one of Elliott’s rules is that of waves one, three and five, wave three cannot be the shortest. We’ve depicted that there and you’ve seen that this small pattern compounds on itself or it iterates to form the same pattern at a larger degree of trend. That’s called a fractal. Alright, so now let’s take a step into the real world and look at some real financial market price data and see if we can find the same pattern there, You ready? Yup. Okay. This a chart of the oil market from 1999 to 2008 and it might look a little daunting, a little intimidating, but I think if you get started, you’ll start to see a familiar pattern here.

So I’m going to hand the iPad over to you, Danielle, and ask if you would please label some Elliott Waves on this chart. So we’ll start at the beginning with wave one. Perfect. Wave two then wave two comes next. Absolutely. Now remember what we said, wave three cannot be the shortest wave of wave one, three and five. So where might wave three go? Up here. Up here, it would go with that peak there. Then the correction for wave four. Perfect. Then that final move, gives us a fifth wave up there. Okay. This is becoming old hat at this point, but after that five wave advance comes, the? Correction of ABC. Comes that correction. So again, let’s just draw an arrow in the direction that we expect the prices to go next. Okay. So we’re looking for a pretty substantial move down here after this five wave advance.

Perfect. I’ll take that iPad from you. Danielle, this was an interesting time in the oil market because around this time there are all kinds of experts and analysts and authors who were making an argument that the world is running out of oil. Because something’s becoming more scarce from a supply and demand perspective, what’s left of it becomes more valuable, right? So they were saying that, oil prices would continue to go even higher. In fact, we can look at just some of the books that were published around this time calling for ever higher prices because of this scarcity argument, running out of oil. We see some of the titles: Beyond Oil, Twilight In The Desert, Out of Gas, How You Can Thrive When Oil Costs $200 a Barrel At the Time it Was Trading in the $140. So this is a pretty different outlook.

These people are looking for prices to go to the moon, whereas if we revisit your forecast, Danielle, you’re expecting the total opposite. You’re expecting a pretty dramatic move down and the oil market, so the choice is yours, Danielle. You can go with the consensus or you can stick with the waves. Which would you like to do? Let’s stick with the waves. We’re going to stick with the way it’s absolutely. Let’s do it. Let’s see what came next. There was a crushing move down in the price of oil. This is a 78% drop in five months. Wow. It caught all of those authors, all of those analysts, all of those experts off guard, but not you, Danielle, because you stuck with the waves. Alright. Now, of course, not every market is this clear or offers this sort of an opportunity, but just the fact that you can make a forecast like this with the Elliott Wave model that’s at odds with the consensus, but can spot a move like that. It’s kind of cool, right? Yeah. Alright, so what have we learned today about financial markets and Elliott Waves? Well, if you look at a graph like this, you can predict what could possibly happen in the future. Absolutely. Yeah. You, you know this pattern of financial market prices, and if you can spot the pattern and you know where you are within it, then you’ve got a shot at seeing around the corner and making this pretty cool forecasts.

Brian, thank you so much for coming in and speaking with us today. Happy to be here. Now you are an expert, Elliottitian. How did you come to the wave model? How did you find out about it? What was it that attracted you to it?

Yeah, it initially caught my interest just because it was unlike anything I’d ever used before in my trading or investing. Then I think what really kept my attention was the simplicity and the practicality of the model. I’m just a minimalist by nature. I like to keep life simple and it really kind of fit my personality. I remember when I first started learning about Elliott Waves, I found this old speech of Bob Precther’s, I think it was back in the eighties. He was walking through some forecasts that he made in the Dow at the time. It was a seminar, but he was walking through some real-time forecasts that he made. It wasn’t, you know, he didn’t come out and say, Oh, I’m bullish or bearish. He was actuall saying, okay, prices, if I’m correct, prices should come down to this level.

Then they should rally to a minimum level here and then they’ll probably be a setback. At every point along the way, he’s hitting the market by, within, you know, one or 2%. Then at the end of the speech, he said something I think he was only half joking where he said, you know, to make these kinds of forecasts, all we really need is the ability to count to five. That is that’s again, that’s only half joking. I mean, it does take a lot of time to kind of learn the rules and to learn the guidelines and to incorporate them into your trading. But once you really understand what you’re looking at you can pull open a chart and you can see these patterns without much effort at all. And so it really does. It’s not much more difficult at some at a certain point then counting to five.

Yeah. We’ve seen some examples of that today, in fact. Now when you think about how you’ve been able to use the wave model as an analyst or as a trader, even, what kind of an edge has it given you? What does it allow you to do?

Yeah, there’s a lot of things to talk about there. I think it might be useful just to kind of talk about my evolution as a analyst and as a trader. I was initially never attracted to fundamental analysis. Some are, I’m talking sort of the Warren Buffet style value investing that just, I found it boring. I don’t enjoy, you know, looking through financial reports and that kind of thing. So I was immediately attracted to technical analysis and I devoured all the books. There’s a famous one by Edwardson McGee that is kind of the Bible of technical analysis. I learned, you know, all these chart patterns in momentum and divergences and all these mathematical tools to use. I still found that I was an absolutely terrible trader. What I realized was, even though you can, you can look at a market and make a great forecast. Once you have your own money on the line, it’s like all your analysis just goes out the window.

