It must be kept in mind that the most important objective of Elliott-wave, pattern analysis is to understand the position of the market relative to the trend.
1. If we believe that the last swing high or low began on impulsive, five- wave trend sequence, the market cannot trade below (above) what we believe is the beginning of wave one. If this should occur, the wave count is incorrect, as a wave two may not exceed the beginning of wave one.
Trading Implication
A protective stop loss should never be placed more than one tick beyond what we consider the beginning of wave one.
2. If we believe that a market is in the initial stages of a five wave sequence and has completed waves one and two and has begun wave three, we can anticipate that wave three will be longer in price range
than wave one. Of the three impulse waves in a five wave sequence
(waves 1, 3 and 5), wave three is most often the "extended" wave. This is particularly true of the stock and financial markets. In commodity markets, wave five is as likely to be extended due to panic, weather condition blow-offs. Wave one is rarely the extended wave.
The fact that wave three is usually the extended wave allows us to make a minimum price objective for a wave three within a five wave sequence. Wave three will usually be greater in price than wave one. A 100% Alternate Price Projection (APP) with be the minimum expectation of wave three. Once a market exceeds the 100% APP, we have a strong indication that a five wave sequence is underway. This is also called a trend confirmation.
Trading Implication
We should not be too quick to bring a protective stop loss close to the market prior to price reaching what we consider the minimum projec- tion which is where wave three would equal wave one. The protective stop loss should be adjusted closer to the market once the price range of the suspected wave three exceeds the price range of wave one.
3. If we believe that a market has completed wave three of a five wave sequence, yet wave three is less in price than wave one, wave five must be less in price range than wave three which is the shorter wave
of waves one and three. Wave three cannot be The shortest of the three
impulse waves in a five wave sequence. In this situation, we have a
definite maximum price objective for wave five which is 100% of the price range of wave three, the shortest impulse wave to date.
We may consider wave three is complete even if its price range is less than the price range of wave one, if wave three has completed a five wave advance. This is the only situation where we can consider wave five has a maximum price objective.
Trading Implication
The protective stop loss of wave five should be moved very close to the market if the price approaches the maximum objective for this wave structure.
4, If we believe that a wave three has completed and the wave four is underway and the market trades into the price range of wave one, the
market has invalidated our count of the waves three and four as a wave four may not trade into the price range of wave one. The wave
count must be re-considered.
Trading Implication
The maximum protective stop loss on a trend trade is the wave one extreme. However, in roost cases the stop loss would be closer to the
market. In the case of a bull market, the maximum protective stop loss is one tick below the wave one high once the wave three high is identi- fied and the wave four decline is underway.
5. The smaller degree pattern will confirm the position of the larger degree. Waves 1, 3 and 5 should each be constructed of five wave patterns of lesser degree. If the market violates any of the rules of impulse pattern within the lesser degree, it indicates that the larger degree is not a five-wave impulse sequence as anticipated. Smaller degree patterns are not always evident on a daily chart.
Trading Implication
If the smaller degree patterns are evident, they are used to advantage by enabling the trader or investor to enter positions with closer initial protective stop losses, adjusting protective stop losses closer to the market and providing narrower time and price targets for trend confirmation and trend termination.
Wave Comparison Notation
Throughout the time and price sections of the book, you will learn how to project the time and price ranges of prior waves forward in order to determine at what price and time a market should reverse trend. When comparing one wave to another a simple notation system is used to quickly recognize what is being compared. Below are some examples.
The illustration above shows a five wave advance followed by an ABC correction. It has not been sub-divided into minor degree waves. Earlier in this chapter, the wave-labeling and notation conventions used to identify
waves was described. This section will describe the notations used to compare waves when making time and price projections.
Wave Ranges
Price ranges are measured by the vertical axis. Time ranges are measured by the horizontal axis.
A wave is indicated by a W.
W.1 above is the distance from 0 to 1
W.1-3 (waves 1 through 3) is the distance from the beginning of wave 1 (labeled 0) to the end of wave 3 (labeled 3), W.1-3 does not mean the distance from point 1 to 3, but the net range traveled of waves 1 though 3.
W.3-5 (waves 3 through 5) is the distance from point 2 to point 5 or the distance covered from the beginning of wave 3 (end of wave 2} through
the end of wave 5.
Wave 5 is often related to both wave 1 and waves 1-3 by either equality or one of the Fibonacci ratios. If we have identified the end of wave 4
(beginning of wave 5), we can project potential time and price targets for wave 5,
Examples Of Price Wave Comparison Notation
642.00: W.5 = 61.8% W.1. At 642.00, the price range of wave 5 equals 61.8% of the price range of wave 1.
643.20: W.5 = 100% W.1. At 643.20, the price range of wave 5 equals 100% of the price range of wave 1.
644.10: W.5 = 61.8% W.l-3. At 644.10, the price range of wave 5 equals 61-8% of the price range of waves 1 through 3.
622.10: W.2 = 50% Ret. W. 1. At 622.10, wave 2 is a 50% retracement of the price range of wave 1.
633.50: W.3 = 100% Exp. W. 1. At 633.50, the extreme of wave 3 is at a 100% expansion of the price range of wave 1.
Price retracements. alternate projections, and expansions are described in detail in the Dynamic Price Analysis chapter. These same wave com- parison notations are used for time projections and are described in the
Dynamic Time Analysis chapter.
Each wave and its sub-divisions tend to have definite characteristics that help to identify the wave and it's position within the larger trend. The following sections describe the main characteristics and price relationships of each wave type, impulsive and corrective, and their sub-waves. The price chapter will provide the detail of how to make the price projections. For now, we just want to be aware of the wave characteristics that are reasonably consistent.