The characteristics of Elliott Waves
Wave “personality” is the reflection of mass psychology acting in the market – the emotions that flow from optimism to pessimism, creating the market structures we frequently observe. The personality of each wave type is the same whether it is a higher-degree wave or a lesser one. This section will expand on the characteristics of some of the waves. Please keep in mind the eight-wave cycle when going over this section.
First Waves (Wave 1)
About half of the first waves seen are part of the basing process and tend to be heavily corrected by Wave 2. Many people feel that this is one more opportunity to trade in the direction of the previous trend, and, if that was down, many will sell short. However, market breadth and volume will subtly increase.
The other 50% of first waves will rise from large basing price movement formed by the previous correction. These tend to be dynamic and only moderately retraced. This is a good probable spot to have a Wave 1 extension.
Second Waves (Wave 2)
Second waves tend to retrace so much of Wave 1 that most of the profits gained are eroded, usually ending on low volume and low volatility. In a bear market, this indicates a drying up of selling pressure. However, during Wave 2, most investors are convinced that the bear market is here to stay.
Third Waves (Wave 3)
Third waves tend to be strong and broad. They are typically unmistakable, as confidence in the direction of the new trend is clearly evident. Wave 3 usually generates the most volume and price movement, and they are the most likely wave to extend. The third wave of an extended third wave will likely be the most volatile point of strength in the new trend and things like price breakouts, continuation gaps, volume expansions and increased breadth will accompany it. In Wave 3 for a stock index, nearly all stocks will participate. Because of the dynamics of this wave, it will provide the greatest clues to the correct wave count as it unfolds.
Fourth Waves (Wave 4)
Fourth waves can be predictable in both depth and form because of the guideline of alternation. They tend to differ with the previous Wave 2 of the same degree. They often trend sideways, building a base for the final Wave 5 to spring from. In Wave 4 for a stock index, lagging stocks will tend to build their tops and start declining.
Fifth Waves (Wave 5)
Fifth waves tend to be less dynamic and display slower speed of price change than the previous waves. They will usually be accompanied by lesser volume and breadth.
Of course, if the fifth wave is the extended wave, this will not be the case in terms of price change. In advancing fifth waves, optimism is extremely high despite a narrowing of breadth. However, the fifth wave of an extended fifth will lack the change of the previous waves and give clues about a change in direction.
A Waves (Wave A)
During Wave A, the public is convinced that this is just a correction of the previous trend and will rush in to capitalize on it, despite any technically damaging signals. This sets things up for the next wave to follow. If Wave A is divided into five sub-waves, it will be a zigzag. If it is divided into three sub-waves, it will be a flat or triangle.
B Waves (Wave B)
Wave B catches people in the wrong direction. It performs the task of enticing the suckers to jump into the market. This is where bear or bull traps happen. As a general rule, B Waves tend to show lower volume.
C Waves (Wave C)
Wave C tends to break the illusions of Wave A and Wave B. In a declining market, it can be devastating and fear takes over with broad participation. An advancing Wave C as an upward correction in a larger bear market can be just as dynamic, fooling investors into thinking that it is the start of a new upswing. The fact that Wave C may do this in five sub-waves helps the deception.
D Waves (Wave D)
Wave D shows up in horizontal triangles. If the triangle is contracting, it is often accompanied by an increase in volume. This is because it does not fully retrace the previous wave and is moving in the direction that the market is about to take after the following Wave E.
E Waves (Wave E)
Wave E shows up as the last wave in horizontal triangles. It will often stage a false break of the trend line on the boundary of the triangle before the market takes off in the opposite direction. If the triangle was a Wave 4 in a rising impulse, it would instill a bearish conviction before the market shot up to produce Wave 5. Thus Wave E is often attended with emotional psychology playing against the investor.
These three articles have gone over the rules of Elliott Wave Theory in some detail. However, as stated before, putting Elliott Wave to use will take some practice. Nevertheless, if you persist in applying the rules, eliminating non-conforming counts and looking at the personality of the waves you are counting, you will find satisfaction in applying Elliott Wave Theory.
You will often find that it is necessary to adjust the count you made to conform to new data. Don’t get frustrated by having to make adjustments – it paves the way to a more accurate wave-count and helps to refine your skills. This is something that is expected in doing Elliott Wave analysis as the skills in applying it come through practice.
Not every nuance of Elliott Wave Theory has been discussed here. There are many books written on the subject.