Elliott Wave Pr1nc1ple

Appliedto the Foreign Exchange Markets

All; Wave Analyst Robert Balan

Elliott Wave Principle

Applied to the

Foreign Exchange Markets

Robert Balan

BBS Financial Publications

5 _ m Wave Analyst
Elliott Wave Principle Applied to the Foreign Exchange Markets
Robert Balan '

© 1989 by Flobert Balan and BBS Publications Ltd. «

A Vallion Company

All rights reserved. No part of this book may be reproduced in any

form or by any means without permission in writing from the publisher.

Printed in the United Kingdom by

Disk to Print Ltd.
25 Liddell Road
West Hampstead
London NW6 3EW
Tel: 01 - 625 5225
Fax: 01 - 6241647

The Wave AnalystTM is a Trademark of Vallion Holding Ltd.

Authorized distributor:

Tech Mind S. A. i

33, route de St—Cergue

1260 Nyon
Switzerland
Tel 41 22 620388
Fax 41 22 620396

m Wave Analyst
Contents

Foreword

Acknowledgements

Organization of the book

Introduction I

The fundamental concepts II

Deviations 1 7 III

Guidelines and other observations , IV

Practical guidance V

A typical Elliott Wave trading plan VI

Case studies ' VII

Conclusion . . VIII

Illustrations by topic

Index

m Wave Analyst
Foreword

The modern foreign exchange markets date from the early seventies
and the eventual breakdown of the Bretton Woods and Smithsonian Agree-
ments on fixed parities. As from 1973 the currencies of the major “free”
industrialised economies began to float freely against each other. For the
rest of that decade the forex markets were in what is best descibed as their
juvenile phase of growth; full of uncertainty and inexperience with varying
degrees of liquidity. The markets were dominated out of London and New
York whilst the Far—East was a distant third. In general, investors and
corporates considered the market to be highly speculative, somewhat illiq-
uid and definitely irrational.

With the arrival of desk-top computing power in the early eighties

technical analysis and chartism began to make a significant appearance in
the Forex markets.The initial reaction of most seasoned traders then, and
even by many now, was one of scepticism. These market were considered
to be highly unpredictable. The need was for experienced and proven
dealers; the thought of technical models that could rationalize the market
price action and regularly predict with any accuracy the future movements
could not be taken too seriously. This somewhat egotistical approach was
in hindsight made more out of ignorance and perhaps with a touch of
arrogance rather than from any real understanding of the markets' dynamic
fundamentals.

Over the lasteight years much has changed. The forex markets now
operate fluidly on a 24 hours a day basis from the Monday morning opening
in Wellington, New Zealand, until Friday’s evening close in New York.

m Wave Analyst
More significantly the U.S. stock exchange crash of October 19th, 1987
demonstrated the legitimacy of the forex markets to be considered not only
as the largest, but also one of the most liquid and transparent markets.
Amongst banks, investment houses, corporates, institutional and private
investors there is now an overriding awareness of the need to dynamically
manage their currency exposure and that this management has to be on a
continual basis. As this awareness has grown, so has the demand for
increased research and analysis into the dynamics of currency movements.
It was from this development the laws of probability and market psychology
began to be applied, it is these parameters that form the basic framework
of chattism and technical analysis.

The “touch” of the successful “spot” forex trader is in his ability

to rapidly rationalize market movements and in the speed of the implem—
entation of those trading decisions. These stem from the trader's expe-
riences of repeated market patterns and the inbred feeling of having been
there before. In reality the trader is individually and independently
analysing the market place as to whether a currency is “overbought” or
“oversold” (price action), what the potential for a market move is (risk/
reward ratio) and the likelihood of such a move (probability). These are the
main foundation blocks of technical analysis.

Chartism as a part of technical analysis enables a rapid visual

analysis of any price action, placing it in perspective of the current market
trend. This allows for a relatively easy and early recognition of important
trading levels. Most dealers now accept resistance and support levels

Foreword - 1
derived from analysing chart patterns, but many do so Without appreciating
the fundamental concepts behind them. This latter approach is a somewhat
fragile one on which to base trading decisions.

Trading decisions using chart patterns and price projections should

always be supported by some form of probability analysis on the potential
for such a move and also its likely timing. This combination allows for a
strong and reliable technical support of trading and investment decisions.
It is from this that the decision-maker should then look for the catalyst event
that could trigger the movement. The Elliot Wave Principle as with techni-
cal analysis in general can not predict economic announcements, but it does
recognise with some exactitude the state of the market and the probable
price action in response to those statistics or decisions.

The Elliott Wave Principle is exactly that, a principle, but it does

endeavour to place the overall market move as well as the short-term wave
structure into an order. The primary objective is to establish the presence
of the most destructive and thereby the most profitable wave formations, be
they a 3rd Wave or a C Wave. The application of the Principle is not
infallible but when its applied correctly it is overpowering in its market
interpretation as well as its success. Above all the Principle accepts implic-
itly the technical chart patterns used by other systems whether terminal or
consolidatory. It is not an alternative, but it places chart formations such
as a “Head and Shoulders” structure into a larger order of events and a wider
perspective.

Turning to the author, Robert Balan, I have over the last few years
seen his concepts take shape, reach a maturity that in the forex market is
remarkable. His success rate both in the strategy and the timing of trades
have given rise to hundreds of avid readers throughout the trading world to
his published daily market commentaries. One either embraces the tools
that can underpin trading decisions or ignore them at one’s own peril. The

fit? Wave Analyst

success of Robert’s commentaries clearly demonstrate the respect his
analysis commands. Above all, he has the humility to accept a flawed
analysis as a fact of life. This book endeavors to show the guidelines and
the values that he has developed over the past 12 years in the practical
application of the Elliott Wave Principle to the foreign exchange markets.
Some of these insights and guidelines are probably unique to Robert's
interpretation of the Elliot Wave Principle and offer the fact that principles
and theories are not inviolate but will over time be advanced from their
original concepts.

Michael Salt.

w .m
Foreword - 2
Acknowledgements

A year prior to the publication of this book in early 1989, I began to

seriously think of the possibility of writing a “user friendly” book on the
Elliott Wave Principle. Every now and then, Michael Salt, my boss at
Lloyds Bank in Geneva would urge me on, as did some friends in the foreign
exchange field.

Mike Salt has since then left to become Director of Foreign

Exchange at Swiss Bank Corporation in London — but not before making
sure that the book’s manuscripts were on to the final draft. Since he was
largely responsible for pursuing this project, he deserves part of any success
— or blame — that the book may receive. I also decided to get even by asking

him to write the Foreword, which he has done.

Some close friends in the forex field also extended a lot of “moral
support” when the going became tough. Franklin Sevilla, Tony Garcia, and
Don Haines were e5pecially helpful in this regard.

I also received a lot of feedback from readers of my Reuters and

Telerate daily commentaries, which made more convincing the suggestion
that a “how-to-do-it” manual of wave analysis has a contribution to make.
For those fellow Elliotticians, my sincere thanks.

Frankly, the thought of writing this book was intriguing, but I

wondered whether I would find the collaborators who would translate the
concepts into required illustrations, diagrams and charts. Marco Bemasconi,

m Wave Analyst
the ultimate wizard in desktop-publishing, conducted mouse, Pagemaker
and Macintosh in a symphony of text and graphics that rates a standing
ovation.

The seed of the idea for this book was sown by Giacomo Ivaldi, my
boss at Lloyds Bank, Hong Kong. Giac also contributed valuable editorial
advice. Hans Moerkerken, a colleague at Lloyds Bank, Geneva helped in
checking for factual errors in the book.

I also wish there were some way to thank the numerous individuals
who have played a role in shaping up the ideas that eventually found their
way in the book. To those people, my thanks and appreciation.

Robert Balan.

Acknowledgements - 1
 Organization of the book

The book is divided into eight parts. Part I is a general introduction

to Elliot Wave analysis and the foreign exchange markets. It outlines the
difficulties and possibilities inherent in wave analysis. A brief background
is provided.

Part II describes the fundamental concepts of Elliott Wave Analy-

sis. The basic patterns, and their more common variations, are provided in
easy-to-compare illustrations. Provided too, are the most common pattern
combinations found by the author in real-time analysis over the past twelve
years.

Part III is devoted entirely to deviations from the normal wave

relationships, both in terms of ratio, and in form. Examples of substitution
of simple patterns by complex ones are also shown in never-before-
published illustrations.

Part IV outlines the most common practical guidelines and other

observations that should be of value to anyone who is just starting out on
wave analysis. Even veteran wave analysts may find the insights provided
in this extensive body of tips and comments useful and informative.

Part V also provides practical tips to the wave analyst who finds the
going rough - especially when he or she is stuck with multiple scenarios and
has trouble defining the options available.

Mzw
A??? Wave Analyst
7 7. . . .. .. .,_~_—_»4..
 Part VI outlines atypical Elliott Wave Trading Plan from the initial
stages of the traditional five—wave sequence, through its final corrective
stages, illustrating various optimal trading strategies.

Part VII provides real examples of trading situations written by the

author. Daily comments have been assembled into case studies which can
be applied for future events.

Part VIII concludes with some insights into the future of wave
analysis, including the study of chaos and disorder, the application of
fractals and recursive patterns, and other recent works on non-linear
dynamics.

Organization of the book - 1

__ . ,_ _ 7: _.._‘ -——-.-.___P“——~—_ Wm—

Part I

Introduction

Can anyone parlay a $10,000 capital into $1,000,000 in a year? In

five years? If so, how do you do it and what are the risks involved?

In the foreign exchange markets, where the value of the worldʼs

currencies are constantly fluctuating, there are currency movements fre-
quent enough, wide enough and often enough to permit this, and more.
Such exceptional results are not impossible. Methods and techniques pre—
sented within this manual, properly utilized, put an average yield of 5 to 10
per cent per month well within the realm of possibility. Compounding
profits at this rate would yield $1,000,000 on $10,000 capital in little more
than 4 years.

While these claims may seem excessive to the reader, they are not
impossible. However, they do imply the capability to do very regular trades
that have corresponding high rate of success. The basis of that capability to
recognize trading opportunities, together with the essential techniques to
win, are the main elements addressed by this manual through the use of the
Elliott Wave Principle.

The forex markets attract many different types of “players”: those

with corporate needs to satisfy or to hedge, banks and investment houses
performing the role of market-makers, and institutional and private inves-
tors as well as speculators. The currency markets, as a consequence of their
enormous size and liquidity, now provide 24-hour trading capability. This
world—wide feature of the currency markets offers a host of opportunities

m Wave Analyst
that are of a constantly changing nature. Substantial sums of money can be
made —or lost— literally in a day. These large enough movements and
negligible transaction costs combine to allow very short-term trades, trans-
actions that are initiated and consummated in as short as 24 hours. If taken
as often as opportunity arises, these shortened trades can add up to an
enourrnous profit potential. This is a fact that is of prime importance to those
who can recognize those poortunities and who possess the techniques
needed to succeed.

The key to any lasting and succesful trading strategy lies in the
ability to “time” trades, both in entering into and exiting from the market
place, a situation which precludes the traditional “fundamental” method
of analysis. Given a timing capability, a whole new concept of profit maxi-
mization becomes possible: improved timing permits shortened trades,
which in turn allows the principle of compounding to take effect.

Assuming an accuracy in transaction timing, one will always

generate more profits from regular short-term trades rather than from
infrequent long-term ones. The impact of frequenCy and length of trading
interval on profitability rests largely on two phenomena that holds true in
the forex market. One is the wave-like nature of forex movements and the
opportunities it presents. The other is profit compounding. After each suc-
cessful trade, more funds are available for investment than before. The
nature of compound interest law is such that capital growth is overwhelm-
ingl y dependent upon the frequenCy of compounding that takes place. In
essence, how short the trade intervals are.

It can be seen immediately that the spigot of this cornucopia is

labelled Timing. Over many years of experience, I have still to see a method
that has consistently beaten the Elliot Wave Principle for its accuracy in the
timing of market turns, which it does sometimes with mind-boggling accu-
racy. When forex movements are tracked in hourly and in 10 minute “snap

Introduction I- 1
shots”, the wave analyst is figuratively on top of the market, with a
panoramic view of the unfolding battle between the forces of supply and de-
mand. With that kind of perspective, the analyst is sensitive to the most
subtle change in market dominance by any of these forces.

A personal experience will illustrate this point. I still remember

with some satisfaction an event in early June 1986; the dollar was surging
in the Forex markets after the “G-5” initiated collapse of the Dollar had
reached the J apanese’s initial threshold of pain. It was almost lunchtime in
Europe; theIO-minute chart for the dollar/mark was going nowhere in a
seemingly random manner. Two weeks before, the dollar had survived a
downward test of the 2.15 lows, followed by a rally of more than 15
pfenni gs amidst mounting speculation that the worst for the buck was now
over. To wave analysts, however, the rally was the ultimate phase in a con-
solidation pattern known in Elliot Wave terms as a “flat correction”. This
was to be the last hurrah for the dollar — a massive trap for the dollar bulls
when the pattern terminated and the buck resumed its underlying bearish
trend.

I was paying particularly close attention to the market patterns

because earlierI had stated in my daily commentary pages on the Reuters
network (LBGB/LBGC) that we were expecting the resolution of the large
“flat” pattern at anytime during the next 24 hours. In anticipation, I had left
half of the screen space vacant with the promise that we would inform
readers when we saw evidence that the rally was over. I was ready to break
off the watch to go to lunch when suddenly, the 10 minute pattern resolved
into a “horizontal triangle” a very reliable indicator that preceeds the final
phase of an existing movement. I watched in fascination as the final “thrust”
accelerated to the upside. It was the signal we had been waiting for, a con-
clusive evidence that the 3—m onth consolidation phase was over. It was time
to turn into a dollar bear once again. I hurried to type a take—profit-and-
reverse call over the Reuter’s network. Barely 20-minutes later, just 5
points shy of the theoretical turning point at 2.3430, the dollar began to

m Wave Analyst
nosedive. An hour later, it was down two pfennigs; it was 16 pfennigs lower
ten days later.

A fluke? A coincidence? Or was it a “self-fulfilling” prophecy?

It was mainly to prove that a performance such as this one was not
a fluke, not a coincidence, and definitely not a self—fulfilling pr0phecy that
this manual on how to use the Elliott wave principle was written.

This manual does not aim to explain the rationale for the Elliott
Wave Theory, nor teach its basics. Several excellent books* on wave
principle fundamentals have been written by highly acclaimed authors, so
I do not intend to cover this well-beaten turf again. The main purpose of this
manual is to show how to use the principles laid down by Ralph N. Elliott
in the early l930’s. To my knowledge, there is no book written as yet on
how to use these principles on a real-time basis. I hope this manual fills this
obvious need.

In going through the trade recommendations in Part VII, I have at—

tempted to take the reader through the deductive reasoning process. I have
also described the drama that accompanies every success or failure; the
reader will be there to share an insight as we weigh which of the probable
patterns will be likely to occur. We will puzzle over a price activity that
momentarily does not make sense. And I hope I have done descriptive
justice to the burst of joy when a move performs as predicted, and to the
philosophical resignation when something goes wrong. For even with the
knowledge that no one is infallible, the acceptance of a flawed analysis is

* I especially recommend the Elliott Wave Principle (New Classics Library,

1978) written by AJ. Frost and Robert Prechter In, which is a ”classic” and considered
to be the ”bible of the wave principle”. Also recommended is The Major Works of RN.
Elliott, edited by Robert Prechter In; another must is The Elliott Wave Principle Applied
to the London Stock Market authored by Robert Beckman.

Introduction I-2
perhaps the most difficult lesson to learn in Elliott Wave Principle.

In my own opinion the biggest obstacle to successful trading is in the

failure even to recognize and accept that mistakes will be made, that losses
are a fact of life and as such must be accommodated. The analyst or trader
who does not accept this, or for that matter does not make provisions for
errors, is headed for disaster. Errors are an unavoidable part of Elliot Wave
analysis due to its all—emcompassing nature. It is not the occurrence of these
errors, but their significance, which makes the difference between success
and failure in trading the forex markets. Analysts who are stubborn and fail
to apply money management techniques may make a lot of money at times,
but when they are wrong, they give it all back, and then some.

That is where the real utility of the wave principle lies. The nature
of pattern analysis provides for a built—in method for cutting losses short, or
allowing profits to run, while also providing ways to enter into and exit from
the markets at extremes in price. Even at times when successful forecasting
eludes the trader, wave analysis has proven useful in giving a perspective
of the market movement. Even if one’s forecast is off the mark, the exercise
is helpful in providing a framework against which to judge later market
action. When the market strays from the forecast significantly, it is time to
re—evaluate.

