The Basics of Elliott Wave Theory

Elliott Wave Theory Basics

R. N. Elliott developed his wave theory in 1934. It is a method for explaining stock market movements.

Elliott Wave Technical Analysis rules and guidelines applied to the charts, and will help you trade and invest successfully through a better understanding of the market to maximize opportunity and minimize risk.

Under the Elliott Wave Principle, every market decision is both produced by meaningful information and produces meaningful information. Each transaction, while at once an effect, enters the fabric of the market and, by communicating transactional data to investors, joins the chain of causes of others' behavior.

According to the Elliott Wave Theory, stock prices tend to move in a predetermined number of waves. Elliott believed the market moved in five distinct waves on the upside (Motive or Impulse Wave) and three distinct on the downside (Corrective Wave).

Motive wave structure is denoted by numbers (1-2-3-4-5) and, corrective wave structure is denoted by letters (a-b-c).

Market cycles are composed of Motive Wave and Corrective Wave, So one complete cycle consists of eight waves.

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Figure 1

Elliott Wave counting and degrees

An important feature of Elliott Wave Theory is that they are fractal in nature. 'Fractal' means market structure is built from similar patterns on larger or smaller scales. Therefore, we can count the wave on a long-term yearly market chart as well as short-term hourly market chart.

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Figure 2

Elliot Wave theory categorizes waves by relative size, or degree. Elliott discerned nine degrees of waves, and chose the names listed below to label these degrees, from largest to smallest:

1. Grand Supercycle
2. Supercycle
3. Cycle
4. Primary
5. Intermediate
6. Minor
7. Minute
8. Minuette
9. Sub-Minuette

The major waves determine the major trend of the market, and minor waves determine minor trends.

Rules for Wave Count

Based on the market pattern, we can identify ' where we are' in term of wave count. Nevertheless, as the market pattern is relatively simplistic, there are several rules for valid counts:

1. Wave 2 should not break below the beginning of Wave 1;
2. Wave 3 should not be the shortest wave among Wave 1, 3 and 5;
3. Wave 4 should not overlap with Wave 1, except for wave 1, 5, a or c of a higher degree.
4. Rule of Alternation : Wave 2 and 4 should unfold in two different wave forms.

Elliott Wave Theory

R. N. Elliott believed markets had well-defined waves that could be used to predict market direction. In 1939, Elliott detailed the Elliott Wave Theory, which states that stock prices are governed by cycles founded upon the Fibonacci series (1-2-3-5-8-13-21...).

According to the Elliott Wave Theory, stock prices tend to move in a predetermined number of waves consistent with the Fibonacci series. Specifically, Elliott believed the market moved in five distinct waves on the upside and three distinct on the downside. The basic shape of the wave is shown below.

http://www.stockcharts.com/education...lliotwave1.gif

Waves one, three and five represent the 'impulse', or minor up-waves in a major bull move. Waves two and four represent the 'corrective,' or minor down-waves in the major bull move. The waves lettered A and C represents the minor down-waves in a major bear move, while B represents the one up-wave in a minor bear wave.

Elliott proposed that the waves existed at many levels, meaning there could be waves within waves. To clarify, this means that the chart above not only represents the primary wave pattern, but it could also represent what occurs just between points 2 and 4. The diagram below shows how primary waves could be broken down into smaller waves.

http://www.stockcharts.com/education...lliotwave2.gif

Elliott Wave theory ascribes names to the waves in order of descending size:

 

1. Grand Supercycle
2. Supercycle
3. Cycle
4. Primary
5. Intermediate
6. Minor
7. Minute
8. Minuette
9. Sub-Minuette

The major waves determine the major trend of the market, and minor waves determine minor trends. This is similar to the way Dow Theory postulates primary and secondary trends. Elliott provided numerous variations on the main wave, and placed particular importance on the golden mean, 0.618, as a significant percentage for retracement.

Trading using Elliott Wave patterns is quite simple. The trader identifies the main wave or Supercycle, enters long, and then sells or shorts, as the reversal is determined. This continues in progressively shorter cycles until the cycle completes and the main wave resurfaces. The caution to this is that much of the wave identification is taken in hindsight and disagreements arise between Elliott Wave technicians as to which cycle the market is in.

Here is an example of a classic Elliott Wave cycle that occurred in the NASDAQ Composite in late 2003.

http://www.stockcharts.com/education...lliotwave3.png

For more information, check out Elliott Wave Principle: Key to Market Behavior by Robert Prechter.