Right? That’s the emotional component that wave modeling really helped me with in a sense, it kind of saves you from yourself and it, it forces discipline on to an undisciplined trader. One of the ways that I love that it helps with that is that you can map out a position before you ever enter that position. You can know specifically, okay, I see a pattern that I recognize and I’m going to trade this pattern. Whether it’s a daily chart, a weekly chart, an hourly chart, and you can say, okay, here’s where I’m going to enter the position. This is what I make the expected move is going to be. So I can calculate that reward and this is where I know that I’m wrong. This is where whatever I saw was just not what it was. I can get out here so I can calculate a defined risk and a defined reward and various traders have a different ideas on what that multiple should be. But you can map out your entire trade before you ever take on a position. And that for me at least, and I think a lot of traders go through the same experience. That really forces discipline on you.

Yeah, and that’s so important as a trader and also as an analyst as well, to be able to say, okay, here’s the key level. We know if we meet this level, then we’ve got to revisit the forecast. Exactly. What are the other things I love about the wave model is that it saves you from the scourge of trend extrapolation, right? We saw an example in the, in the oil market earlier where we’ve got the whole tide of conventional analysts just extrapolating that trend on and on and on, but with the wave model you can extrapolate with a fractal and see these big moves coming before just about anybody else.

That’s also interesting is because it’s naturally contrarian. You know when you see a five wave move to the upside and you start seeing every analyst on the planet just saying, hey, this is just going to continue get into this market. That’s a clear sign that something is about to to reverse.

Now let’s talk in a little bit more detail about what the wave model allows you to do. That would be pretty tough to do with just about any other method. Yeah, let’s look at some charts. Sounds good.

Right, so the thing I love most about the wave model is it really helps to contextualize a market action and the context comes from the fact that we have this fractal pattern. We have a basic underlying pattern that is playing out at nearly every degree of trend. I brought a few charts just to show that on the left, all I’m looking at here is tick data in the Dow Jones, right? We’re looking at three minutes from 3:56 Eastern standard time to 3:59 Eastern standard time. This happens to be on October 6th, 1997 and you can see the basic pattern. We have a five wave advance and that advanced gets corrected with a three wave decline. We can take this out as far as we want. We have hourly data here. Every bar represents, represents one hour of trading in the Dow. We have the same five wave advance and the same three wave decline, we can go further with this to daily date data.

These are daily bars. Every bar represents one day of trading and we have the same five wave advance, three wave decline, same way with the weekly data. So the thing that is fascinating about Elliott Waves is they provide this context and they take a market that is oftentimes mysterious and seemingly chaotic and they make markets understandable. You can look back at weird market data. There was famous crash in ’87. We can look at you showed a chart of oil prices before. You can look at the financial crisis in ’08. And you look at these things and you’re like, what is going on here? The market is making new all time highs one day and the next day in ’87, it’s down 25%. The financial crisis over a period of one year market lose half of its value. The interesting thing is looking at those moves on a chart is really no different than looking at this daily chart or this weekly chart. All that’s going on is the market is tracing out progress and it’s correcting that progress at every degree simultaneous.

We’ve seen so many charts of that here from the tick data all the way up to the hourly to the weekly. I imagine some people are going to want to know, Brian, how far back can we take this? How, how big can we zoom out?

It’s a great question. The question is if we see this on a five minute chart on a five day, five hour, five week chart, do we also see this on a five decade chart or a five century chart? The answer seems to be yes. A colleague of mine. We actually have good stock market data back through 1700’s. A colleague of mine took this chart. This is the UK financial times all share index. We’re going back through the 1700’s and there’s a very commonly occurring pattern called a contracting triangle. There’s an ideal representation of that up here. All a triangle is doing is it’s a pause in the market, right? You have three wave moves where the price action kind of contracts in on itself. And we see this all the time on the near term charts.

It’s actually a really easy pattern to trade because you can kind of see where this is going to end and it always results in a thrust up or down out of that pattern. And so we looked at stock market data back through the 17 hundreds and we have exactly that pattern. This peak here is in 1720. That’s the famous South sea bubble. I think that one even got Isaac Newton caught up in it. That’s right. Over here we have basically a two century contracting triangle that ended around WWII with the siege of Britain. So this is one thing that really I think validates the wave model. We’ve got a pattern that we see on near term basis all the time. We look at historical market data and we see the same pattern over two centuries. I think that kind of perspective is really quite powerful and completely unique to the wave model/

So today we learned about the Elliott Wave model. We saw a nine year old learn the basic five three pattern. We saw a college student use Elliott Waves to call a turn in the oil market better than just about every conventional analyst on the planet, and an expert shared with us how Elliott Waves allowing them to analyze markets unlike any other approach. So now when you see charts of the markets, you might just find yourself counting waves and spotting opportunities that put you ahead of the herd. Happy surfing out there and I hope you ride the perfect wave.

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