The “best of both worlds”, that is what the wave principle promises
in terms of profit build—up and risk control. Used properly, the Elliot Wave
can provide the analyst with a quantitative and a qualitative measurement
of the risk involved in any specific trade in its corresponding time horizon.

The forex markets are so extremely volatile so that for any trading
method to survive for long, it must be able to precisely measure profit
objectives against expectable losses; at the same time, the method must
also be able to define the time parameters within which the trades have to
take place. This is a tall order, but the patient reader will soon find that the

m Wave Analyst
Elliott Wave Principle can perform this multi—faceted task admirably.

The question asked by some people who saw the preliminary book
materials was this: “If such fantastic results can be gained in the foreign
exchange market, why isn’t everyone doing it?”.

There are several reasons for this, but a few stand out. These can be
categorised as: efi‘ort, knowledge, and psychological barriers. Any goal
this worthwhile requires effort — lots of it. One of the complaints levelled
against the wave principle is its “complexity”. “Too many exceptions to the
rules”, says a top-notch analyst who openly admitted to Barron’s magazine
that “it (wave principle) has defeated him”. This observation was pooh-
poohed by a young acquaintance who claimed that “wave analysis can be
done by anyone who can count from one to eight”, in allusion to the total
number of waves in a bull-bear cycle. The truth probably lies in the middle
of these two extremes.

The Elliot Wave Principle has only three rules and less than two
dozen guidelines as its framework. To make it work, the analyst has to see
to it that none of the rules are violated; the ensuing analysis should be in
accord with as many of the guidelines as possible. Charts should be kept and
labelled or “counted” periodically. An analogy is likened to learning to ride
a bicycle; you can read about it, but the only way to learn is to actually
getting on the machine and try to keep from falling flat on your face. The
message: you will only learn by actually doing it.

In addition, most foreign exchange players — amateur and profes—

sional — do not have the kind of analytical background or the inclination
needed to shear through rumor, opinion, and myth to get at the basis of how
the forex market unfolds. And finally, even with knowledge in hand, many
market players, especially amateur individuals, lack training in the emo—
tion-logic balance required for success. And this could be the most difficult
barrier. Too often for comfort, I — even with the benefit of long and

Introduction I-3
deliberate training to be objective « still succumb to the disease called
“opinionitis”. I sometimes have difficulty in believing what I see in the
wave patterns, especially in the face of seemingly contrary “fundamental”
situations.

Nevertheless, all these obstacles can be overcome. One purpose of

this manual is to provide the framework for understanding why the forex
market does what it does. Hopefully, my endeavours with the wave
principle will encourage the reader to do his or her OWn research with
IO—minute and hourly fluctuations of the forex market until he or she too will
discover the intricate beauty of the universal laws codified by R.N. Elliott
in 1934. It will not be an easy road. Learning to ride the forex “waves” can
be likened to a Hawaiian surfer. The bigger the wave he tackles, the more
chances of a “wipe out”. But the occasional water dunk is the price one has
to pay to be a master of the sport. Pursuing the analogy, the more often one
goes out to sea to meet the “monsters”, the more one learns how to “read”
the characteristics of each incoming wave.

For no book, not even the most detailed and most descriptively
vivid, can help the analyst who does not help himself. The methods
mentioned here in this manual are yours only if you care to apply yourself
with sufficient intensity. There is a lot of truth in the adage that “the worst
enemy of the trader is himself”. In applying the wave principle, no less than
rigorous observance of rules and guidelines is required. Sloppy thinking
will be swiftly penalized where it hurts most in the pocket. For people
:

looking for short—cuts to success. this manual will be a disappointment. But

for those who are willing to spend time and effort to learn, a new dimension
to your trading practices will open up to you. '

m Wave Analyst
 T
Introduction I-4
Part II
The fundamental concepts

Figure 1

1) A major movement unfolds according to a pattern of five waves, after

which the entire sequence is “corrected” by a pattern of three waves
going in the opposite direction (as in Fl g. 1 above).

2) The “numbered phases”, formerly called “cardinal waves” by R. N.

Elliott, are now known as “impulse waves”, a term popularised by R.
R. Prechter and A. J. Frost. The “lettered phases” are now known as
the “corrective waves” or sometimes as simply “threes”.

m Wave Analyst
3) Wave 2 “corrects” Wave 1; Wave 4 “corrects” Wave 3. The entire
sequence of Wave 1 to 5 is “corrected” by the sequence a—b-c.

4) In a macro sense, the sequence of Wave 1 through Wave 5 completes

a wave of a “higher degree”, or simply put, a wave belonging to the
next higher tier of wave sequences. Thus, the movement from Wave 1

to Wave 5 completes either a Wave ®,@ or ®, while the a—b-c

sequence completes either a Wave ® or @. (see Fig. 2).

®,®or®
. 5

Figure 2

5) In a micro sense, each of the waves in Fig. 2 may be broken down into
smaller wave components according to the concept expounded in (3):
Wave 2 corrects Wave 1; Wave 4 corrects Wave 3, while the a-b—c
sequence corrects the entire sequence of Wave 1 through to Wave 5
(see Fig. 3).

The fundamental concepts II - 1

 Figure 3

6) The basic rhythm of “lives” corrected by “threes”, as well as the

various rules and guidelines of the Principle remain constant re gard-
less of the time unit used as reference. Patterns in hourly charts are
“counted” in the same way as weekly or yearly charts.

7) The time scale of wave patterns is less important than the “form” of the
patterns themselves. Waves may be stretched or compressed but the
underlying forms remain constant.

A? Wave Analyst
8) There are 3 rules which are considered “unbreakable”:

i) Wave 2 will not retrace past the starting point of Wave 1. If the
impulse waves are going up, wave 2 cannot go below the origin
of wave 1 (refer to F ig.4). If the impulse sequence is going
down, wave 2 cannot exceed the peak from whence wave 1
originated.

ii) Wave 3 can not be the shortest of the “impulse waves” (refer to
Fig. 5). Wave 3 is not necessarily the longest, but it is almost
always the longest.

iii) In an upward sequence, Wave 4 cannot overlap the peak of

Wave 1. In a downward sequence, Wave 4 can not rally above
the bottom of Wave]. If any of these combinations is violated,
the particular sequence is not impulsive in nature (refer Fig. 6).

Figures 4, 5 and 6 illustrate the ”wave counts" disallowed by the Principle.

Figure 4 ' Figure 5 Figure 6

The fundamental concepts II - 2

Impulse waves
1) A variation known as an extension may appear in one of the impulse
waves. Extensions are exaggerated or elongated movements that are
totally out of scale when compared to the other impulse waves. Expect
extensions to occur in only one of the impulse waves (either the 1st,
3rd or 5th). Most extensions occur in the 3rd wave. Extensions may
also occur in the extending wave itself.

3 5
(5)
Sequence (1) through (5) is
an extended Wave 3 ( 3)

4
Figure 7

Sequence i through I) is an
extended Wave (3), which is
itself part of extended Wave 3.

Figure 8

m Wave Analyst
2) Another variation in impulse waves is the diagonal triangle, awedge-
like pattern formed by two converging lines, in its usual form. These
patterns occur in fifth wave positions, usually after the proceeding
third wave has moved extensively in a short time. Usually, the sub—
waves in the wedge subdivide into “threes” rather than “fives”.
Overlaps between the terminals of waves 1 and 4 are also frequent,
although not obligatory. This is the only knOWn exception to Elliott’s
“non-overlap” rule between waves 1 and 4. An example is provided
in Figure 9.

Diagonal triangles are also found in C wave positions during the

“lettered phase” or corrective waves. As in wedges found in 5th wave
positions, these formations indicate the termination of the movement
one degree higher.

@cn
Wave 5 is a Diagonal Triangle

Figure 9

mm...
The fundamental concepts II - 3
 A special type of diagonal triangle observed by Robert R. Prechter in
1986 has sub-waves composed of five waves instead of the usual
“threes”. This type is ussually found only in A wave positions and is
followed only by B waves. See Figure 10. In a rare case in the forex
market, this type is found as a B wave of a large irregular pattern. See
deviations III 9.
——

A
Special Type ®

Figure 10

A rare pattern is the expanding—type of a diagonal triangle. It is a mirror

image of the “converging type” in all respects. This pattern was never
mentioned by Elliott; Prechter and Frost did not provide for this
variation in the latest edition of their book “Elliott Wave Principle”,
1987. See Figure ll.

Abe} Wave Analyst

 Expanding Type <5)

Figure 11

Experience has shOWn that the 5th leg of the converging type diagonal
triangle tends to overshoot or undershoot the upper trendline. On rare
occasions, the 5th leg will fail to exceed the extremity of the 3rd leg in
a “failure”. The 5th leg of the expanding type, however, must exceed
the extremity of the 3rd leg to qualify as such.

The fundamental concepts II - 4

3) A fifth wave sometimes fails to exceed the terminus of the preceeding
3rd wave. This inability is called, somewhat uninspiredly, a “failure”.
This pattern can be verified by noting that the internal waves of the
“failed fifth” conform to all the three rules governing impulse waves.

A failure is a reversal pattern, and gives rise to what is known in

classical charting theory as “double tops”or “double bottoms”. This
pattern is fairly rare in daily or weekly price action but is quite
common in hourly charts.

A fifth wave ”failure”

Figure 12

m Wave Analyst
Corrective waves

1) Movements against the trend are called “corrective waves” or simply

“corrections”. Sometimes, they are referred to as “consolidations” or
“lettered phase”.

2) Identifying and fitting corrections into particular patterns in advance

is very difficult. This is because corrective patterns have more vari-
ations than impulse waves. At times a corrective pattern becomes
apparent only in retrospect; that is; when they are completed and
behind us.

3) The complexity of corrective waves can increase or decrease without

warning, so the extent or depth of corrections are less predictable than
impulse waves.

4) There are several basic forms as well as derivatives from these basic
forms. They are:

i) Basic forms: zigzags, flats, irregulars and triangles

ii) Complex corrective forms: double—threes and triple threes

The complex corrective forms are further subdivided into four catego-
ries, namely: zigzag complex, flat complex and irregular complex.

The fundamental concepts ll - 5

 Basic corrective forms

Zigzag corrections Irregular corrections

13
A

Bull correction Bear correction Bull correction Bar correction

Flat corrections Triangle corrections

A
“3 @
.‘ N; .

Bull correction Bear reflection Bear correction

m Wave Analyst The fundamental concepts II - 6

Double-Threes
Zigzag complex

Tria nglc

l
‘ Z tgzag Flal Irregular

mWave Analyst The fundamental concepts II — 7

 Complex corrective forms
Double-Threes
Flat complex

F lat Flat F lat Triangle

®
T,
.‘4_4>\

l—riaz —i— x H—zigug——l i—-Flat —‘_i— X +—-lrregular ——d

m Wave Analyst The fundamental concepts II -8

Double-Threes
Irregular complex

l—‘lrregulnr —i— X +“-lrregular ——i

B

l—_lelllflY—i" X —i——Zigzng r—i l‘lnegular —‘—i* X —l—Trirmglr ~__i

The fundamental concepts II-9

f/l'h: Wave Analyst
 Complex corrective forms
Tri pl e-Threes
Zlgzag complex

l—Zlgzng 4FX—l—lnegum—l—X —l—F1ni ——| l—Zigng v—l—X—F—‘lmguhr—F—X —l—Trimtgle ——|

m Wave Analyst The fundamental wnoeps II - ta

Complex corrective forms

Triple-Threes
Flat complex

1"
1\ 41

C
A
|——Flfll —|—X~l———-—Zigzng —4—X —l—lrregular—l P—-Flnl —+—X—l— Irregular—PX +75ng ——1

m Wave Analyst The fundamental concepts II - 7 1

 Complex corrective forms
Triple-Threes
Irregular complex

I—lm’gulflr -—l—X Irregular —|—X —l—lrregulflr—l l—lm’gulur A—l—X —l—Flal —+—X 4—Trinngle H

I—lrregular —l—X —|—Flut ——j—X —|——Zigzag —j l—lrrcgulnr —}—X —+—Zig1ag il—X 4—Triflnglf A—{

m Wave Analyst The fundamental concepts II - 12

Fibonacci Ratios
1) The Fibonacci numbers are: 1, 1,2,3, 5,8, 13, 21,34,55, 89,144, 233,
377, 610, etc.

2) Adding any two adjacent numbers will yield the next number in the
sequence. Example: 3 + 5 = 8; 5 + 8 = 13: 8 +13 = 21; 13 + 21 =
35, etc.

3) After the first four digits, dividing a Fibonacci number by the number
immediately preceding it will produce the ratio 1.618. Example:
34 + 21 = 1.618. Furthermore, dividing that same Fibonacci number
by the one immediately following it will yield the ratio 0.618.
Example: 34 + 55 = 0.618.

4) The inverse of the ratio 1.618 is 0.618; likewise, the inverse of the ratio
0.618 is 1.618. Example: 1 + 0.618 = 1.618, and l + 1.618 = 0.618.

5) Dividing any Fibonacci number by the number which precedes it two

places in the sequence will turn up the ratio of 2.61 8. And, dividing that
same number by the number which succeeds it two places in the
sequence results in the ratio of 0.382. Example: 55 + 144 = 0.382.

6) The inverse of the ratio 2.618 is 0.382, while the inverse of the ratio
0.382 is 2.618. Example: 1+ 2.618 = 0.382; 1+ 0.382 = 2.618.

7) Dividing any Fibonacci number by the number which precedes it three

places in the sequence will provide the ratio 4.236. Example:
144 + 34 = 4.236. And, dividing that same number by the number
which succeeds it three places in the sequence will yield the ratio
0.236. Example: 144 + 610 = 0.236.

m Wave Analyst
8) The inverse of the ratio 4.236 is 0.236, while the inverse of the ratio
0.236 is 4.236. Example: 1 + 4.236 = 0.236; 1 + 0.236 = 4.236.

9) The ratio 1 (equality) is an expression of the comparison between the

first two numbers in the Fibonacci sequence; thus 1 + 1 = l. The ratio
0.5 comes as expression between the second and the third number in
the sequence; therefore I+2 = 0.5 .

10) The Fibonacci numbers, by themselves, do not have any utility in

forecasting the extent of market movements in terms of price and time.
The key elements are the ratios between the numbers in the sequence.
Elliott considers these ratios to be the primary determinant of the
extent of price and time movements in any market.

11) The most common and most reliable Fibonacci relationships can be
found between alternate waves, rather than adjacent waves. For
example, the length of Wave 3 in a five wave sequence would be
influenced by the length of Wave 1, rather than by the length of
Wave 2.

12) Fibonacci targets usually show up as important levels of support or

resistance even if they are subsequently penetrated.

13) An important adjunct to the Elliott Wave Principle is the recognition

that Fibonacci ratios are the primary determinant of the extent of price
movements in the market. Elliott’s Wave Principle provides the form
and the framework, while the Fibonacci ratios provide the tool for
measuring the potential for any price movement, including the prob-
able time windows for terminations of these movements. This is a very
powerful combination.

The fundamental concepts II - 13

Part III
Deviations

Deviations from the norm seem to be the rule rather than the
exception in wave analysis. Difficulty in this aspect arises from two
sources:

1) Deviation from the mathematical ratios of parts of the pattern. Ex-

amples of this type will be seen on pages III - l and III - 2.

2) Substitution of the simple type of correction patterns by one or more

of the complex types. -

As the reader will see from the preceeding examples, the degree of
difficulty in forecasting the termination of a correction pattern increases
proportionately as the number of basic patterns join together. To make
matters even more difficult, any one of the basic “corrective” patterns can
incorporate the form of more complex figures, such as the irregular, flat or
triangle in its own corrective wave. The following examples will illustrate
this point:

”fl/“Z: Wave Analyst

 Deviations from mathematical ratios

Zigzag

C=.618A C=1.618A

Flat

C = .618 A C: 1.382 A
C= 1.618A

Deviations III - 1
 Deviatlons from mathematlcal ratios

Irregular

C:.352A C=A
C=.6181\

Triangle Expanding triangle

d = 1.618 b
c =1.618c

Deviations III ~ 2

j Substitution of Patterns
Zlgzags

B -* Double-Three 5

(flat + triangle)

fa) Wave Analyst Deviations III - 3

 Substitution of Patterns
Zigzags

A Zigzag

>o
—*

>o
A ~'th

f/i: Wave Analyst ' Deviations m-4

Substltution of Patterns
B Irregulars

Double-Three A a Flat C
B '*
(flat + zigzag) C B *Zigzag .