Elliot Wave Analysis was developed by Ralph Nelson Elliott* in the early 1930's, following what remains the most devastating market decline in U.S. history - the Crash of 1929.

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R.N. Elliott

</td> <td style="font-weight: bold;" valign="top" width="83%">An accountant by profession, Elliott had a successful career as financial consultant to numerous railroad companies, a booming sector when he began his professional life just before the turn of the 20th Century. Elliott had a passion for Latin America (his boyhood home in Texas exposed him to nearby Mexico and its culture) wrote and spoke Spanish fluently, and spent much of his professional life working for firms in Mexico, Central America and Cuba. He was considered an expert in business planning, and his services were in very high demand. Such was his reputation that Elliott caught the eye of the U.S. State Department, which sent him to Nicaragua as an economic consultant, where he helped reorganize the country's finances. It's said that one of his greatest talents in business was a shrewd eye for detail. </td> </tr> </tbody> </table> 1929 was a terrible year for Elliott. Like many others, he suffered major losses in the market crash. To make matters worse, he had contracted a parasite during one of his trips to Latin America, infecting him with a life-threatening anemia. In 1930, he moved to California, where, to occupy his time as he recovered from his illness, he took to studying charts of the major market indices. Part of his motivation was a book on the market theory of Charles Dow (creator of the Dow Jones Industrial Average); the other part was an intense desire to understand the mechanics that led to the Crash of '29.

Training his meticulous eye on decades of market charts, he discovered a persistent and recurring pattern that operated between market tops and bottoms. He theorized that these patterns, which he called "waves," were a collective expression of investor sentiment, giving the market a distinct form and behavior. Through a use of measurements that he called "wave counting," an analyst could forecast market turns with a high degree of accuracy. After testing his theory over four years, Elliott organized his research into an essay that he titled "The Wave Principle," which was published in book form in 1935 with the assistance of Charles Collins, a respected newsletter publisher who helped popularize Elliott Wave analysis in its early years.

The Wave Pattern
Elliott's main discovery was that market behavior could be identified and measured through a repeating eight wave sequence, consisting of 5 waves that he called "impulsive," followed by a 3-wave "corrective" sequence. Impulse waves are labeled numerically 1 through 5, corrective waves are labeled A, B and C, as per the following example:

http://www.market-harmonics.com/imag...waveseqeng.JPG

Below, the pattern is illustrated in a chart of the Dow Jones Industrial Average from 1921 to 1932:

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The above chart also illustrates another of Elliott's key discoveries, namely that wave patterns themselves subdivide into smaller patterns that trend in the same direction as the wave of one larger size, or, as Elliott termed it, "degree." In this example, the encircled wave numbers are labeled as Primary waves. The Primary waves subdivide into a five-wave sequence of Intermediate degree waves, which, in turn, subdivide into a sequence of five Minor degree waves. A three-wave "corrective" sequence then begins from the 1929 market top and ends in July 1932, well below the start of the bull market, a loss of about 90% in the Dow's value.

Extended Impulse Waves
The above chart of the Dow also illustrates the concept of "extended" waves, which holds that one of the three impulse waves in an Elliott sequence will always be "extended" or longer than the other two, regardless of degree. In Elliott's original work, he noted that 5th waves were more frequently the extended wave in a sequence. Frost and Prechter in their 1978 book "Elliott Wave Principle," revised this view to suggest that 3rd waves were more commonly extended, and their view has come to dominate wave labeling. Each of these tendencies is seen in the above chart. Both at Primary and Intermediate degree, the 5th wave extends from 1926-29, and 1928-29, respectively. At the Minor degree level (1928-29) wave 3 is clearly the extended wave. Correctly identifying the extended wave is important in forecasting the depth of the correction to follow.

Differences Between Internal Wave Structures
Frost and Prechter classify internal wave structures as being one of two modes -"motive" or corrective. They use the term "motive" to describe those waves that "impel" the market. Internally, motive waves are always 5-wave structures; corrective waves are always 3-wave structures. In the impulse sequence, therefore, Waves 1, 3 and 5 are motive; Waves 2 and 4 are corrective. This should not be confused with the ABC corrective pattern (discussed below) whose internal waves may subdivide as motive or corrective, depending on the type of correction taking place.

