By Elliott Wave International
In the 1930s, Ralph N. Elliott discovered that stock market prices tend to move in recurring patterns. He defined these patterns (or "waves") and explained how they combine to create larger versions of themselves. He called his discovery the Wave Principle.
After much research into R.N. Elliott’s work, A.J. Frost and Robert Prechter published the 1978 text Elliott Wave Principle. This lesson captures a flavor of Elliott’s fascinating approach to market analysis.
The first step in Elliott wave analysis is identifying patterns in market prices. At their core, wave patterns are simple; there are only two of them: "motive waves," and "corrective waves." Motive waves are composed of five sub-waves and move in the same direction as the trend of the next larger size. A corrective wave follows, composed of three sub-waves, and it moves against the trend of the next larger size. As the picture below shows, these two patterns form similar structures of larger sizes, or "degrees," as R.N. Elliott, the discoverer of the Wave Principle, called them.
The above pattern begins with waves 1, 2, 3, 4 and 5 that together form wave (1) — a five-wave, motive structure that tells us that the trend at the next larger degree is also upward. If you were reading this in real-time, and the rest of the pattern was not visible, it would also warn you to watch for a three-wave correction.
Corrective wave (2) in the chart above is followed by waves (3), (4), and (5), to complete an impulsive sequence one degree larger � labeled 1 (circled). This is followed by a three-wave correction of the same degree: wave 2 (circled) with subwaves (A)-(B)-(C). One way to think about corrective waves is that, because they move against the next larger trend, they lack the strength to unfold into a full five-wave move.
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This article was syndicated by Elliott Wave International and was originally published under the headline R.N. Elliott Discovered the Wave Principle Over 70 Years Ago. EWI is the world’s largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.