C _, Diagonal mangle

E . Zigzag
C A * Flat C
C ' Double zigzag C E fl Dcmlilezrgzng

Deviations m-5
f/ihv; Wave Analyst
 Substitution of Patterns
Irregulars Trlangles
B

n ,, Irregular
b 4 Zigzag
L‘ 4 Zigzag
d 4 Irregular
e * Triangle

a ’ Flal
b ‘Zigzng
B * Irregular ( 4 Flat
d 1 Zigzag
l’ ' Flnl

m Wave Analyst Deviations Ill - 6

Substitution of Patterns
Double-Threes

X 4 Triangle X " Double lhn’u I

(flat + zigzag) C

X —* Irregular

A? Wave Analyst
Deviations III - 7
 Substitution of Patterns
Double-Threes

B >Trimigle
A »lncgillnr C

Alternate Wave Count: X hTrianglz

A B C A B C
(ab e lube)

Triple-Three

X -' Irregular /

f/lj’lt: Wave Analyst Deviations IlI - 8

Substitution of Patterns
Diagonal
Triangles

B > Dingmml triangle

{Special type)

®
Double zigzag intn a diagonal triangle
DingaimI triangle at A
Wave A and C

A , Special type
C fl Normal type

///T:e\ Wave Analyst Deviations I/l»9

Part IV
Guidelines and other observations

The basic rules of wave theory are simple enough; what makes the
application of these rules daunting to the beginner is the added complexity
of various guidelines that are supposed to be there to make life easier for the
wave analyst in the first place.

In subsequent pages we have attempted to categorize guidelines and

observations under several headings. Some of these observations were
taken from Elliott’s writings, but most of them are products of the author’s
own experiences with wave analysis.

It must be remembered that many of the relationships between

waves, especially those reflecting the aspect of Fibonacci ratios, are mere
tendencies — not permanent relationships cast in concrete. A tendency may
be more prominent than another during the author’s market experience, but
there is no law that says these relationships cannot change. What is common
now may become rare when the market undergoes a major cyclical change.

The best way to benefit from these guidelines and various observa-
tions is to adopt a criticale attitude. Until the evidence is in, a tendency
should be treated as just that, a tendency.

Some of the most common tendencies are provided in subsequent

pages. The subjects are classified into several categories; some of them are
provided under more than one heading to give an easier cross—reference.

m Wave Analyst
Time
1) There are no time constraints on market patterns. Waves belonging to
the same degree may spend a disproportionate length of time tracing
out to their completion, with total disregard for the “right look” or
“right size”.

2) In terms of time spent in completing a pattern, corrective waves are

more closely related to each other than to the impulse waves.

3) Turning points in the forex markets are easier to recognise as they

occur, if projections of time and price movement fall into the same
area, and are supported by the completion of an acceptable wave
pattern.

4) However, Fibonacci time multiples are insufficiently reliable for use

in forecasting the peaks and troughs of certain movements. Turning
points do occur often enough at Fibonacci time targets to be beyond
coincidence. But miscues also occur sufficiently enough so as to
diminish the value of Fibonacci related time targets.

5) In any five wave sequence, only 30 to 35 % of the time is spent on

impulse waves. The rest of the time is spent on corrections.

Guidelines and other observations IV — 1

Impulse Waves
First Waves

1) In so far as the aspect of momentum durability or “staying power” is

concerned, lst waves have nothing to prove. It is only 3rd and 5th
waves that have momentum standards to meet. Therefore, the most
effective way to use rate-of-change indicators with wave analysis is
to downgrade momentum readings until a suspected ”3rd of a 3rd"
phenomenum is seen. If the indicators do not confirm the wave
analysis by then, look for other likely patterns.

However if Wave 1 kicks—off to the accompaniment of a prominent

divergence between your indicator and price activity, the trend has
probably changed; your wave analysis is almost certainly correct.

Third Waves

1) The ending point of the 3rd wave is the most difficult to forecast
among the three impulse waves. Since the 3rd wave can be shorter
than the lst wave, but rarely so, predicting its terminus is a veritable
trap to the unwary analyst. If it is not shorter than Wave 1, Wave 3
maybe equal to, or 1.618 times the length of Wave 1. In the case of
extensions Wave 3 can even be 2.618 or 4.168 the length of Wave 1.

2) One of the most effective ways to recognise a 3rd wave in a five way
sequence is by its slope. It is almost always steeper than the 1st;
experience shows that it is often represented by an almost vertical
line. By its nature a 3rd wave is the most destructive of all impulse
waves and should not hug a trendline drawn between the origin of '

Wave 1 and the end of Wave 2.

A: Wave Analyst
 /l

3) The thrust of 3rd waves can be so’ powerful that they are often
mistaken for 5th wave “blow-offs” or “sell-offs”. Compounding the
situation is the fact that 5th wave “blow-offs” or“se11—offs” are not
all that rare in the forex markets. The only possible indicator that can
make the distinction is volume. If the thrust occurs in record or heavy
volume, it is likely to be a 3rd wave, possibly extended. If the vertical
move is accompanied by a relatively lesser volume (especially if
compared to the previous impulse move), then it is likely to be a 5th
wave “blow-off” or “sell-oft”.

4) The general public, which normally resists the idea of a trend

reversal, usually changes its mind during the 3rd wave. In this phase,
investors find new reasons to buy in the case of bull markets, or sell
in the event of declines. Since by then the economic background
begins to improve or deteriorate, as the case may be, fundamental
reasons pile upon technical considerations to make 3rd waves as
powerful as they are. This makes it imperative for an analyst to
recognise the onset of 3rd waves (before the fact) as they offer
immensely profitable trading opportunities.

5) Third waves are not always longer than 1st waves . However, they
are almost always more powerful technically (i.e., higher volume and
stronger momentum).

6) The highest volume will usually occur in the “3rd wave of a 3rd
wave”.

7) Once a 3rd wave exceeds the length of Wave 1, project its length as
1.618 times the length of Wave 1. If Wave 3 extends, the next
objectives are 2.618 or even 4.618 times the length of Wave 1
(3.618 is not a Fibonacci ratio).

Guidelines and other observations Iv - 2

Fifth Waves

1) Terminal points for the 4th and 5th waves are easier to predict or to
recognise as they occur. The extent of the 4th wave may be derived
as a Fibonacci ratio to the extent of Wave 3. The length of the 5th
wave may likewise be obtained as a Fibonacci ratio of the price travel
from the origin of the lst wave through to the end of the 3rd wave. The
typical relationship in a five wave sequence is this: Wave 5 is 0.382
or 0.618 times as long as the price travel from Wave 1 through to the
terminus of Wave 3. Very often, Wave 5 is also 1.618 times as long
as Wave 1. These relationships assume that Waves 1 and 3 are not
extended.

2) During 5th waves, a deterioration of the momentum picture becomes

evident. Most divergences between the direction of momentum
indicators and the price activity are seen during 5th waves.

3) As explained in Third Waves, section 1, 5th waves are usually

related by a Fibonacci ratio to the price travelled from the origin of
Wave 1 through to the end of Wave 3. When the 5th wave develop-
ment stops short of the Fibonacci related targets, often times the
B Wave (of an irregular pattern) of the ensuing 4th wave of a higher
degree will score new “highs” or “lows”, usually where the 5th wave
should have ideally “topped” or “bottomed” out.

4) Fifth waves reflect the element of bullishness or bearishness which

has been building up continuously over the preceeding four waves.
This awareness shows-up first among the market professionals who
are closely involved with the market on a daily basis. The general
private investor, as usual, comes last.

m Wave Analyst
 l
Extensions
1) In any five wave sequence, expect only one of the impulse waves
(either the lst, 2nd or the 5th) to be extended.

2) If the 3rd wave is extended, Wave 1 and Wave 5 will tend to be equal
in terms of length of price travel, or equal in the length of time taken
by the movement from the point of origin to the terminus.

3) of an extension, the middle of the "3rd wave of the 3rd

In the event
wave" usually marks the centre of the entire 3rd wave movement.

4) Awesome as extensions maybe, it is one of the least understood

phenomena under the Wave Principle. A succession of first and
second waves of lesser and lesser degree generally mimic terminal
patterns, so the ensuing resumption of the trend usually catches the
unwary analyst by surprise.

R.N. Elliot did not lay down any method to tell in advance whether a
wave is extended or not. But based on market experience, a series of
overlapping waves at a point in the wave structure where horizontal
triangles or diagonal triangles are not expected, usually turn out to be
an extension.

5) In the forex markets, about 60% of extensions occur in 3rd waves.

Extended 5th waves happen for 35% of the instances and the remain-
ing 5% in extended 1st waves.

6) When the extended wave in a sequence of five waves is the lst, expect
the subsequent correction to target the area of the 2nd wave, instead
of the usual 4th wave. This is especially true if the 5th Wave in the
sequence is smaller by far compared to the 3rd wave.

Guidelines and other observations IV - 3

7) Corrections tend to be milder within extensions. The usual retrace-
ment percentage of the preceeding wave is 23.6%; corrections rarely
exceed 38.2%.

8) Expect a high probability of a 3rd wave being extended when the 2nd
wave retraces less than 50% of the lst wave. This tendancy increases
if the 2nd wave traces a "flat" or "irregular" pattern.

9) If the 5th wave extends in any five wave sequence, in about 80% of
cases this five wave sequence is Wave 3 in a larger formation.

10) When Wave 5 is extended, its length is very often 1.618 times the
entire price travelled from origin of Wave 1 to the peak of Wave 3. See
diagram below:

Y = 1.618X

b-<

11) Waves within an extension may be bi ggerin scalethan the preceedin g

waves of larger degree.

m Wave Analyst
 ,./
Principle of Alternation
1) The Principle of Alternation, deSpite the appellation, is just that, a
valuable guideline, but not an unbreakable, rule under the Wave
Principle. Market experience shows that the principle holds true for
90% of the time between waves 2 and 4 in a five wave sequence.

2) The principle as expounded by R. N. Elliott, requires alternating

occurrence of simple and complex corrective patterns in Wave 2 and
Wave 4. A simple, deep correction (zigzags, double zigzags) in
Wave 2 should give rise to a complex, sideways correction (flats,
irregulars, triangles, double or triple threes) in Wave 4.

3) In my experience in the forex market however, the Principle of Alter-

nation holds true more on the extent rather than the pattern of correc-
tions. For instance, if Wave 2 has retraced 61.8 percent or more of
Wave 1, then Wave 4 would very likely retrace 38.2 percent or less
of Wave 3. If Wave 2 has retraced 38.2 percent of Wave 1, then Wave
4 whould correct 23.6 or 50 percent of Wave3. The alternation of
patterns may take place, but significant exceptions may be observed
from time to time. The more consistent alternation process occurs in
the extent or depth of corrections rather than in its patterns or forms.

4) This principle also requires us to look for different formations in

double or triple-threes. In a double~three, the most common pattern
is a flat and a zigzag. If a triangle occurs, it is almost always the last
pattern in the correction phase. Two successive flats implies a third
pattern, usually a triangle. A triple-three may be composed of three
flats or irregular patterns.

5) In a triangle, the principle entrusts us to look for different patterns

between the adjacent and integral legs. Leg A will not be the same as
leg B; B will not be the same as C, etc.

Guidelines and other observations IV - 4

Corrective waves and retracements
1) Methods used to predict the extent of corrective waves under the
Elliot Wave Principle can vary, but the underlying approach involves
the application of the Fibonacci ratios 0.236, 0.382, 0.5 and 0.618 to
the length of the preceeding impulse wave.

2) There are two ways to deal with a market consolidation of a larger

degree. One is to watch every price "tick", trying to read in it any
glimmer of confirmation as to the course of the market. The other is
to step back, decide on a strategy, and then let the market consolidate
for as long as it takes. For analysts, the first approach is unavoidable.
But for the investor the second would be more appropriate. Follow
the maxim — if in doubt, stay out.

3) Corrections tend to bring prices back to the area of the previous 4th
wave of one lesser degree, and usually to just beyond the extremity
of that 4th wave.

4) Elliot enumerated eight types of corrective patterns, and then ob-

served that they may double or triple in extended sideways consoli-
dations.

5) The double-three pattern is the trickiest corrective pattern within the

Wave Principle. It is the single most common cause of a flawed
forecast and ill—timed expectations. Double-threes are infrequent
occurences in the larger degree, but are quite common in the hourly
and lO-minute charts.

6) If the correction starts with a complex, sideways pattern (a flat,

irregular or a triangle), the damage to the prevailing impulsive trend
is usually limited to 38.2% retracement, or exceptionally to 50%. This
is generally true, even if the correction is a 2nd wave.

m Wave Analyst
 J
7) A retracement that fails to go beyond 38.2% of the preceeding
movement indicates a pent-up, underlying strength. Similarly, a
consolidation that takes some time to finish is a prelude to explosive
action once the corrective pattern terminates.

8) Fifty percent retracements are common in five wave sequences, but

do not occur as frequently as 61.8% corrections. However, 50% re—
tracements are very common in the internal waves of bear market
rallies, i.e. within a B Wave of a "zigzag” correction.

9) The termination of a zigzag pattern does not guarantee that the

correction is over since the retracement forms can take up complex
patterns. Still, the analyst should stick with the simplest completed
pattern in accordance with the Principle of Parsimony (Occam's
Razor). R.N. Elliot also stated that the simplest pattern is likely to be
the correct explanation most of the time. Elliot was never able to
define precise rules for anticipating the more time-consuming
corrective patterns.

10) In double zigzagging patterns the second zigzag should terminate

. substantially below the bottom of the first (in a bull market). Conver-
sly, the second zigzag should end well ab0ve the peak of the first in
a declining market.

11) At the start of a tum-around from a major decline, pessimism is

usually more pronounced at 2nd wave bottoms than at the actual
lowest point from whence the 1 st wave originated. Traders generally
look at the“rally” (i.e., Wave 1) as another opportunity to sell on. The
converse is true at the peak of a bull market. The 1st wave sell-off is
often touted as another opportunity to buy cheaply, the second wave

Guidelines and other observations IV - 5

 countertrend rally is viewed as the beginning of a new rally to new
peaks. Fundamentally, the market appears bleakest at the bottom of
2nd waves in a bull market, while the economic situation appears the
brightest at the 2nd wave peak of a major market decline.

12) The Wave Principle does not provide a way to forecast where a 2nd
wave should end. It should not be overly difficult to recognise the
terminus as it is occuring. But even the usually reliable Fibonacci
ratios are of no help in predicting the ending point in advance. All that
Elliot can offer is projection of probable stopping points. That is why
the trading of 2nd waves should be avoided.

13) It is more common for 2nd waves to be simple (a zigzag or double—

zigzag) and 4th waves to be complex (flat, irregular, triangles,
double-threes or triple-threes, etc.).

14) Wave 2 normally retraces deeper than Wave 4. Wave 2 tends to

retrace 61 .8% or more of Wave 1. Failing this, the next most common
retracement is 50%.

15) The most typical retracement for Wave 4 is 38.2% of the length of
Wave 3.

16) If a 5th Wave failure occurs, the ensuing retracement will likely target
the maximum potential of the corrective pattern.

17) When a five-wave sequence falls short of an ideal Fibonacci objec-

tive, the ensuing correction will usually exceed its target by an
amount equal to the deficiency of the 5th Wave.

f/l'li: Wave Analyst

. Channels and trendlines
1) An Elliot Wave trend channel is constructed by first drawing a line
connecting the terminal points of Waves l and 3. A parallel trendline
is then drawn from the end of Wave 2. This trendline, in conjunction
with a pertinentFibonacci ratio, should provide insights as to the point
in time window where the 4th wave correction should end. Given the
timing reference, the analyst should be able to deduce what pattern is ’

likely to occur in the 4th wave.

If the 4th wave ends above or below the trendline (as in the case 95
percent of the time), a new line is drawn from the end of Wave 2
through the terminal point of Wave 4. A parallel trendline is then
drawn from Wave 3. The specific purpose is to determine the probable
ending point of Wave 5. As before, using Fibonacci derived objec-
tives, the analyst may project the time frame where the Wave 5 is
likely to peak. If the slope of the projection derived by this method
has the same degree of steepness as Wave , then the Fibonacci targets
1

are almost certainly correct.

2) The trendlines are drawn through the orthodox terminal points. It may
happen that a portion of the price activity may lie outside the channel
drawn this way, especially in Waves 1 and 3. This is of no conse-
quence in the Elliot Wave channelling method.

3) Occasionally, terminal points of 4th waves will breach the trendline

parallel to the line drawn from Wave 1 through Wave 3. Usually, the
5th wave will commence immediately after the breach.

4) It is also generally true that if a trendline break occurs in the 4th wave
(usually as a result of a triangle ), then the ensuing 5th wave will also
break the opposite trendline of the channel in a “throw-over”. The
scale of the “throw-over” is generally the same as that of the 4th wave
trendline break.

-—-————_ Guidelines and other observations IV - 6

5) A normal 5th wave should be able to reach the channel objective.
Failure to attain this objective is a significant sign of the potential
strength of the subsequent retracement.