Corrective Wave Patterns
Elliott, Frost and Prechter classified 21 corrective patterns, from simple forms to more complex structures and combinations. Three of the simple patterns, and those which form the building blocks of the more complex structures, are illustrated below. These are corrective patterns following an uptrend. The patterns would be inverted following a downtrend.

http://www.market-harmonics.com/imag...simplecor2.JPG

Zigzag: Zigzag patterns are sharp declines (or advances in a bear rally) that substantially correct the price level of the previous impulse sequence. Often wave B (the counter-trend wave of the ABC pattern) is the shortest relative to A and C. In zigzag patterns, the sequence may double or triple up until the price correction target is achieved. Zigzags internally subdivide 5-3-5 as follows: Wave A (5-waves, motive), Wave B (3-waves, corrective), Wave C (5-waves, motive).

Flats: Flats are triangular structures that tend to move the market in a what Elliott called a "sidewise" (sideways) pattern. The ABC waves also tend to be equivalent in length. In the flat pattern, wave B will often undo the work of A and frequently tops in the area of the previous wave 5. Because of this action, wave B's tend to fake-out traders who think the correction is over. Wave C then undoes the work of wave B. There are also variations on the flat correction pattern, which include "expanded" flats (Elliott described them as "irregular") in which wave B tops well beyond the start of wave A, and wave C is substantially larger than A, generally by 1.618 or 2.618 the length. In a "running" flat, waves A & B are similar to an expanded flat, but wave C is shorter than wave A. Flats internally subdivide 3-3-5 as follows: Wave A (3-waves, corrective), Wave B (3-waves, corrective), Wave C (5-waves, motive).

Triangles: Elliott described two distinct types of triangles: Diagonal and Horizontal. Diagonal triangles are part of ending sequences in a wave pattern, and therefore can occur within a wave 5 or a wave C. According to Elliott, diagonal triangles form when market action has moved "too far, too fast" and represent exhaustion of the trend. The 5th wave of the diagonal will frequently spike sharply above the upper trendline of the triangle in what Elliott called a "throw-over." A trader should be alert to a diagonal triangle formation, as it signals an impending and sharp trend reversal. Horizontal triangles, on the other hand, are corrective structures. Also called "wedges," horizontal triangles are identified by drawing parallel trend lines along the peaks and troughs of the wave labels. D and E labels are added to fill out the sequence. In heavily corrective and choppy markets, there can be as many as 11 to 15 waves within the overall horizontal triangle structure. In all cases, the completion of a triangle pattern is normally followed by a sharp "thrust." The direction of the thrust is determined by the wave pattern in progress. One unique type of triangle, that is related to the family of "irregular flats" is the "Running Triangle," which was described by Frost and Prechter as one in which Wave B of the triangle exceeds the start of Wave (A). Since Running Triangles are cousins to both flats and horizontal triangles, they are most common to fourth waves and other corrective wave patterns.

Internally, all subwaves in a triangle are "threes", which tend to overlap. The only exception is a structure identified by Frost and Prechter (though not originally by Elliott) called a "leading diagonal" triangle, which occurs in the first wave position and subdivides 5-3-5-3-5 (like an impulse wave). Unlike an ending diagonal, this structure implies a continuation of the trend. They caution, however, against confusing this with a progression of first and second waves, which is far more common.

Corrective Combination Patterns
In forming more complex corrections, the basic corrective patterns may, and often do, combine to extend the corrective process. Most common is a doubling of the pattern, and less frequently, a tripling. These result in the following types of combinations:

1. Double Zigzags and Triple Zigzags (self-explanatory)

2. Double-Three: The components of a double-three include...

1. Flats-Flat
   

2. Flat-Triangle
   

3. Zigzag-Flat
   

4. Zigzag-Triangle
   

3. Triple-Three: The components of a triple-three include...

1. Flat-Flat-Flat
   

2. Flat-Flat-Triangle
   

3. Zigzag-Flat-Triangle
   

4. Zigzag-Flat-Flat
   

To help clarify the labeling when these combinations occur, Frost and Prechter devised the labels W, X and Y to identify the main sections of a double combination, and W, X, Y and Z for triple combinations.