6) R.N. Elliot once observed that a market which hugs the innertrendline
(the lower one in the case of bull markets; the upper line in bear
markets) makes for dramatic moves once the 3rd wave pulls away
from that trendline and starts heading for the opposite channel line.

7) A channel that tapers into a “wedge” shape is a sign that the movement
is about to end.

Determining targets and objectives

1) Attempting to determine a price objective in advance is useful in

several ways. If a reversal occurs at that level, and the wave is valid,
then the projection is most probably correct.

2) One sure sign that the end of a major trend is approaching, is What I
call the “multiplier effect”. This is the sudden raising (in a bull
market) or lowering (in a bear market) of the speculative objectives
of the prevailing trend, usually by several degrees from the current
price. The primary victim of this surge in confidence is very often the
small private investor. The ordinary investor is usually "sucked in"
near or at the end of the major trend. By the time he is aware of the
market move, all the professional traders have been and gone. This is
often the catalyst for a rapid tum-around.

3) When various independent methods project a specific and more-or-

less identical price area, the objective is very likely to be obtained.

All; Wave Analyst

Flat corrections
1) If the corrective wave begins with a flat, the worst case is a 618 re-
tracement of the previous wave, even if the correction is a second
wave.

2) of Wave C will tend to be higher than the

In a flat correction, the end
terminus of Wave A. A Wave C “failure” is quite common in flat
corrections that may be found in forex market movements.

3) If Wave A in a flat correction failed to retrace 38.2 percent of the

adjacent impulse wave, Wave C is likely to be a “failure”. Given the
above situation, if Wave C has retraced at least 23.6 percent of Wave
A and has already completed a five-wave sequence, it is likely that
Wave C will be shorter than Wave A.

4) If a pattern starts with a 3-wave structure, and subsequent market

action rules out a double zigzag, then the correction will very likely
trace out a flat or an irregular formation.

5) A flat formation is considered as a complex correction; and so are

irregulars, triangles, double threes and triple threes.

|rregular corrections
1) It is extremely common for C waves in irregular flat corrections to be
1.618 times as long as A waves (Irregular corrections are very common
in forex markets, especially in the lO-minute and hourly charts).

2) Wave B in an irregular correction is frequently 1.382 times the length

ofWave A. IfWave B is 1.618 times as long as Wave A or more, then
tendency is for Wave C to end at the same level as Wave A.

Guidelines and other observations IV - 7

 C

3) Wave C of an irregular correction is commonly 1.618 times as long

as Wave A. On rare occassions, Wave C may be 2.618 times as long,
butonly if Wave B has been more than 1 .618 times as long as Wave A.

4) fairly common for the distance between the impulse wave's

It is also
peak and top of wave B to be equal to the distance between the end of
Wave A and the bottom of Wave C. Barring equality, the relationship
between the appendages is likely to be a Fibonacci ratio.

5) The normal retracement of an irregular correction is 38.2 percent

from the orthodox end of the adjacent impulse wave.

6) In a bull market irregular correction, the bottom of Wave A is almost

always higher than the bottom of Wave C. The converse is true in a
bear market irregular correction.

7) If the pattern starts with a 3—wave structure, and subsequent market

development rules out a double zigzag, then the correction will very
likely trace out a flat or irregular formation.

A} Wave Analyst
8) An irregular is considered a complex correction; and so are flats,
triangles, double threes and triple threes.

9) The concept of orthodox tops and orthodox bottoms must be well

understood to be able to accept the proposition that bull and bear
markets do not necessarily end at the extremities of price movements.
Briefly, anupwards five-wave sequence ends at the conjunction of the
fifth waves of several degrees (the so-called “fifth wave of the fifth
wave of the fifth wave”).

Usually, this conjunction marks the extremity in price. But if the

ensuing correction of the entire five—wave sequence takes the form of
an irregular pattern, then by definition, the peak of the irregular
correction (Wave B) will exceed the orthodox top. The converse is
true for any five-wave sequence going downwards.

Horizontal triangles
1) The triangle is one of the most reliable forms under the Wave
Principle. [ts appearence is practically a guarantee that the prevailing
trend will continue. A triangle is a holding pattern which separates
two waves in the same direction (Waves A and C, or Waves 3 and 5).
So therefore by inference, the “thrust” from the triangle is the last
movement in the prevailing trend.

2) It is normal for e waves of triangles (the last leg) to exceed the triangle
boundary line in a “false breakout”. However, E waves never exceed
the extreme point hit on Wave C. See diagram on following page.

3) Apexes of horizontal triangles usually provide significant support to

any decline after a major upthrust. This comes as a consequence of
triangles being located in the 4th Wave position in any five-wave

Guidelines and other observations IV - 8

 sequence. Conversely, a triangle's apex provides major resistance to
any rally after a major decline.

4) Alternative waves within symmetrical horizontal triangles are usu-

ally related by aratio of .618 (i.e., C = .618A; D= .618B; E= .618C).
For expanding triangles, the alternate waves are frequently related to
the ratio of 1.618 .

5) The principle of alternation within a triangle warns us to expect that

no adjacent waves will be similar in form.

6) When the triangle comprises the entire correction (rather than only a
part of a multiple three), it may occur only as 4th waves or a B waves.
But if the triangle occurs as part of a double-three or a triple-three, the
entire correction can be situated even in the 2nd wave position.

7) If a horiontal triangle occurs as part of a multiple three pattern, it can

occur only as the last formation, or as an intervening X wave between
basic forms.

”It? Wave Analyst

8) Corollary to the above, if the first corrective pattern to evolve is a
horizontal triangle, then one can rule out further development into a
double— or triple—three.

9) The thrust that follows the termination of a triangle in the 4th wave
position will generally be of the same length as the widest part of the
triangle. See diagram below:

5
X=Y

10) However, the potential of a thrust from a triangle that is merely part
of a double—three or triple-three is not determined by the triangle
width. It is dependent on the dimensions of the entire multiple-three
formation in which the triangle is a part. The longer and wider it is,
the more extensive the subsequent thrust.

11) The extent of the thrust from a triangle in the B Wave position is
projected differently. By implication, a triangle occurring as a
countermove can only appear in the B Wave position of a zigzag.

Guidelines and other observations IV - 9

 Therefore, the subsequent thrust from the triangle (the C Wave) is
likely to be equal to the length of the A Wave. (see also Zigags in this
chapter).

12) If the first leg of the triangle (Wave A) is no longer in time scale then
one should normally expect from the dimensions of the preceeding
sequence, expect the last leg (Wave E) to be relatively smaller in scale
than Wave A.

Zigzags and double Zigzags

1) Zigzags and double Zigzags, often referred to as deep corrections tend
to retrace 61 .8 percent or more of the immediately preceeding
impulse wave, especially when the deep correction is at the 2nd wave
position. If the deep correction occurs as a4th wave, the retracement
is usually 50 percent, or rarely 38.2 percent.

2) In the forex market the usual relationship in a zigzag correction is for

Wave C to be 1.618 times as long as Wave A. The second most
common relationship is for Wave C to be equal to Wave A.

3) Wave B in a Zigzag normally retraces 38.2 percent of the preceeding

Wave A. Fifty percent retracement occurs less often, while 61.8
percent retracements are rare.

4) In double zigzag formations, the second Zigzag usually finishes

significantly lower or higher than the termination of the first, as in the
case of bull and bear markets, respectively.

”fl/h; Wave Analyst

5) In a double zigzzag, the X wave can take any shape: a zigzag, a
triangle, a flat, or even a double three.

6) X waves in a double zigzag often reach the same level as the

preceeding B wave. See following diagram:

7) There is no reliable way to predict the occurence of double—zigzags.

However, if the first zigzag has retraced less than 50 percent of the
preceeding impulse wave, and as long as a suspected X Wave has not
retraced more than 61.8 percent of the first ABC sequence (see
diagram above), there is high probability of adouble zigzag occuring.

Guidelines and other observations IV - 10

Diagonal triangles
1) A diagonal triangle is a wedge-shaped formation which is always
positioned at the termination of the larger move (i.e., a 5th Wave or
a C Wave).

2) As a 5th wave, the diagonal triangle usually exceeds the end of the 3rd
wave. But if the diagonal pattern fails to surpass Wave 3, expect a
quick and sharp reversal.

3) A sharp reversal following a diagonal triangle usually takes the shape

of a zigzag or double zigzag. The reversal normally retraces back to
where the diagonal triangle began (terminus of Wave 4).

4) There is a strong tendency for the entire diagonal triangle to be 1 .618

times as long as Wave 1.

5) Within diagonal triangles, Wave 3 is usually 0.618 times as long as

Wave 1.

6) Do not expect the 5th Wave of a diagonal triangle to terminate exactly

at the objective trendline. It is likely to overshoot or to fail to reach the
target trendline.

7) When a diagonal triangle is in the 5th wave or Wave C position, as it

most commonly is, its internal waves are composed of threes. But
when it is located in a Wave A position, its impulse waves are fives..

8) Eighty percent of diagonal triangles occur as the 5th wave of the 3rd
wave of alarger degree. This can be inferred from the observation that
diagonal triangles occur when the preceeding move in the same wave
degree has moved too much too soon.

f/j'h’: Wave Analyst

Substitution of Patterns
1) A five wave sequence in a C wave may be substituted by a diagonal
triangle. In some rare cases however, a deep correction, like a double
or even triple zigzag, may replace the five-wave sequence. The occur-
rence of patterns other than diagonal triangles in C waves was not
discussed by Elliott, but observations of the phenomenon in the forex
market has been frequent enough to warrant an exception to general
tenets of wave analysis.

2) In a double three or triple three, horizontal triangles generally occur

as the last form in the pattern. However, horizontal triangles can also
occur as X waves, effectively connecting two or more simple forms
into a single complex formation.

Guidelines and other observations IV - 1 1

Part V
Practical Guidance

Success in using wave analysis is not merely aquestion of applying

rules, anymore than, say, science or mathematics. It does not merely make
the most combinations possible according to certain fixed laws or rules.
The combinations so obtained would be so exceedingly numerous, cum-
bersome and practically useleSS. The true work of the analyst consists in
choosing among these combinations so as to eliminate those of limited
value, or rather to avoid the trouble of making them. The rules that must
guide the choice are extremely fine and delicate. It is almost impossible to
state them precisely; they must be felt rather than formulated.

The French astronomer, physicist, mathematician cum-philoso-

pher, Jules Henri Poincare who lived at the turn of the century, wrote in his
“Foundation of Science” about determining which hypothesis or which
facts to examine in situations which “admit an infinity of others”.

Poincare suggested that the selection is made by what he called the

“subliminal self”, an entity that can be likened to “pre-intellectual aware-
ness”. The subliminal self, Poincaré said, looks at a large number of
solutions to a problem, but only the interesting ones break into the domain
of consciousness. Mathematical solutions are selected by the subliminal
self on the baSis of “mathematical beauty”, of the harmony of numbers and
forms, of geometric elegance. “This is a true aesthetic feeling which all
mathematicians know”, Poincare said, “but of which the profane are so

AZ]: Wave Analyst

ignorant as often to be tempted to smile”. It is this harmony and beauty that
is the centre of it all. This is no romantic beauty that Poincare was talking
about. He meant “classic” beauty, that comes from the harmonious order
of the parts, and which a pure intelligence can grasp.

It is this sense of beauty which should make an analyst choose the

facts that contribute the most to this harmony. Usually, the facts by them-
selves do not suggest much, or are worth much. It is when the facts merge
with the matrix of the wave structure that harmony, and therefore success,
is achieved.

Poincaré suggested some rules in classifying facts leading to a

mathematical hypothesis. With slight modifications, we can use his guide-
lines in determining the heirarchy of facts that should lead to a proper
“count” of the wave structure.

The more general a fact, the more relevant it is. Those which serve
many times are better than those which have little chance of recurring. So
we ask: which facts are likely to appear? The simple facts. How to recog-
nise them? Choose those that seem simple. Either this simplicity is real, or
the complex elements are indistinguishable. If it is real, we are likely to meet
this simple fact again, either alone, or as an element in a more complex fact.
But start with the simple ones. Occam’s razor is a compelling argument for
simplicity

The principle of Parsimony, otherwise known as Occam’s Razor,

holds that when tossing around explanations for a natural phenomenon you
should opt for the simplest theory that fits the facts. As the fourteenth-
century philosopher William of Occam puts it: “Non sunt multiplicanda
entia preater necessitaem” (Entities should not be multiplied beyond
necessity). Failure to heed Occam is generally an invitation to trouble.

Practical guidance V - 1
 Its proper to begin with the regular facts, but after a wave count is
established, the facts in conformity with it becomes blasé because they no
longer teach anything new. Then its the exception that becomes important.
So we seek not resemblances, but differences. And we choose the most
accentuated differences not only because they are the most striking, but also
because they are the most instructive.

The next thing to do is to look for cases in which this wave count has
the greatest chances of failing: assume either a very large movement in price
or a very large movement in time. Almost always, we find that in these
extreme projections our wave counts are overturned. These “upsets” are
important; they enable the analyst to see better the little change that may
happen near his point of reference. What we are trying to do here is less the
ascertainment of likenesses and differences but rather the recognition of
likenesses hidden under apparent divergences.

If we focus on each individual rule or tenet in Elliot Wave analysis

the collective rules and tenets seem to be discordant at first. But looking
more closely, we will see in general that they resemble each other: different
so as to matter, but alike in form, and similar as to the order of their parts.
This makes wave analysis confusing at times. But as soon as one under—
stands that the apparent complexity emanates from the multiplicity of
possibilities because there are too few rules, then the task of looking at
likenesses (similarities) becomes less daunting and can even become
enjoyable.

Unsuccessful use of Elliot Wave Analysis does not always stem

from failure to apply its rules and tenets precisely. In many cases where
there is no significant progress. the analyst's sense of values and attitudes
are more to blame than anything else. The most common contributors to
failure are a) lack of persistence and intellectual honesty, b) inflexibility,
c) too big an ego, d) anxiety, e) boredom, and f) impatience.

All: Wave Analyst

A) Lack of persistence and intellectual honesty

An aspiring wave analyst needs akind of “stubbornness” that is en-

gendered by intellectual honesty.There can be no short—cuts in wave analy-
sis. A recitation of a plausible scene in wave analysis will illustrate the point.

You are analysing a chart and a wave pattern appears which you can
not classify. You “gloss” over it and continue with your wave count your
mind is already racing ahead to what should evolve, so it takes a little time
to realise that this unclassified minor annoyance of a “non-regular” pattern
is not just irritating and minor. It has stopped you from proceeding any
further. You are now completely stuck. You can no longer arrive at a sound
wave count.

This is not a rare scenario in wave analysis. This is perhaps the most
common problem of all. For the analyst this is the worst of all moments.

Reasoning out is no good to you now. You do not need any one
to tell you what is wrong. Its obvious what is wrong. What you need is a
hypothesis, how to classify the recalcitrant wave pattem. This is the zero
moment of rationality. It is normal at this point to feel like tearing up the
chart into little pieces. You think about it, and the more you think about it,
the more you are inclined to throw this book into the dustbin and forget
about the whole concept. It is outrageous how an unclassified “squiggle” in
a chart can totally defeat your “perfect” count. However, the reality is that
the market is not conforming to that count. So the “squiggle” must have a
value, therefore the count is wrong.

The moral of the story is obvious. Be intellectually honest; the un-

classified wave pattern is a problem, so treat it as such. Do not "gloss" over
it. Resolve the situation because it will surely resurface later on to stymie
your efforts.

Practical guidance V - 2
 If one finds oneself in this situation, obviously the solution is to find
the relevant fact or set of facts that will enable you to put a label on the wave
pattern.

According to the “doctrine of objectivity” we should keep our mind

as a blank tablet which nature will fill for us, and then reason disinterestedly
from the facts we observe. Clearly, this is easier said than done. As Poincare
would have said, there is an infinite number of facts about the wave pattern,
and the right ones do not necessarily dance up and introduce themselves.
The right facts, the ones we really need are not only passive, they are elusive.
You have to be searching for them, otherwise the true pattern will not unfold
and the count will remain lost.

One of the key requirements of a good wave analyst is this ability

to patiently select the relevant facts from the irrelevant ones, and to quickly
recognise those errors as and when they occur.

The difference between a good wave analyst and a bad one is

precisely this ability to select the good facts from the bad ones on the basis
of a “feeling of harmony”. In wave analysis the application of pure logic
is insufficient. You have to have a sense of “correctness”, a feeling for what
is right. That is what will pull you through. This is a capability borne out
of experience, persistence and intellectual honesty.

Despite rigorous efforts to be honest, one will still hit an Elliott

dead—end occasionally. When this happens, it is betterr to consider the event
as not so much a situation to be feared, but rather a moment to be cultivated.
This is a situation where the entire problem—solving process goes beyond
the mind-logic plane. As stated before, the solution to a problem often
appears unimportant at first, even undesirable. Passage of time usually
allows the solution to assume its true importance. Your mind, given enough
time, will naturally and freely move towards a solution. This kind of
4

f/ll'fi Wave Analyst

understanding or “feeling” is only acquired from practical experience; it
can not be developed inside the lecture room where the concepts are only
imported rather than “discovered”.

B) Inability to be flexible

A rigid set of values often leads to the inability to assess what one
sees.If your values are too rigid, it becomes very difficult to learn to accept
new facts. This often shows up as pre-mature diagnosis, when you are sure
you know what the eventual outcome will be. When this does not happen,
a revision is required, and, given the normally volatile forex cash markets,
reassessment. You will have to search for new clues, but before you can find
them you have to clear your head of “old” opinions. If you are not flexible,
you may fail to see the real answer even when it is staring you right in the
face.

If you get caught in this trap, you have to slow down you’re going
—

to have to slow down anyway whether you want to or not — but do so

deliberately and go over ground that you have been over before. This is to
see if the things that you thought were important really were so, and to just
stare at the chart. Just live with it for a while. Watch it the way you watch
a line while fishing. Before long you’ll get a nibble; a new fact will come
along. It may not be the fact that you are looking for but before long you
may find that the nibbles you are getting are more interesting than the
original purpose of classifying a recalcitrant wave pattern. When that
happens you have arrived. You are no longer just a technical analyst. You
are a wave analyst.

Practical guidance V-3

C) Too big an ego
If you have a high evaluation of yourself, then your ability to
rec0gnize new facts is weakened. Your ego isolates you from reality. When
the facts show that you just goofed, you’re not likely to admit it. When false
information makes you look good, you’re likely to believe it. On any wave
analysis, ego comes in for rough treatment. You’re always being fooled;
you’re always making mistakes. An analyst who has a big ego to defend is
at a terrific disadvantage.

If you know enough analysts to think of them as a group, and your

observation is the same as mine, I think you’ll agree that analysts tend to
be rather modest and quiet. There are exceptions, but generally if they are
not modest and quiet at first, the work seems to make them that way. As well
as skeptical. Attentive, but skeptical and not egotistical. There is no way to
“judge” your way into looking good on analysis, certainly not in the long
term.

If modesty does not come easily or naturally to you, one way out of
this trap is to fake the attitude of modesty anyway. There could be certain
soothing if twisted mental benefits. If you deliberately assume a medioc-
rity, then your ego is boosted when the subsequent events prove the analysis
as being correct. In this way you can keep going motivated by the success
until you overreach yourself again.

I was going to say that the market analysis does not respond to your
personality, but it does. Its just that the personality it responds to is your
real personality, the one that genuinely feels and reasons and acts, rather
than any false, blown-up personality images your ego may conjure. These
false images are deflated so rapidly and completely by the market that
you’re bound to be very discouraged very soon if you derived your staying
power from ego rather than from a desire to excel.

m Wave Analyst
D) Anxiety
When you are so sure that you will do everything wrong, the
tendency is to feel like doing nothing at all. Often, this rather than laziness,
is the real reason you find it hard to get started. Anxiety which results from
over motivation can lead to all kinds of excuses stemming from excessive
fussiness. You will relabel those wave counts that do not need relabelling,
and chase after multiple alternate counts. You will jump to wild conclusions
and build all kinds of rationale into the analysis. These errors, when made,
will tend to confirm your original underestimation of yourself. This will
lead to further errors and into a self-stoking cycle.

The best way to break this cycle is to work out the anxieties on the
charts. Read everything you can on wave analysis. The more you read the
greater the confidence you build into your analysis.

When beginning an analysis, prepare as many chart copies as you

can, label the waves in coloured pens in as many ways as possible, then
arrange them in proper sequence. You will discoverthat as you organise and
re-organise the sequence again and again more and more ideas come to you.
The time spent this way is much more productive than time spent staring at
a blank chart.

You can reduce your anxiety by recognising the fact that all analysts
have gone through the same learning curve and have all made errors. It is
a painfull learning curve, but just as l and countless others have survived,
you, too will rise above your initial difficulties. A piece of iron is hardened
by application of heat and repeated hammer blows. The making of a wave
analyst follows pretty well the same procedure; in the end, all of us have to
pay our dues in terms of bruised egos and lowered expectations. However,
new and hardened resolve is enough compensation for this.

Practical guidance V - 4
 One thing to do when working with charts, as in many other tasks,
is to cultivate "the peace of mind" which according to Poincare "does not
separate one's self from one's surrounding". When that is done successfully,
then most other things will follow naturally. Peace of mind produces right
thoughts. Right thoughts produce right actions, and right actions produce
work which will be a material reflection for others to see.

E) Boredom
This is the opposite to anxiety and is Commonly associated with ego
problems. Boredom means that you are not seeing things freshly, and your
analysis is vulnerable. When this occurs there is a need to focus your mind
elsewhere for a time being other than at the chart, preferably on other
supporting work such as momentum analysis, etc.

When you are bored, stop. Do something else and call it a day. If
you do not stop then you will become susceptible to making a big mistake.
Boredom plus a big mistake can lead to major losses. The best remedy for
me has been coffee and sleep, or preoccupation with other aspects of
technical analysis.

There are, as with all professions, boring tasks that, however, must
be done and for the wave analyst the worst is in making a current analysis
fit the main scenario all the way to the beginning of a sequence. If the daily
pattern happens to be part of a sequence stretching back several months it
becomes easy to become distracted. Sometimes, it seems such a waste of
time. But back-tracking is essential to the understanding of the current
pattern.

Boredom is usually a signal that the analyst is taking things for

granted. On the first sign of boredom, go through what you have done

m Wave Analyst
before, at least twice. This is a small price to pay, knowing that the penalties
for sloth will sooner or later be great.

F) Impatience
This is almost similar to, but not quite the same as boredom.
Impatience almost always stems from one cause: an under-estimation of the
amount of time the analysis will take. This is particularly true when market
action has settled into a lazy sideways consolidation. You can never be
certain what kind of pattern will turn up.

Impatience is the first reaction against a setback, and can soon turn
into anger and frustration if one is not careful.

It is best handled by allowing an indefinite time for the task, or by

doubling the alloted time when circumstances force time planning. It can
also be prevented by scaling down the scope of what one wants to accom—
plish. Overall goals must be scaled down in importance, whilst immediate
goals must be scaled up.

Practical guidance V - 5
Part VI
A Typical Elliott Wave Trading Plan

There’s a price for too much arrogance,

a price for too much greed;
And in complacent ignorance,
we’ve sown the whirlwind seed.

Don Simpson, from the song “Serpent’s Reach"

Errors in trading occur due to a variety of reasons, but the most

common causes of trading disasters can be traced to three cardinal sins,
namely arrogance, greed, and ignorance.

The sin of arrogance is less frequently seen nowdays; increased

volatility in the forex markets has taken its toll. Traders who presumed to
possess the inside track on market movements, and speculators who tried
towill the market to go their way before it is ready, did not survive this far.
There are not enough of the cocky traders left to make a mark on the casualty
chart.

On the other hand, the incidence of the sin of greed waxes and wanes
like an epidemic with the rise and fall of prices in the currency markets.

Air? Wave Analyst

There is no way to smooth the swings except by changing the way people
think. And that is an even more difficult proposition than eliminating greed
in the marketplace.

The sin of ignorance is the most pervasive of the lot. With the
amount of money being shifted around at the slightest perception of
impending market change, its not unreasonable to presume that players
involved in this zero-sum game actually understand the mechanics of price
change. But the moans of victims who were zero-summed in their trading
accounts at some point in the game is actually on the rise. So one is tempted
to say that ignorance of market mechanics is endemic in the market place.

This last sin is one that nobody needs to suffer from. Even if the
causes of price change are not yet fully understood (nobody knows exactly
why people decide to buy or sell en masse at a point in time), it is enough
to know what does not cause prices to fluctuate. For instance, the laws of
cause and effect in the science of physics do not apply in the largely
psychological phenomenon of price change. In another, price movements
are not wholly random in all degrees of possible intervals between price
changes; the October 1987 stock market crash drove this painful lesson
home.

If a tool is workable, it is not of over riding importance to know

exactly the why's and wherefore’s as long as the basic truth behind it is
understood. This is especially true of the Elliott Wave Principle. It suffices
to know that the Principle is based on the proposition that the market is
comprised of people, and that people will never change. They will react to
similar situation in the same manner over and over again.

A typical Elliott Wave Trading Plan Vl - 1

 The Elliott Wave Principle, to my knowledge, was the first to
explicitly recognize that market mechanics do not cause changes in market
direction; only changes in psychology do. What RN. Elliott has done is to
establish normative behavior patterns from which specific rules can be
declared; and from these rules broad guidelines and description of tenden—
cies can be inferred. Specific market action can then be derived from these
inferences.

Given the highly serialized structure of the model, a study of Elliott

Wave Principle will train one to assess the probability and frequency of a
future event. Situations which are deemed impossible under the various
rules and guidelines are eliminated from consideration, thereby limiting the
possible eventualities the trader has to cope with. Robert R. Prechter once
likened the knowledge of the Elliott Wave Principle to the possession of a
road map. With it, one can make a few deductions that will identify the most
likely path that a bus will take (even if one has not made the trip before),
thus eliminating 99 percent of other possible routes across unpaved lands.

It should immediately become obvious that the use of Elliott Wave

Principle is not a mechanical approach to the market place. It is an approach
in which probability rapidly becomes the catchword; it is a method in which
the terms prediction andforecasting become irrelevant, even unwelcomed.
One soon learns to replace these terms with the word anticipate.

Any analysis derived by application of its principles will always

imply a forecast or prediction. Don’t let the implied turn into explicit. While
the Wave Principle is probably the most effective forecasting tool available,
do not use it to forecast or to predict. Use it only to establish targets with high
probability of achievement, or to establish alternative courses if subsequent
market action nullifies the original objectives.

m Wave Analyst
 This may disappoint those who are looking for rigid, absolute
answers to the forex markets’ questions. But it is a fact of life that most
predictions and forecasts are destined to fail; it is simply impossible to pin-
point the confluence of specific time and price elements at any part of a
market movement. The best way to use the wave principle is to accept this
fact. Provide for the occurrence of errors of judgement, then subsequently
deal with the alternatives to produce winning strategies. There are no
guarantees in the forex market, there are only maybes.

If one is to derive maximum benefit from this method, one has to

learn to accept it for what it is, a tool to provide the input necessary to
quantify the degree of risk or degree of reward in the current market struc-
ture. It is not a magical philosopher’s stone; it does not turn base ideas into
gold.

To a certain degree, this quantification process — lets call it “money

management”— is more important than the analysis part of the tandem. To
use an old analogy, analysis is the door to fabulous riches, while money
management is the key that opens that door.

The first requirement of money management is a trading plan —a

written, well-analyzed, step-by—step process, not a set of vague intentions
kept in your head. This plan must not only provide for entering trades; it
must also provide contingency for taking losses and accepting profits.

Put it this way. A trading plan without a system of cutting losses

short and maximizing profit potential is like boarding a car without brakes
and gearshift. You will certainly be able to depart, but it is doubtful if you
will arrive at your destination. The worst, of course, is not having a trading
plan at all. Its like boarding a car without a steering wheel. It is doubtful if

A typical Elliott Wave Trading Plan VI - 2

you can even depart; it is certain that you will never arrive.

In drawing up a trading plan, its spirit should be what Robert

Beckman once said: “We are not trying to beat the market. We are trying to
join it.” There are subtle implications in Beckman's plea. The objective
should be less in being “right” but more in being “successful”. In other
words, do not aim at getting a correct “forecast” for ego-boosting reasons.
Rather, aim at making money on the trade, even when the forecast was
wrong.

There is no contradiction involved here, from the standpoint of

Elliott analysis. Most of the time, the probability of likely occurrence are
so evenly distributed that favoring one scenario over others becomes a
matter of preference. It is only at certain times in the market development
that reliable, precise projections can be made. At most times, it is only
possible to assess that being long is preferable to being short, or vice versa.
With meticulous planning, that information is usually enough to succeed in
the market place.

A? Wave Analyst
Very Short Term Wave Scheme

tick-by—tick Price Chart

—- IO-minute Price Chart
Trade Technique: ....... Market Scalper

Typical trade time-frame: ...... 5 minutes to 1 hour

Technical support: .................................. Real-time tick~by—tick momentum

analysis is essential
Short Term Wave Scheme

_-— 10-minute Price Chart

Hourly Price Chart

m Wave Analyst
Trade Technique: ................................... Positions taken to capture minimum
of 1 % price movements

Typical trade time-frame: ........................ i - 3 days

Technical support: Tick-by-tick and 10 minute momen-

, tum analysis for timing of trade
initiation and termination. Hourly and
daily momentum analysis for decision
support.

A typical Elliott Wave Trading Plan Vl - 4

Medium Term Wave Scheme

- —» — Hourly Price Chart

Daily Price Chart
Trade Technique: ...... .,.' .......................... Strategic and investment positions
to capture minimum 5 % price
movement, hedging strategies

Typical trade time-frame: ........................ 3 week ~ 1 month

Technical support: .................................. Continued long term momentum

essential in order to support Wave
analysis. Beware of accelerating
speed of change in deteriorating
10 and 20 day stochastic analysis.
Long Term Wave Scheme

f” "7 Daily Price Chart

—— Weekly Price Chart

fit; Wave Analyst

Trade Technique: ................................... Fundamental investment positions
or balaince sheet strategies seeking
to capture a minimum 10% price
movement

Typical trade time-frame: ........................ 3 - 6 months or longer

Technical support: .................................. Continued long term momenum

analysis.

A typical Elliott Wave Trading Plan VI - 5

Preparations for the Typical Elliott Trading Plan

Ascertain from the preceeding wave count that a five—wave se-

quence is highly probable from Point 0 (see Trade No. 1). Preferably, the
expected five-wave move should be part of a larger pattern that could be
comprised of five waves itself. In this ideal situation, the move from Point
0 to Point T (termination of the five—wave sequence) should compose the lst
Wave of the larger pattern (see Short—Term Trading Plan). However, if a
large zigzag or any other deep correction is expected from the wave count,
the Trading Plan may be activated. Just make it a point to remember that
the potential movements are limited in this case.

Divide your trading capital into 10 equal units, if you are trading on
cash basis. If you are trading on margin basis, divide your risk capital into
10 equal units, just the same. The intention here is to prevent the trader from
risking his entire stake in any one trade. This also ensures that the trader will
survive errors in judgement early in the trading exercise, and will have the
wherewithall to continue the trading plan.

The nominal value represented by the leveraged capital is irrelevant

to the over—all scheme of this money management system. If you are taking
market positions on the basis of trading limits (as in the case of a bank forex
trader), the maximum net exposure recommended in the trading plan should
correspond to about two-thirds of your limit.

Finally, this typical Elliott Trading Plan maybe used with any of the
four wave schemes mentioned, the very-short term, the short—term, the
medium—term, and the long-term wave schemes. The tactics won’t vary sig-
nificantly; only the time horizons of the recommended trades will differ. For
example, the time of travel from Point 0 to Point T in the Very Short Term

m Wave Analyst
Wave Scheme might be as short as 18 hours. On the other hand, it might
take all of 7 or 8 months for the market to travel from Point 0 to Point T on
the Long Term Wave Scheme.

The size of the price swings will of course vary from one wave
scheme to the next. It can range from 75 to 125 points in the tick-by-tick
chart to 200 pfennigs in the Long Term USD/DEM chart. Any choice of
trading horizon, if a choice is available, will depend largely on the capacity
of the trader to take losses. The shorter the wave scheme being followed, the
smaller the risk in terms of face value. In percentage terms however, the risk
in trading in accordance with the Very Short Term Wave Scheme should
equal the risk inherent in the Long Term Scheme.

All of the trades described in the Typical Elliott Trading Plan follow
a certain pattern, namely: 1) initiation of trade, 2) setting-up of stop loss
levels, 3) case-by-case addition to existing position, 4) provision for partial
profit-taking, 5) case-by-case reinstatement of position, and 6) termination
of trade.

A typical Elliott Wave Trading Plan VI - 6

 l—L

@I.w
I01
..
iirade No. 1 - Trading the 1st WaveJ Point T

Maximum number
01 units tor Trading plan: 10

Units committed in Trade No. 1: 3

Units remaining after Trade: 1

GD

—- Partial profit taking:

|A©
M 2 writs: leaving 1 unit
in case Wave LT‘ "extends".