Rules of Wave Labeling
Correctly labeling waves is at the heart of wave analysis. Incorrect labeling can prove very costly to a trader, and so it is important to observe the rules of labeling. Elliott established three simple rules that, if not observed, will invalidate a wave count:

1. Wave 3 can never be the shortest impulse wave.
   

2. Wave 2 can never exceed the start of Wave 1.
   

3. Wave 4 can never overlap Wave 1 (i.e., cross into the same price area).
   

In addition to these rules, there are guidelines that aid in labeling waves. They are not as inviolate as the rules, and they help in telling you what to look out for. Three of these guidelines include:

Alternation: If Wave 2 is a sharp correction, expect Wave 4 to be a sideways correction. Conversely, if Wave 2 is sideways, expect Wave 4 to be sharp. More often than not, Wave 4 is sideways, subdividing as either a flat or triangle. In corrections, if Wave A is a simple structure, expect Wave B to be more complex. Wave C may or may not be more complex relative to A.

Depth of Correction: Generally, following impulse wave sequences where Wave 3 is the extended wave (the most common scenario) the subsequent Wave A correction should terminate in the area of Wave 4.

In cases where Wave 5 is the extended wave, either Wave A alone, or the entire correction, will be sharp, and bottom in the area of a Wave 2 of lesser degree. We see an example in the Dow chart above. Note that Primary Wave A terminates right at the area of Minor Wave 2. Wave C may bottom here as well, or just as often in either the Wave 4 area from where the extension began, or it can also erase the entire impulsive rise, as also seen in the above chart of the Dow.

Wave Relationships: Two of the non-extended impulse waves (generally waves 1 & 5) will tend to be equivalent in length and time of formation, or will be related by a Fibonacci ratio (more on that in the next section). Waves 2 & 4 are also similarly related, as are Waves A & C.

There are other guidelines identified by Elliott, Frost and Prechter, and it is important to note that all rules and guidelines operate at all wave degrees, whether intraday or over longer time-spans.

Wave Labels & Degrees
Since all waves subdivide into smaller waves, there is a hierarchy that is used to label wave movement that covers everything from broad expanses of time, to hourly market movement. Elliott developed a labeling method that was slightly revised by Frost and Prechter in their 1978 book. Most important are the wave degrees under study, which include, in descending order:

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1. Grand Supercycle
2. Supercycle
3. Cycle
4. Primary
5. Intermediate

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1. Minor
2. Minute
3. Minuette
4. Subminuette

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At the top of the pyramid are the family of Cycle waves, which can take decades to complete. Primary and Intermediate waves cover shorter periods of years and months. Minor waves and lower reflect daily and intraday market action. In describing a wave pattern, an Elliottician might say, for example, "the S&P is tracing out a Minor Wave 5 down within an Intermediate Wave (A)." What this would tell the analyst is that the subwaves of Intermediate Wave (A) are about to complete their sequence, and that an Intermediate Wave (B) up (a good, tradable market rally) will begin once (A) bottoms. A series of price targets for a bottom will normally be included in the analysis. Which leads us to the next section in our guide...

Dear Itme
thanks for sharing your knowledge and experience with us..
from this now i will study the elliot wave..
and hope more and more for your teaching.

thanks Itme for your effort, but doesn't wave 2 on your chart go below wave 1? and wave 4 overlaps wave 2?

because it defiles the rules of elliot. wave two should not retrace over half of wave one if it does its invalid.

http://www.elliottwave.com/education...=789&lesson=16

Great Thread. Thanks for sharing the information with everybody.

Rojo,

This is great. Thanks

I took a look at this chart and I think where the mistake is Wave 1 and 2 happen much earlier and below Wave 4 low. My chart is too big for FF or I'd post it.

As far as Wave 2 retracing more than 50% of Wave 1 - that is perfectly acceptable. And actually it can almost completely retrace W1 but not beyond W1 start point. Most times it should go to between 50% and 61.8% levels.

Excuse me, this is not correct information....Wave 2, usually retraces more than 62% of wave 1...This is precisely true to almost all wave 1s...It relates to the psychology of traders & the market...Wave 1 emerges from huge pessimism (If the market is in a downtrend)...The market is bleeding, going down day after another, and then a rally occurs...People being convinced that the status is a bear & that the trend is a down one, heavily sell the rally, bringing the price down as hell with retracement usually over 62% (In fact I studied several wave 1s and found that wave 2 usually retraces anywhere between 70-80% of wave 1, sometimes more, sometimes less, but this is the percentage retracement in 80% of wave 1s)....

However, even with people selling like hell and bringing prices down buyers emerge once again & take prices up in wave 3 where people start to see weakness turning into strength & the market confirms the reversal...


Thanks,

Nader

There is only one rule that applies to Wave 1 and Wave 2 formations:

Wave 2 cannot retrace past the origin or starting point of Wave 1.

There are also many guidelines used in Elliot Wave analysis that are helpful in predicting price movement. Nader in his post points out one of the guidelines to Wave 2 formations. The important point is that guidelines are not rules. Guidlines can be and are many times broken but the wave count can still be valid. The trick is that the more guidelines are found to be valid the more confidence you can have in your wave count.

EW is in the end a method of measuring market psychology. What traders are thinking is what shows up in the price. Being able to intrepret what traders are thinking out of the unfolding patterns is the real art of EW. Something I am myself still very much grappling with.

Jeffrey

Greetings fellow wavers,

Let me present an oxymoron that you might find interesting: “conventional wisdom in the financial markets.” The phrase would be laughable if so many people’s livelihoods didn’t rely on the success of the markets.

The fact is, there’s nothing “wise” about the conventional way of thinking when it comes to media-driven financial forecasts – on which the majority of investors say they base their decisions.

The Elliott Wave Crash Course is a series of three FREE videos exclusively for Club EWI that demolishes the widely held notion that news drives the markets. Each video – released Monday (today), Wednesday and Friday of this week – will provide a basis for using the Wave Principle in your own trading and investing decisions.

Here’s the rundown:

Online Now: Why Use the Wave Principle

 

1. This video uses real headlines, actual events and charts to provide a comprehensive look at what the financial media say drives the markets and why their “fundamentals” are usually wrong. And more importantly, you’ll learn why the Wave Principle is your best tool for forecasting the markets.

Wednesday: What is the Wave Principle

 

1. This video gives you a brief biography of Ralph Nelson Elliott, the father of the Wave Principle. But it also explains in vivid detail the recurring “motive” and “corrective” patterns Elliott discovered in the DJIA in 1938. Hands down, this is the best introduction to the Wave Principle we have ever created.

Friday: How to Trade the Wave Principle

 

1. This final video of the series goes past the history and serves up the meat and potatoes of the Wave Principle, sharing real charts and strategies for position management, such as entry, stop, target and risk/reward assessment. After watching this video, you’ll know the rules and guidelines and our favorite wave patterns for trading.

Watch Why Use the Wave Principle Now!

Stay tuned for What is the Wave Principle and How to Trade Using the Wave Principle later this week.

Warmest Regards,

Robert Folsom
Club EWI Manager

P.S. Feel free to forward this email to others who might share your interest in the financial markets.

<TABLE cellSpacing=0 cellPadding=0 width=575 border=0><TBODY><TR><TD vAlign=top>Crude Moves Higher... Why, Again?

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By Vadim Pokhlebkin

</TD></TR><TR height=12><TD width=6 height=12></TD><TD height=12> </TD></TR></TBODY></TABLE><TABLE cellSpacing=0 cellPadding=0 width=575 border=0><TBODY><TR><TD width=6></TD><TD class=EC_article vAlign=top>Oh, what a short memory the markets have.

Just last week crude oil stirred up happy commotion in the headlines as prices fell close to a one-year low of near $58 a barrel. Crude fell, according to analysis, for two reasons: "Because U.S. oil supplies advanced to a five-month high" and because of expectations of a mild early winter in the U.S. That's why, said one energy analyst, oil "may be hanging around this area for a while" (Bloomberg).

Well, that "a while" barely lasted a week. "Oil Prices Rise Above $63 a Barrel," reported the newswires yesterday (Nov. 30) with some trepidation. Why the rise? Two reasons: "Technical trading" plus "the approach of the Northern Hemisphere winter."



Never mind the five-month high in inventories, and forgotten are the expectations of a mild winter. So much so that energy analysts are now "split over whether the recent surge in energy futures represents a correction... or if it is the beginning of a new upswing" (AP).



Well, we at EWI have an opinion on that. In fact, we had one two weeks ago, too – when crude was trading near its recent low of $57.02 a barrel. That's when our Energy Specialty Service published this chart, showing that crude was likely ready to rocket off:



http://www.elliottwave.com/images/ez...%2012-1-06.gif



Our energy analysts watch the same weather reports and get the same inventory news as the rest of the energy market. But their bullish stance on November 15 had nothing to do with oil's "fundamentals."