I_l\)
—_
Initiation of trade:
at 50 in 61.8 percent retracement of Wave 1: 34V 3 units
Major support lewd

-‘
1— ———————— Staploss : Reverse of Trade 1:

-
Point 0 If Wave Zjnlls bellow Paint 0, 541137 units

Tans",- “rm-a a ‘I a a ‘l a ‘I ‘I II A A A A A a ‘h A
Trade No. 1

1) A sharp rally usually takes off from a pivotal juncture like Point 0.
Upon retracement of 50 to 61.8 percent of that rally, buy 3 units.
Place a stoploss-reverse order just a few points below the level of
Point 0.

2) The reverse order calls for sale of 5 units but not more. The purpose
of the net short position is to try to recover all or enough of the losses
from the long trade so as to prevent the capital from being impaired.
A bigger stake on the downside is unjustified at this point.

3) Remember: your analysis indicated that Point 0 is probably a pivotal

point. If the analysis was wrong, it probably erred in identifying
Point 0 as the end of Wave 5 in the previous sequence. If a mistake
was indeed made, the odds are that Point 0 is an ending point for minor
Wave 3 and therefore the rally from Point 0 is part of minor Wave 4.
The downside profit potential, namely minor Wave 5, is therefore
limited and should be traded as such. In this situation, being net short
of 2 units fulfills the expressed objective of the reverse order, which
is to recoup losses from Trade No. 1. Turning in a profit from the
reverse trade is welcome, but not of overriding importance.

4) When the upmove from Point 0 has completed a five-wave

sequence, thereby terminating Wave CD as well, sell 2 units. Leave
one unit long in case a low-probability extension occurs at this phase.
The probability for a peak of Wave 5 may be calculated by taking the
price difference between the peak of Wave 3 and Point 0, then
multiplying it by the ratio 0.618 and adding the product to the
termination of Wave 4. Lets call this process the Fifth Measurement
Method. Refer to Part IV for other methods on how to predict ending
points for 5th waves.

m Wave Analyst
 Trade No. 2 - Trading the 3rd Wave

Units from Trade No. 1: 1

Units committed in
Trade No. 2: 6
Trade No 2A: 10
Units remaining after Trades 3

Partial profit taking: ——'

M 7 units; leaving3 units
in case Wave C3) “extends"

Trade No. 2A:

Critical point, where the rally from
Wave @ equals the rally from Point 0 to (D.
Egg 4 units more (total no. of units long: 10) ————

Major resistance level ®

M319? supplier/9

-
_

m ‘ ..,,A,,‘l.,fl
Point 0
II n A A 1
\
 --— —— —Point W
Midway stopprofit
of Trade No. 2:
‘

' ©
2
_,
if the market falters and
moves back below the peak ' ‘—

of wave 1, §gll 6 units

— Trade No.2:
At 50 to 61.8 percent retracement of Wave (D :&y 5 units
Total number of units long : 6 (5 + 1 unit from Trade No. 1)

— Inital Stoploss:
Reverse of Trade 2: 10 units

a
§e_ll

l A .‘"l 11 ll A A A A A All. a.
Trade No. 2
1). When Wave C2) has retraced to 61.8 percent of Wave (D, buy
5 units. The open position is now a total of 6 units long. Since 3rd
waves are generally the most powerful phase in any five wave
sequence, one can choose to be more aggressive at this point. Another
reason for confidence at this time comes from the following observa—
tion: a minor five-wave sequence has terminated in the previous
upwards pattern. So even if a major expectational error was made in
projecting the continuation of the move to Point T, the implication is
that there should be at least one more five—wave sequence to the
, upside emanating from the end of Wave C2). Commit up to 60 percent
of your capital in this particular trade.

2) Put in place a stoploss-reverse order at just below the level of

Point 0. If the order is elected, se_ll 10 units. The net short position
will be 4 units; even a relatively small movement falling below Point
0 should suffice to recover any loss incurred on Trade No. 2.

3) The order to reverse can now have more aggressive intentions relative
to the first stoploss order, even if they are situated at the same level.
The reasoning goes like this: There was a five-wave sequence from
Point 0 to the peak of Wave 6). If it was followed by a drop below
Point 0, then it is almost certain that the original analysis was flawed.
The upmove from Point 0 to the Wave 6) top should be correctly
labeled as a C wave of an irregular correction. Therefore what has
been labeled as Wave 6) peak could actually be the terminus of a
larger degree Wave 2. or Wave 4.

m Wave Analyst
4) If the statement in 3) is true, the ensuing drop below the level of Point
0 has a long way to go. The termination of Wave 2 or Wave {1
mentioned above should be followed by a downmove as damaging
as the five-wave rally projected from Point 0 to Point T. That is
why the reverse order for Trade No 2 not only seeks to recoup any
losses from the upside trade, but also serve as gambit in a new trading
plan oriented downwards.

5) If the market moves higher according to expectations, contingency

plans to preserve some of the profits have to be in place. The most
critical point at this stage is located at (W), the level where the
distance traveled by the rally from Wave (2 equals the distance
traveled by the upmove from Point 0. If the market falters near to
that level then drops far enough to overlap the peak of Wave 1 (in
Wave ®), $11 6 units to square off all positions. Then stand aside.
There is nothing more that could be done rationally until the market
unfolds further. '

6) When the price has exceeded Point (W) by the equivalent of 10

percent of the distance between Point 0 and end of Wave 6), buy
4 more units. This brings the total number of units long to 10. Call
this Trade No. 2A. There is now sufficient grounds to expect that
Wave 6) will be at least 1.618 times as long as Wave 6). If Wave C3)
extends, as is the case 60 percent of the time, it will likely be 2.618
times as long as Wave (D, or even longer. Clearly, it is desirable to
be very agressivc at this point. Commit the entire stake of 10 units.

A typical Elliott Wave Trading Plan VI - 8

 If you placed the stop profit level at the peak of Wave 1 (as suggested
above), the most that can happen is that you will break even on
Trade No. 2 and No 2A if the market drops unexpectedly. The whole
trading effort has been geared towards this big moment. All the trades
before and after this juncture are mere trading exercises. These two
trades are what it is all about.

7) When a sequence of five waves take shape from Wave ®, project the
probable terminal of Wave G) by using internal and external wave re—
lationships. Use the Fifth Measurement Method to calculate the
probable end—point of Wave 5 in Wave ®. Measure also the distance
traveled by Wave 6), multiply it be 1.618, then add it to the bottom of
Wave (2). The price objective provided by this method should not vary
much with the target obtained from the Fifth Measurement Method .

8) fi 7 units at the expected peak of Wave 3 Fifth measurement

method, leaving 3 units long to take advantage of a high-probability
3rd wave extension that may materialize.

m Wave Analyst
A typical Elliott Wave Trading Plan Vl - 9
[Trade No. 3 - Trading the Fifth Wave

Units irom Trade No. 2: 3 — — — Profit Taking:

Units commited in Trade No. 3: up ms §e_ll all lung positions
Units remaining after Trade No. 3: 0

/\
\_ _Y Critical point:
when Wave 4 of mlly from
X Watx' (Doverlaps Wave 1:
_| M all positions (re/er 7)
2 Critical paint: V
where the rally from @
Wave © exceeds 61.8
Trade No 3:
Arson:
______
@\
61.8 percent
perrenlofthcdrop from
Wave L‘J‘ ta Wave a)
\
.

retracmient of Wave G" .' (rEferGJ

M3 units if Wave at is longer by \
1.618 times or more than Wave 07:
or
M \ ————— Ideal Stoplass:

IA@
5 units if Wave Ci? is less
than 1.618 timrs as lung as Wave a) \ Reverse for Trade Na. 3:
Tuiul No. of units lung: M maximum DflS units
maximum 8 units 2,

A, Point 0
Trade No. 3
1) After Wave @ has retraced 38.2 to 50 percent of Wave ®, one of
the following steps is recommended:

i) M 3 units ifWave ® is 1.618 times as long as, or longer than

Wave 6) ; or

ii) BM 5 units if Wave @ is less than 1.618 times the length of

Wave 6).

2) The reasoning for the above steps goes along this line: If Wave CD was
longerthan Wave 6), by a ratio of 1.618 or higher, Wave (5) is not likely
to extend; its development is likely to be normal. Moreover, if
Wave ® had been extraordinarily strong, and had gained ground very
quickly, Wave (5) has higher chances of turning into a failure , which
would be the inability to exceed the peak of precursor Wave 6).
Therefore, being overly optimistic of the upside potential at this point
is not justified.

3) If Wave 6) was less than 1.618 times the length of Wave (D, Wave ®
has a very high likelyhood of being extended. In this case, what is
being labeled as Wave 6) is actually the middle phase of an extending
Wave ©. Being aggressively long at this phase is therefore reason-
able, even desirable.

4) The ideal stoploss-reverse order for Trade No. 3 should be placed

just below the level of Wave 6) peak. If the decline which is being
labeled as Wave @ drops below the peak of Wave (D, the premise of
a five-wave sequence to Point T is wrong. The upmove to Wave ®
should therefore be more appropriately classified as azigzag correction.

Ah: Wave Analyst

 Any drop from the peak of this zigzag is therefore part of a large-
degree decline which should travel way, way down the chart. The
stoploss—reverse strategy can therefore be very aggressive, as the odds
for an extensive downward move is very high in this situation. If the
stoploss-reveres level is hit, sLll up to 15 units, depending on the net
long position in Trade No. 3.

5) If Wave (3) was extended (i.e., it is at least 1.618 times as long as

Wave (D), and Wave @ has given indications of following a 50 per-
cent retracement orless relative to Wave (3, then a stoploss order may
be placed at the level just below the corresponding 61.8 percent re-
tracement of Wave ®.

There is no hard rule being invoked here. This contrived stoploss

level will only be effective if the pattern of Wave @ follows one of the
sideways correction patterns (Le, a flat, an irregular, a triangle, or a
double—three). The basis for a limit below the 61 .8 percent retrace—
ment is the observation that if a correction pattern starts with a
sideways pattern, the likely limit of the retracement is 61 .8 percent.
Also bear in mind the Principle of Altemation with Wave (2).

6) If the drop from the peak of Wave ® can be established definitely

as a three (composed of 3 waves) rather than a five, point X
becomes a critical juncture for any rally to new peaks. Beyond this
point, the probability of further declines diminishes to a negligible
degree. With a 3-wave count from the peak of Wave (3), the only
remaining argument for an extensive, large degree decline de-
scribed in item 4) is for a small irregular correction to be ending
at point X (this argument is technically in error when the larger

A typical Elliott Wave Trading Plan VI - 10

 degree wave schemes are being traded). However, if the market rallies
above pointX, that is to say, higherthan 61.8 percent of the drop from
Wave 6) peak, then the irregular correction scenario is negated.

7) As in the earlier trades, a plan to preserve some profits should be in

place once the market has sufficiently moved upwards. If the market
has gone as high as the peak of Wave 3 of Wave but subse-
(5),

quently declined to the level of Point Y, then M

all positions and
stand aside. In this hypothetical example, it is very likely that
Wave @ is not over yet and that the corrective pattern (probably an
irregular) will probably bring the. market below the origin of the ad-
jacent upmove. It is desirable to side step the short duration but
generally destructive effect of the correction’s resumption.

8) As before, once a five-wave sequence has nominally formed, project

the probable ending point of Wave (5) by internal and external wave
relationships. The peak of Wave 5 in Wave 6) may be calculated by
using the Fifth Measurement Method, the peaks of Wave 3 and
Wave 4 all in Wave (5). The peak of the larger structure Wave (5) may
be similarly derived by applying the method on the peaks of Wave ®
and Wave @. The peak of Wave 5 coincides with peak of the larger
degree Wave 6).

9) At this stage, the trader has probably exploited most, if not all, of the
potential of the five-wave movement from Point 0. It may be the case
that Wave 6) will eventually extend. Or what has been described as
Wave (5) peak may actually be just the mid-way point of a grossly
extended Wave 6). But we have no way of knowing this at the peak
of Wave 6). There is no longer any excuse for keeping the long
positions open. The name of the game is taking profits; at a certain
point paper profits have to be turned into hard cash. And this is as a
good place as any.

”42: Wave Analyst

10) So, at any of the levels where either Wave 5 or Wave (5) are expected
to peak, £11 all long positions without delay. Stand aside and wait for
appropriate conditions to trade the correction of the movement from
Point 0 to Point T.

A typical Elliott Wave Trading Plan Vl - 11

Trades No. 4 and 5 - Trading the Corrective Waves

Units from Trade No. 3: 0

Units commited in Trade No. 4: -3
Units commited in Trade No. 5: -4
Units after termination of trade 0

Point 0
 1,3,5 Trade No 4
/
At 50 to 61.8 percent
retracement of Wavel : ' —— __
/ Stoploss:
5L” 3 units
/ Reverse for Trade
2 _l N04: Mmaximum
/ of 7 units
@/
C/
— — Trade No.5
At 38 .2 to 50 percent
retracementof Wave (a),
S_eI_l 3 units more ,

Critical point: ————

__
whereafive—wave sequence from
Point T confirms the drop as 5
possible zigzag, therefore, deep
correction.

GD
At completion of a valid five- wave sequence
from Point T, or at a point where the drop
from Point T has retraced 38.2 percent of the Termination: — — —
U‘I

movement from Point 0: Cover all short

B_u32 units, leaving] unit forcompletion of positions
Wave (c).
4
Trades No. 4 and 5

1) When Wave 2 of ® has retraced 50 to 61.8 percent of Wave 1, s_el1

3 units. Since the expected decline is a mere correction, although a
large one, the profit potential is limited. Tactics are therefore adjusted
accordingly.

2) Put a stoploss-reverse order just above the level of Point T. If the stop
is elected, my a maximum of units. The size of the stake depends on
how the length of the previous Wave 3. If Wave 3 was not extended,
reverse the position by buying up to a maximum of units.

3) Point Z confirms a five-wave sequence from Point T. The retrace—

ment pattern of ® is likely to be a deep correction, probably a zigzag.

4) The bottom of Wave 5, and therefore that of Wave @ as well, way be

calculated by using the Fifth Measurement Method. At the projected
peak, Lu 2 units, leaving 1 unit to take advantage of the hypo-
thetical Wave © decline. Alternatively, take some profits at the level
where the drop from Point T has retraced 38.2 percent of the upmove
from Point 0 to Point T. The rationale is this: If the count of the minor
waves can not precisely produce a five-wave count (as it often
happens in short-term wave schemes), then then probability of a
sideways correction (for example, a flat) is too high for comfort.
Taking some profits at 38.2 percent retracement level is a very logical
actlon.

5) When Wave ® has retraced 38.2 to 50 percent of Wave @ , Ed

3 more units.

6) Move the stoploss (no reverse this time!) to above the 61.8 percent
retracement level of Wave @. If the stoploss is elected cover a_11 short
positions and stand aside.

m Wave Analyst
 7) Finally, when a five—wave sequence from the peak of Wave (D has
taken shape, compute for the likely trough of Wave 5 in Wave © using
the Fifth MeasurementMethod. Project also the target for Wave © by
assuming equality between the length of Wave@ and Wave 6) Cover
afl short positions at the objective closest to the current market
price.

8) Wait for a new sign of a rally to activate the Elliott Wave Trading
Program through another cycle.

Notes on trading corrections

There is a maxim popular with wave analysts, which should set the
tone for this section: “You make money trading the impulse phases; you
lose it trading the corrections.”

There is a lot of truth in this somewhat facetious observation. But are

reasons for having your skill in trading corrective waves. The market spends
about 70 percent of the time in consolidations, while impulse waves take up
the rest. Side-stepping corrections of course mean that the trader will be idle
for more than half of the time. There are situations where corrective waves
can be extremely profitable, as in second waves, for example. It is normal
for second waves to retrace 50 percent or more; full retracement of 100
percent is not unusual.

Trading fourth waves can be very dangerous, however. There is no

reliable way to predict where third waves will end. Many a pause suspected
of being the onset of a 4th wave correction eventually turn out to be just that
—a minor retracement in a roaring 3rd wave extension.

Trade corrective waves if you require, but proceed with extreme

caution. ,

A typical Elliott Wave Trading Plan VI - 12

Part VII
Case Studies

Applying Elliott Wave Analysis on Very

Short Term Patterns

What you have just read is probably more wave analysis material
than you would care to know. Reading it was easy. Applying these various
rules, tenets and observations on market data, with the expectation of
making money on the exercise, is something else.

The easiest way to learn is by looking at examples; wave analysis

is no exception. Experience has shown that the principles are best learned
by looking at “blow-by-blow” accounts of actual analysis and tactics. The
learning process is further facilitated if critique of the performance is
provided.