The media had a great point when they said that "technical trading" was partially responsible for the crude's push above $63. By our technical analysis calculations, at $57.80 in mid-November, crude finished a 5-wave decline (See those purple 1-2-3-4-5 Elliott waves on the chart?), and a bounce was a strong possibility.



As for whether this bounce is "just a correction" or "the beginning of a new upswing" – our Energy Specialty Service has an opinion about that, too.



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Very nice thread! You should rename it to Elliot Wave revealed....

Very professional, thanks for sharing!

MeteorOILogy Misstep

The following was first published on Elliottwave.com on 11/29/06

If you happened to tune into the Weather Channel this past summer, chances are that if you live in certain regions of the U.S., you're only just now peeling the duct tape off the windows and doors of your house.

Fact is, a relative few months ago, predictions for the 2006 Hurricane Season sounded like a potential sequel to the disasters of the 2004-2005 seasons. Forecasters anticipated the development of "17 tropical storms, nine to ten of those being hurricanes, and four to six of those qualifying as Category Three or greater."

According to one expert: "With the weather pattern and hydrology we're seeing in the oceans, the likelihood of a major hurricane making landfall is not a question of if but when. The North East is staring down the barrel of a gun."

Turns out, the gun was shooting blanks: In the period from June 1 to late November "nine tropical storms" formed, yet not a single one reached Category Three status or inflicted "catastrophic damage to any area of the US."

In the words of a November 27 news source: "Meteorologists blew it. 2006 was the quietest hurricane season in a decade."

If it's any consolation, they're far from alone. About the same time, in fact, the masters of MeteorOILogy were predicting that a "perfect bullish storm" was set to make landfall in the energy market, one that could have major repercussions for the US economy.

On this, the following news items from the time say plenty:

 

1. "Get set for $80. Producers and consumers alike should get used to the fact that oil prices will likely never fall below $60 a barrel again."(DJ MarketWatch July 7)
2. "I am sure we'll see over $80 this year. Crude prices, which have double in value over the past two years, could even strike $100."(AP July 7)
3. "Oil will soar well over $100 and stay high as part of a sustained commodities bull run that has another 15 years to run."(Reuters July 6)

For many, the wide expectations of a terrible-two Tropical Storm redux went hand-in-hand with triple-digit oil prices. This logic continues to astound us in lieu of the fact that Hurricane Katrina made landfall on August 29, 2005, causing 95% of crude production in the Gulf Coast region to shut down.

Yet on August 31, oil prices kissed their all-time high goodbye in a three-month long sell off that slashed nearly 20% off its value.

This time, the abundance of geo-political unrest MORE than made up for the lack of geologic unrest. And still, on July 4, 2006, crude oil prices set a new record peak, only to reverse in a powerful, 24% plunge that has pushed the market to its lowest level in 10 months.

As for "never falling below $60 a barrel again" -- see November 22.

Bottom line: in forecasting weather or markets, the phrase "exact science" doesn't apply. Yet when it comes to financial markets, objective analysis more than applies when it comes to wave patterns.

And, in the July 25 Elliott Wave Theorist, Bob Prechter presented a special, 20-page report on the long-term trend changes in store for oil based exclusively on this measure. In his words: "Today, oil appears to be finishing a rally. The danger of holding oil investments at this time far outweighs the potential reward. A setback of at least Primary degree is due now. Stay away from the long side."

I know some consider Robert Prechter to be the guru of guru's regarding EW since he wrote the book on R.N. Elliott. But in the 90's he also became well known for calling for the top of the bull market. Only problem was he was years ahead in the calling the top. I think he was looking for it about '94 and it didn't come till 2000. I guess that was the extended wave of all extended waves? He is one of those academic types. Those that can't, teach.

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EURUSD: Volatility, Anyone?

By Vadim Pokhlebkin

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</td> <td class="EC_article" valign="top">Here’s what a good friend of mine – a forex trader with 11 years of experience – once told me:

“I rarely trade in December. Many traders are off on vacations; others have already made their profits for the year and are sitting tight, refusing to take any risk in the remaining weeks. As a result, the forex markets thin out, making it easier for big players to push the prices around. Trading a trendless market is very difficult, so come December, I scale way back.”

Well, another December is upon us, and once again I see my friend’s point. Over the past three weeks, the EURUSD has covered an incredible distance of 600 pips: from $1.2750 all the way up to $1.3350 (and counting). It's now just 2 cents away from its all-time high of two years ago.

Of course, after hitting that all-time high of $1.356 in December 2004, the EURUSD tumbled down for a whole year. Things are different this time around, say forex analysts. Maybe, but that's not the point. Regardless of whether or not the euro can hold its recent gains, one thing's for sure going forward: volatility. Remember how wildly the EURUSD swung last December? Some days it would easily cover 100+ pips in each direction, and this year should be no different.

Strong volatility is all the more reason to rely on Elliott wave analysis this time of year. Prices may swing more than normal, but wave patterns in the markets remain intact. Case in point: the EURUSD forecast our Currency Specialty Service published last night (Dec. 4). "Topping" was the key word we used, and for good reason: See how the ongoing rally shows only 3 waves so far?

http://www.elliottwave.com/images/ez...%2012-5-06.gif

As you know, an Elliott wave impulse has 5 waves. That's why, if our analysis is correct and wave 3 is indeed nearing completion, what should come next is a strong pullback in wave 4. Just how far could it drop? We do have a few Fibonacci-calculated targets in sight for the EURUSD, but since volatility will likely persist as the year-end approaches, this is a time for caution…

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<table border="0" cellpadding="0" cellspacing="0" width="575"> <tbody><tr><td valign="top">It's All About 'Fives and Threes' -- Part II

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By Vadim Pokhlebkin

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</td> <td class="EC_article" valign="top">Regular readers of this column will remember that we talked last week about how easy it is to follow professionally produced Elliott wave counts in market charts – and how hard it gets when you try to do your own real-time wave counts while trading.

The reason for that difficulty, we concluded, lies in the fact that you can never know for sure what kind of Elliott wave structure you're dealing with until it's complete – and not even then sometimes. Yes, we all know that it's all about 5-wave impulses and 3-wave corrections, but counting them in real time can be a bigger challenge than it seems.

That's a sobering fact for many Elliott wave beginners. They often expect to count perfect five and three wave structures in market charts all the way down to milliseconds. But the truth is, you can't. The explanation veteran Elliotticians give is – "It's not a perfect world." It also has a lot to do with the limitations of your data feed. But even if your data were perfect, some ambiguity with the real-time wave counts would still be present.

That means that sometimes (often?), you'll be left guessing if what you see is a 3-wave or a 5-wave structure. Which is OK if you're an individual trader. At moments like that, you just wait until the wave pattern clears up. Patience is a virtue, doubly so when it comes to trading. Anyone who trades the markets for a living will tell you that.

But let's say you absolutely have to trade that market that very moment, regardless of any wave pattern ambiguity. For whatever reason, you must trade now – but for the life of you, you cannot see that perfect 5-wave structure within your ostensible wave 3.

That happens. But can you see waves 1 and 2 clearly? Have the 3 Rules of Elliott and most of the guidelines been met? Then what you're probably looking at is a 3rd wave! Should you assume that just because you can't see its internal structure perfectly, your entire count is bad? Some people might; I wouldn't.

What if you make a mistake in your wave analysis and end up in a losing position? Well, it's not the end of the world; it happens to the best of us. Here's how Bob Prechter puts it in his classic 1986 report, "What a Trader Really Needs to Be Successful":

"...my observation, after eleven years in the business, is that the biggest obstacle to successful speculation is the failure merely even to recognize and accept the simple fact that losses are part of the game, and that they must be accommodated. The perfect trading system does not exist. Expecting, or even hoping for, perfection is a guarantee of failure."

In Market Wizards (another great read, both Vols. I and II), many of the world's best traders say that you must be ready to take lots of small losses to work your way to a big winner. Just don't let those small losses become big ones, and don't let them compound on you. "Cut your losses short and let your profits run," remember? That's easier said than done – but who said market speculation was easy? There is a reason why 90% of traders lose money…

Trading is tough, and don’t let anyone tell you otherwise. Don’t let them tell you all you need is a correct forecast, either. That is maybe 20% of your success, but you only realize that after you've traded for a while.

Don’t rely on "expert opinions" too much, either. Experts are people too, and if you rigidly follow their market views, you'll also make their mistakes. Instead, what you need is to establish your own set of trade confirmations. You need to trust nobody but yourself with your trading decisions. Only then can your mistakes become your own. And only then can you truly learn.



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This week's question is...

"How do you differentiate between the end of a Contracting Triangle and an ongoing Diametric or Symmetrical"?

To see Mr. Neely's answer, go to...
http://www.neowave.com/qow.asp

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