Effort has been made therefore to provide a set of examples that can
also serve as “wave count exercises” to the beginner in wave analysis. These
were actual recommendations made on the Reuters and Telerate networks
during the eight weeks from May 18 to July 10, 1987. This period was
primarily chosen on account of the complexity of the market movement
during this time. Hopefully, this will help prepare the beginner to the
realities of forecasting wave analysis. It should be appreciated that Wave
Analysis is an ongoing process of deduction and evaluation, the period in
question should only be considered as one complex part of the overall
structure.

A? Wave Analyst
 Beyond the textual context of the recommendations, I wanted to
show the pitfalls that await the unwary, as well as the occasional rewards
that comes the way of the wave analyst from time to time.

The purpose of the short term analysis was to anticipate the ter-
minal point of the B wave of an "irregular" or "flat" pattern from the
lows of January 1987. Once the terminal point was identified, the next step
was to determine the structure and objective of the ensuing C wave.

Wave A had conclusively ended in early March at 1.8750 - The

B wave objective therefore was somewhere below the 1.7665 origin of
wave A. Ideally, the projected point should be 1.382 times the length of
wave A if the pattern was an "irregular". This scenario had 1.7250 as an
objective. On the other hand, if the pattern was a "flat", the terminal point
of B should not go far from the 1.7650 area.

The price action leading to the bottom of wave B was expected to

take shape of a downwards diagonal triangle, or wedge. As the commentary
started in the week of May 18, 1987, the bottom of wave B may have already
been seen at near 1.7650 or, as the favored scenario called for, it may be
seen at the lower 1.70's.

The prevailing sentiment at this time was one of extreme pessimism

for the US dollar's health. One New York analyst had even proposed that the
dollar was about to drop into a "bottomless pit". The Elliott wave outlook
was slightly more optimistic. Subsequently to the end of the B wave, a sharp
rally to the area of 1.90 was expected to complete an irregular or flat pattern.

Case Studies VII - 1

3.500 '

"A ' 7 fl
i US$/DEM Weekly ‘

[um- 83 ~ May 87
I (High—Luw-Ciuse) ‘ H

anon

2.500 t
L'r

2.000-

1.500
1983 1984 1985 1986 1937

LIS$/DEM Daily
1 Oct 86 -15 May 37 l

( H igh-Low-Close)

zoo - Limit

1.80 '

1.70
October 55 Nave mber

m Wave Analyst
 US$/DEM Hourly

74l
1.82 i

13 April ~ 15 May 87
(Close)
l_
1.81

1.“

1.76

J
1 .75

April 13 - 17 Apr" 20 - 24 Aprll 27 - May 1 myrr-rs

W
Monday 0745 GMT Week of May 18 '87 Friday 0750 GMT
I was hoping that action in late Friday would provlde The narrow range last night proved a boon as it gave us
some clues on near-term direction, but there was not , time to evaluate the near-term in depth. My Elliott dis
much to go on. Very short patterns indicate a probable T- course yesterday was slightly oil. I tailed to mention that
snap»back to the 17850179 DEM area but its guess- a downmove is still possible even with lhree~wave pat-
work aller that point. The original scenario or a retrace terns il the bigger picture is a diagonal triangle, which
3

to 1.8250 has very slim chances alter the break at might be the current lorm ol the DollariMark. This thesis
1 1750 Friday. but I have nothing to replace it with a! the * will undergo a crucial lest today. Therefore we have no
moment. We Will have to look elsewhere for new direc~ choice but temporarily join the ranls ol the breakout
lions. i artists. The most likely scenario calls tor a sharp move
mm to the 1 .75—1 7450 area in about 56 hours. but this is con-
firmed only a breakdown oi 1.7570. The joker in the
Tuesday 0750 GMT pack, the view at a jackknife to 1.8250. gets a new suit
with a break 01 l 7850. The real message today is (his;
The dollar is still suscepllble lo a very shorflerm tick-up Take profits on out ovemite cable longs and wait for a
lo the 1.7350 area but these higher levels should be break through 1 15910 reinstate. There is a slow at llgures
used to sell the buck on short-term. The medium-term coming out today. and while I normally lgnorethem when
outlook has not crystallized suiticiently to support an allv the waveoount is well defined, the presentsituation is so
out recommendation to bash the dollar. but the short “lily" that we will trend Inllowjust (his time.
side ol the market seems to be less rifly at this point.
While the scenario oi rally to 1.8250 remains viable
(il will be until a breakdown oi 1 .761 D) ilwill lake 3 push ‘ - may ' Monday
through 1.7950 to warrant revivrng this short term View.

Wednesday 0745 GMT Thursday 0142 GMT

We‘ve got the down move. Lets look at appropriate levels to take By position takers standards. yesterday‘s low ol 1 .7S70 was sul-
short-term profits. A small triangle in the to-mln graphics pro- ficiemly close to the target or 1.7650-60. but it was not enough.
vides alargetol1.7660-1.7650.Tha!s one. The price travel tram as the hourly DEM chart will show only a 3-wavo sequence lrom
1.8005 May 1 1 to 1 771000 May 18mullipliedhy05133ndthen 1.7830. Therally sincothen horn "191.7670 lows rules out an im-
subtracted irom lhe 1.7830 high Tuesday will yield the area ol mediate drop to 1765010 complete a 5—wave sequence. In the
1.7550. Thats two. and thats enough. The current decline may process. thls inability to make a S-wave sequence influences our
or may not go below 1 7650. but when the dollar getsthero. guer- outlook tor the mediumrlerm. It the market pattern traces out
rilla traders should take their profits and wait tor other opportu- nothing bul three-wave terms. than it is not in an impulse phase.
nities to take low—risk positions again. The medium term is slowly and we can lorget about immedlara moves to new lows. This in-
shaping as a drift to the lower 1705, so at me moment. we can evitably revives the issue of a possible move up to the 1.8250
rule out a hard landing for the buck. The usual medium term area balore drilling to new lows. Wharnow? We missed the ideal
strategy of sell-and-hold may still work, but on account 01 the larger by just 10 pips on the Dollar/Mark. but I am not happy
limited downside potential (and horrendous whrpsaws) the about it.
stomach-churning game or intra- and nnterday trading will proba
bly provide the best returns.

it? Wave Analyst Case Studies VII - 3

Monday 0745 GMT last few days won't do much damage to the overall trend.
Week 0] May 25 'B7 Consolidation phases are panel the general pattern and
We are at the edge. with Friday’s action being 01 no are as necessary to the market's well being as sleep is
help. So once again. we locklor very shcn~term trading to yours and mine. But consolidations or corrections are
opportunities in the meantime. We will likely get a break the most difficult phases to hack, and it is quite easy
of 1.7850 today. judging lrom the way hourty patterns during corrections to loose the money you have made
have evolved from Friday's vertical rise. This is a warnv during the "inmulse" phases or that pan of the sequence
ing that the scenario ol a diagonal triangle is on the which goes with the general trend. Evan novice wave
tfllflo
verge of being nullified. A further break of 1 .79 confirms analysts look good during impulse phases. But the
that our iokerin thepsck. a rise to at least 1 .8250, gets corrective phases generally make the pros stand out.
a new deal. Tactics: buy Dollars tor a possible test of Newcomers to the wave prlnciple are often put off by the
1.79 in 24 hours. After which we wrll reassess the lactthaf if is not always possible to know precisely where
situation. the market is in all degrees of its wave count. especially
during the meandering corrective phases. However,
Tuosdoy 0752 GMT because a market is almost always clear in rnostdogrees
of the trend, an analyst can usually formulate a wlnnlng
We haven'tbroached 1.79 docisivelyyet. butaller a few strategy around what he does know. while obiactiveiy
more hours ol consolidation (inthe 11917850 range) placing stops to protectagalnst the least likely outcomes.
the Dollar will likely push through 1 .79 without much dil-
liculty. The final nail in the coffin hasn't been hammered 1iW In mosl days. we give precise assessments of possible
in yet. bul it is sale now to bid adieu lo the diagonal market movements, but in some days It is just lmpOS'
triangle scenario that has threatened to depress the sible. During such days. we provide the various possibili-
buck lotho1.75area pilot to a sustained rise. Ourjokor. ‘ Friday ' Mar-day ‘ mm 'wm.sm' mumay' Friday L of occurrence based on our expe-
a wild card at the outset. is now ‘ and turns hence. lhe limits where these scenarios remain valid,
inlo an ace. This view. which had practically given up
I and specify whether an opinion is a product of analysis
early last week. calls for a rally to1.82-1.Ba, followed by some Frldly 0745 GMT or plain of guess. Andthen its every man for himself. For a long
nervous selling to test the nerves of the bulls at the 1.78180 stretch of time sometimes, a clearand shalpassossmemisollen
area, should usher in a sustained dollar firmness until the first The Dollar‘s dip yesterday stopped at 1.81. a strong evidence impossible (even undesirable) in this arena where Ieality is
hall at 1988. Ableakof i .83will likely provoke a testolthe 1 .8750 that the slide was but a minor 41h wave. Therefore. the 5Ih and notoriously vague and where uncertainty often leads to funda-
highs, which ll broken will obviously test the resolve ol longterm last wave of this minor sequence should make a new high over mental errors. The most common error is to adopt a concept.
dollar boars. Just some foodforthought, but don't get any mental the next 24 hours. The 10~minu|e graphics support this conten~ The one cunerllly In vogue I5 that the Dollar can onlygo down.
indigestion. tion. The vertical nature of the price movement since aslan And then compounding that error by ignoring anything that con»
opening today is characteristic of exstensicns. so its sale to say tradicts it.
Wednesday one am that 1.8280 would probably provide but the slightest resislarce
to this awesome dollar advance. If you took you profits as sug- Adoptlng aconcepl istheopposito of havingan open mind. lnlhe
The Dollar rally is very healthy. and performing as per expects» gestod wednesday. look for levels to reinstate long bucks. with former, the analyst sticks to one theme and then proceeds to
lions ii may add. but shorHalmers should be gearing up to take
I slight improvement to make the waiting worthwhile. The next bolster his case in every Imaginable way. In the latter. the
some profits during the trading day. The slight pause in Asia trading target is now 18375434. if we attain this over the next analysts is not predisposed to favor any particular movement in
loday is panel a minor consolidation process prior to an assault 24 hours I seriously suggest to reluctam long-term bears to slam a currency. which can be up. down. or sideways. Obviously.
of 1.82—1.83.alter which we will roapraiso the mediUm term. So covering-shon positions because it would be such a waste to adopting a conceptimplies that a conclusion has already been
keep those long buclslor a while but take some. it not all, shon~ wait for indication at 1.8? before taking action. Break 1.83 and a arrived at long before the evidence warrants it, and that the
term profits at the 1.82483 range and stand aside. We won't tesl of l .97 can't be far benind. process of siltlng for peninem data is an exercise lo support that
recommend going short unless wave patterns indicate a sizable contention. This blindness becomes even more pronounced ii a
retrace or that the entire upmove is over. The Dollar is doing just fine, so slight corrections like those in the trader happens to bet the wrong way, and prevailing trend goes
against his position.

/7:e\ Wave Analyst Case Studies VII - 4

Monday 0&0 GMT of metered scenario. It proposes that a large 6 wave

Hilly“ Week of lune! '87 oomposodollivowavosisenrouteto1.930EM.andthat
As mentioned Friday. trading ob)actives at 1 .8375-1 .84 the first of these live waves terminatsd at 1.8405. The
are levels to take profits. but you may want to hang on Volker drop and subsequ en! reversal are part 01 a large
for a low hours more to see it New York will boosl the 2nd wave that is either flat or irregular. which means that
buckle 1 .3450, if you havosteel nerves, thalis. Less ad— despite another rally to 1.84 or higher, still see major
I

venturous shortlerm traders should play sale. take buying opportunity to come at the 1.784 .77 inaweek or
your money and wait for high probability trades. Eternal
bears who are waiting lot a drop to sell on may get a
chance during lhe nex124 hours. but consider the po-
I
razoo
trill 1. y.
so. A variation considers the drop to 1.7850 as all of the
2nd wave. making the overnite rally as part of a powerful
3rd wave. This is unlikely, but the power of the reversal

r ”with
lontialto 1.81-1 .81 SOsuch slim plokingsthat won'irec-
I is a burr that demands attention. The 3rd view is thal a
ommond it except to the kamikaze traders. mice failed 5th ocwrred at 1.83 in Asia. setting up 2nd wave
buy levels at 177-178 soon.
This rally ls wrning off some of the widest momentum
divergences t have seen in years. Evpevlence has
shown that when monthly. weekly, and daily rates of
if Thursday 0750 GMT

change play the same tune. It will take more than a The rally liom yesterday was stronger than expected.
I

couple of days or couple of weeks for the power lo be spawning a host of possbilities. But in the process. it
dissipated. Long term investors should do well to start 1 row nullified the specter of the Dollar falling to new lows in the
.
listening to this new music. medium~temi, an event have held unlikely in the faceol
I

technicalevidenceandgiventhopoliu'cal situation. Mean-

while we have probably seen a short-term top at 1.83
Tuesday 0750 GMT ' may ‘ Monday T Tuna-y 'wmu¢-y ' Thursday ' rum, DEM in Asia. so the buck will very likely trade lower to at
least 1.8075 over the next 24 hours. The Dollar could
Traders who heeded the take yourmoney. .. recommen- make a now, marginal top, but would recommend sell-
cm
I

dation yesterday ought to feel pleased. but before you ruin the Wodneodoy 0750 lng it for a quick downside trade. The short-term possibilities, as
record by going short bucks. consider these: Ending points of assessed by Elliott principles. are too numerous and too contra
3rd waves are most difficult to pinpoint, and am not quite sure
I The retrace was a real killer. a slammoi. a Volker, or all of the dictory at this point. So aside from this very shortlorm dollar
it the minor 3rd wave is over. Even assuming that the 3rd wave above. But the drop did nothing to change the medium-term out- sales, no other contingent moves are warranted until and unless
is over, the mutant declineloonsolldalion is but a 41h wave, and look. It did point out though that my short-term wave count was we reach 1.8075.
the following 5th wave should normally make a new peak or at wrong. A live-wave sequence ended at 1.8405. Short term mo-
least equal the 3rd, which isto say make a potential double top mentum indicators suppon the modified view that a 2nd wave Fridly nmo cm
at the 1.34 level. am not saying that you can't make a little
I base-building process is currently in the making. so wewill have
money on intradayselling. but if you do so. be sure to remember to draw short-term trading tactics with this wave count in mind. Our l .8075 objective has been satisfied. though the Dollar may
that intra-dayspaoo and not to overstay your dollar shorts. A rally backto 1.8150 is not an unreasonable assumption since tick down again to 1.8070 bid within the hour. But the scenario
it marks roughly a 50 percent retracement of the killerdrop from of an irregular and wave consolidation got much support by
A simple zigzag. the most Ilkely pattern for the 411- wave accord- 1.84. The last phase of this basebullding should be a test of the doing exactly whattheory says itwould. Cover short-term Dollar
ing to rule of alternation gets steady support at the 1.8218210 previous 1.7660-1.77 lows. look for 1.8150 being reached
I shorts taken yesterday and initiate purchases. with an oblective
area. So unlessthis retrace pattern develops into a real killer like today, and a subsequent decline during the end of the week or of 1.85, with a less likely target of 1.84. The retracement from
a double zigzag or triple three slammar. 1 am recommendan early next week 1.83 took exactly 50 percent, which Is typical ol small degree B
buying short-term trading bucks at the 1.82-18210 area for an- waves. Put stoploss at below 1 .80, because it this current slide
olhal try with 134-1345. This expected runrup ends the 5-wavo The buck has found a mediunHerrn bottom at the 1.76 area extends to more than 61.8 percent for the 1 .78601 .83 move, the
sequence. continues to get support from cycles, momentum and rate-ol- buck is playing an entirely different ball game. A break of 1 .8150
ohango analysis. and that has invevitably influenced my choice in Europe confirms.

m Wave Analyst Case Studies VII - 5

 r; 7,
. IIS$/DEM Hourly
l 18 May -12]une 87
lHigh~an—Close)

N
1.76
May 25- 29 June1- 5 June 8 - 12

./\n

Tuesday 0750 GMT Thursday 0300 cm

15200
szk of [141128 ’87

The rally from 1.8070 was aborted. electing our stop We‘ve had the rally predicted by theory. another addllim
loss at 1.30. No clear cut pattern can be deduced yet to the growing pile ol evidence at a major turn-around.
tromthe market action on Friday and Monday. but while there is a recurring pattern lhai seems to be the standard
we can‘t say what it Is, we can be unequivocal on what response when the dollar breaks out cl a tight consolida-
not:
it isn't. There's no evidence lhal the dollar is accelerat- 1ion.Thoso keeping hourly mans will see 1hat pattern on
1

ing on 1he downside. Drifting, yes, but as part ol 3 May 20 to 22. which is described in Elliott literature as flat
basing process normal Ior and waves. The best ways correction. believe we are seeing the same phenome-
I

oountso la! is to consider all the actionlvom the 1.8405 non in the USD/DEM now. It implies that the buck will
peak as part ol this 2nd wave consolidation which probably struggle to reach the 1.8035 peak or marginally
should terminate in a diagonal triangle apex at the higher levels late on the trading day. Followed by an
1.7350 area. But boprepated lorlhis retracement biting orderly drill pads to the 1.79 area. lollowed by an explo—
;
deeply into the 177 area. it it tune out to be a typical sive rally similar to that one which sired tho upmovo lo
double zigzag. The picture should clear up by tomor- 1.84. And it am right on the majorwavecount. the 1.84
I

row. Meanwhile. those still long bucks. despite our ride will look like a water pistol squirt beside the cannon-
cautionary stop at 1.80, should endeavor to cover their ”goo- baII 3rd 0! a 3rd explosion that is to come.
year by seeking reluge on the DEMJCHF cross in case
I am wrong on the gradual downward drill and the buck
Friday 0740 GMT
tall-spins instead. There will be Iotsolopponunlty to buy
modiumtorm dollars at tho 1.78477 area in a tow
am alraid the dollar did exactly as what we expected.
I

days.
Much was nothing. Om scenario yesterday has not
any ' may flu-Mr] 'wa11na¢u1 ' nun-y ' rnm,
changed, and we list and Itch with inc 1551 as we wait lor
‘

Wednesday 0750 GMT trade figures to induce some action. The biilish election
FI.N. Elliott once observed that Corrective phases, or “retrace- is the biggest non-event otthe year, insular as the lorex market
We have attained the 1 .7850 target provided by atrlangle 1h rust, ments" are often complex and are the most dillicull aspect ol the lsooncemed. andl commiseiaie with the guyswhc haveto come
so Its buying time again, at least tor the shortterm. lam also rec- wave sequence. A wave analyst can recognize points where the in 314 in the morning to watch the stoning rally. or tall. Nothing
ommending to medium-termerslo start accumulating Dollars in and may be booming, but the only cenalnty is that when it does 01 that sort happened, no sustained rally. Blame it on the Bank
anticipation ol the most powerful part ol the rally, the 37d wave end, It will have traced out one ol the eight patterns which are 01 England and that llsell Is omnious. Yes. I still believe its the
in a sequence oi live. The worst scenario now defines the risk as typical of corrections. The most straight forward. and I believe right time to got out oi Sterling. There are parallels to the current
a possible 2nd wave bottom at 1.775. but even that view the most likely. pattern being followed by the 2nd wave is a situation. Most ol the Signing rise from the lower 1 60‘s to 1.69
concedes a prlol move to 1.8030. at least. Technical analysis double zigzag, which is quite typical at this juncture. Tho llrsl was fueled by expectation of Mrs. Thatcher calling for an
students will find a 111i discussion oi the altomalives below. As zigzag is the Volkar drop "cm 1 3405, with its dramatic reversal election. As soon as she did. the pound lost 4 cents. Then the
our regular readers know. we have been waiting for today's doing the job of an X-wave. the link between two juxtaposed rally lrom 1.61 was basically in expectation 01 a conservative
dollar low since last week to issue a major buy 1600 mmendatlon. simple patterns. The 2nd zigzag may have just terminated at viciory in the polls. Now that they have it. I wonder now may cents
star-gel derived by protecting the likely counterpart oi the Volkoi 1.7825 as lwrite this. culminating in a diagonal triangle or lalling the Sterling will give away this time. This sounds irrational only
drop alter that brie! reversal. The 1.7850 objective was further wedge which should be obvious to anyone keeping hourly it you are convinced that torex rates are tied to current events.
refined yesterday by a triangle in the hourly chart, a double charts. There is no guarantee that this indeed is the 2nd wave This isn't saying that Elliolters know what is going to happen
whammyin my vocabulary. Go long bucks, despite how you 1891 bottom. For Instance, the double can develop Into a triple. but the next. merely that wave forms don't fit rationally Into changes in
about the turdamentals. This is well-documented. The public, implications ollhe wedge assures ol 3 rlselo at least 1 5030. The events.
especially the popular press. tends to be most bearish during the level where that structure began. But that Is the essence oi the
2nd wave of a major rally. In a major bear market, the public wave principle. which is assessing probabilities. And right now
psychology during 2nd waves is one at unbriddled enthusiasm. the odds Iavor a major tum-around.

m Wave Analyst Case Studies VII - 6

 Monday 0800 GMT Thursday 0800 GMT
Week of June 15 '87
This is just the start of a cannonball explosion we The forex gremlins continue to frustrate our 9110115 to get
mentioned last Thursday. We are not even on the an accurate hands on the short-term, but a colage of bils
booster-stage 3rd of a first. How to cope with the rally on and pleces from our stable of currencies suggest that my

ill-umrvl
rssoa call to sell at 1.3305 yesterday might have been prema-
showterm. Extensions are all over the place, so there
is actually no hurry to pinpoint a level at which to take ture. if moderately profitable. Thocurrenl consolidation in
short-term profits. The biggest sin atrader can commit the hourly charts suggests a triangle in the making.
new is to play cule and try to catch the top fick and implying one last gasp lo the upside. A final thrust that
attempt to reinstate his position a plennlg lower. Do this should complete a minor degree sequence. But this
and you will missthe boat just when the fun starts. I've thesis has weak spots. Example, the rtop from the
heard some people say lhatsurely1.830r1.84 must be 1.8330 top in New York last night looks impulsive. sug-
a formidable resistance. Sorry. but those foils haven't gesting that the pause at 1.8220-30 area could be a
internalized Elliott yet, and think like typical breakout 131m minor 2nd wave preceding a fairly sharp 3rd wave mop
am‘sls. When this socallod barrier gives way, as it will below the touted 1 £070 support. Throw in a caveat that
in duetime, watch the gaps in the charts as the breakout a drop below 1.82 renders this forecast of a tick—up to the
artists andlhe moving average uowd soamble back in. 13418415 areain 24 hours invalid. I hate to say this. but
5000
the only intelligent way to trade the market today is
breakout trading. The 8.0. artists will snicker, but tomor-
1

Here is how we see the dollar over the next 48 hours.

Another lrd( up to LBS-1.3280 should take place. row is another day. Break through 1.3330 mnfin'ns a
completing a mirror 3rd wave. A fairly sharp retrace move to 1 .84-1 .8415.
should follow. bringing the buck down to 13150-18050
area. This should be followed by a dollar surge to 1.84. Monday 1mm Twwly ‘ mar Friday woo our
completing a minor 5~wave sequence.
The triangle concept mentioned yesterday is starting to look
Tuesday 0740 GMT Wednedsdny 0300 GMT absurd in the Dollar/Mark. it will be tough for forecasters today.
and one more to my infinite d’lagrin, am joining the rants of the
The buck is now on the 2nd phase of a 3-legged decline which I must have missed a minor furn. or the dollar axecirted a low— breakout snisls. There are subtle clues that make me favor the
was anticipated at the 1.33 high. Elliott calls this “ , ”, pattern. “ it is, the activity does upside very slightly. For instance. the relracemenl from the
rally as a Bwave in ZigZag. It should and at about 1.8240, and not give a clear intraday picture at this point. so we look at the 1.8330 peak to the 1.82 area is 236 of the dslanco traveled by
should be followed by alairly persistenl slide 10 1.82404 5125. sterling pattern for clues. A minor degree five-wave sequence the move from 1.7825 to 1.8330. This Fibonacci ratio or 235 is
Short~termers should reinstate long bucks at that area. probably probably ended at 1 $230 in Asia today, or if not. than the cable the smallest and the least common of the ratios operative in the
in late New York or early Asia. The next run should see 1.34 is susceptible to adjustme more slight dip to 1.6210 area. This forex market. and usualy finds expression as minor 41h waves
s
wkhoul much difficulty. We Iookat 1 .34 the end of the lst wave should be followed by a recoveryto 1 .64~1 .65 lasting 2 or 3 days. or as initial stopping points of major retracements. If the current
of the 31d of C. where typically skepticism still runs rampant on |n USD/DEM terms. this translates into a possible test oi 1.8350 consolidation is part ol a sizable 2nd wave correction. as my
the longevity ot the bull move. Medium-tonnes would be better whim completes the five-wave sequence from 1.7825. A less» newest wave count suggests, then the buck should rise to about
off side-stepping the correction lrorrr the expected 1 .84 high by likely possibility is for1he buck to spiral down to 1.8170 area from 1.8275 before coming down in earnest. In the current consolida-
taking profits. Unrepentant boars will probably look at this so- current levels to complete a minor 4th wave that metamorphosed tion is a4lh wave, a Iesserpcssibillty, then expecf another strong
called formidable resistance a one more excuse to sell on. from zigzag to an irregular. llavovlhe first scenario. so we should upmove to 1.34 area before the 2nd wave correction can 90.
There is no way of predicting how low their selling frenzy will now shift short-lam strategy from buying to selling. Short Dollars From a trading point of view in Europe time therelore, favor I

depress the budt. But its a safe bet that it won‘t be much. run the tolerable risk of a final surge to 1.8360. or at worst. 1.84. going long, that Is, if you point a gun at my head and say trade.
probably not more than 50 percent of the run-up from 1 732510 But a run-up to new highs definitely completes the lst oi the 3rd Otherwise. I'll wait for new tops or break oi 1 £170 to sell.
1.84. The subsequent explosion. the 3rd wave of the 3rd. will olC. Setting up a sizable short term decline. Minimum downside
lollow with the waning oi the selling pressure. target therefore is 1 £170.

A Wave Analyst Case Sludies VII — 7

W
Monday 0700 GMT ' Thursday 0700 GMT
Week of lune 22 17
The short-term picture has suiliciently cleared up, with The decline from the 1.3490 top has completed a five
the Sterling‘s triangle finally being resolved in a spec- wave sequence. and with it the 2nd wave relracemenf.
tacular manner. The downside thrusrhas performed the soils time torthe buck to have another go for new peaks.
obligatory liveawavo sequence in the hourly chart, and is As explained below. a decline to 1.8150 completes the
rem last leg of an irregular correction, harbinger of strong
now in the process of base-building preparing for a
continuation ol the bullish trend. Technical discussion
minor 2nd wave countenrend rally later in the week The
Dollar/ka gives the same impression, as the double
lhree scenario gains ascendancy over the other possiA
j l
below. There are several reasons for adopting the very
bullish irregularcorroctlon scenario. instead of the rather
bilitlos outlined at below. A new peak would be charac- stodgy zigzagconcept. Asexpiained below. completion

of
lerisllc of double threes. As described. (we are in for a issue of a five-wave sequence from the 1.3490 highs will
$3,-

whipsaw action punctuated by false breaks of the 1.82 provokes rally to at least 1.8340.becauseoftherequire-
support and 1.8340 resistance levels), The lesser pos» ments of the zigzag pattern. But I am putting the odds on
sibility of 3 51h wave mn to 1 .84 is possible. but unsuo the view which says thatlhe powerhouse 3rdofa 3rdhes
started. ergo will be looking at 1.90 as next destination.
ported by the wave situation. It this run-up continues to
1.34. the move finishes a live-wave sequence and meow it“ Evidences: r) the fact thal the C wave drop stopped at
should be followed by the 2nd wave retracement back to 1.8150 which is 2.618 as long as the 18335482 A
the 1 $1704.32 area 81 least. The doublelhrae scenario wave. 2) 1.8150 ls 32.2 percent retracemerrt from the
is not perfect. A236 percent retracemenl is unusual. but orthodox 1 £335 lst wave peak. 3) the recoveryfrom the
not unknown for 2nd waves. But a shallow retrace is 1.8150 low is crisp, sharp, and impulsive. Could be part
harbinger of an explosive continuation of the uplrend. of a zigzag. but too many coincidences.
Start buying medium-term bucls at 1.32.
15100,
muy Monday ' Tuesday tummy ' mm mm

Tuesday 0730 GMT Wednesday 0700 GMT Fridly 0700 GMT

The action last night proved my preferred short-term count Our expectation of a longish downside retracementwes fulfilled. We've finishedlive minor waves in the run irom 1.31 501013300,
wrong with crushing finality. So. ilyou're up to your neck in the We are back on track But calling the short-farm move won‘t be which was followed by a correction toiust below 50 percent of the
sharks, itmighlbeagoodidea tohop in the boatlora while. The easy. As the 51h~wava scenario to a 1.3530 peak was not entire rally. So the dollar is 581 for another rally which should
new shcrHerm count considers the consolidation from 1 .33401o realized yesterday, I am not quite sure if the 1 32185 rally was clarify the short-term direction. once and for all. The situation is
5
1.82 minor 41h wave. a possibility ltairly dismissed yesterday. a minor 51h wave. it has the wave oountand the facial a Bwave. this. believe we are looking at the start of the fabled 3rd oi the
i

This makes the run-up from the 1.82 level a minor 51h wave, The difference in the topside target -30 pips might be slight. but 3rd. The worst is for the buck to lick down slightly before it takes
completing the so-called lst wave of the 3!!! pic. This minor 51h the downside retracement objectives between a 8 wave top and all like a rocket. The alternative -I assign 5 percent probability-
wave should be composed of Swaves itself, so we need just one a 5th wave too vary widely. it a Bwarve -my preference than all ls that the Dollar is still completing a Bwave of a large 2nd wave
stab to a new peak. say. 1 8530, after which the buck goes into we need is to soefive waves from the 1.85 peak to conclude that zigzag. a move which should bring the buck to at least 1.8375
consolidation mode once more. Tracking this 2nd wave of the the 2nd wave retracemant is over, and the3onl the 3rdis on the before leveling. No ifs, no buts. ShortAtorm and medium-term
swatches proved to be more difficulttharr usual. The new wave way up. Downside target in fhis case is 1.8250152, 111,85 was traders should be long at this point, even if had the wrong
I

count is not very cornlcnable. The run~up yesterday does not aSIhwavelcp.thadownsideralracacmgodownlc1.320reven preferred scenario. chances of a rally to at least 1.6375 today is
have lhe feel of impulse waves. The market's hesitation ls as low as 1 .8125. But allthesa arguments poimlo one thing. The much too great to miss, If the buck goes through 1.84, forget the
polpmla. and I am tempted to maintain that it is a Bwave in an downrnove is not quite over, and despite my references of it prognosis of the doom-and-gloomers because the rockets next
irregularcorrecbbn. But then, aliek-uplc 1 8530 side, this view providing buying opportunity at 13350183 area, the most we stop is 1 30.
has the some Implications as a 2nd wave retracomenl. it will can expect on the upside is a tickup just below 1.84," 1 B5 was
provide us buying opportunity at the 113350483 area to take 3 51h wave lop. Otherwisa.1ha buck slides to 1.82501hen ccn~
advantage of the so~cal|ad 3rd 0! the 3rd. sofidales.

m Wava Analyst Case Studies VII - 8

Monday 0700 GMT Thursday 0130 own
I
Manny-37
So far. so good. The book did one last downtick last We had the rally from 1.8190. Just as theory predicted.
Friday to retrace exactly 61.8 %ol the move from 1 .81 50 another boost lcthecontention that a massive dollar rally
This is one blow against the zigzag scenario and more is but a low days away The 1.80 zigzag scenario is only
support for the contention that the 3rd DI the 3rd Is 1 use a tow hoursfrom being invalidated ~a conclusion that is
underway. The rally from 1.82 out ol asia is showing a inevitable it the buck rallies above 1.3340 lrom current
classic extension signal, which is short rallies tolloweo levels. Right now. bearish alternatives look a sorry lot,
by shallow corrections. 3 pattern that can only be labeled though the Molina 3rdis not necessarily home free at
with a series of wave ones and wave twos. Conclusion. 1 arson { this point. Bu! "1 wave analysis. one must always go with
I don't think we will have any difficulty reaching 1.8375. the most simple. most straightforward wave count. as 90
1 also reduce the probability of the zigzag view to 5 percent of the time it isthe valid one. Flight now, our bird
percent The dollarrYen showstheway. but cable shorts still looks like a heron. but it is beginning to walk. waddle
willproducsthomostspectacularratumsloryourmoney. and quack like a duck. Almost certainly ll is a duck. The
if our scenario of a large and very sharp Cwavo plunge rally from 1.3190 completed five minor waves 311.8310.
back to the 1.40145 area is correct, then the pound is so the current consolidation is a minor 2nd wave which
just about 591 lor adownside 3rd wave acceleratron. should find solid support above the 1.8250 level. The
Even the cross currency picture ol the pound is bleak drop from 1.831010 1.3260 has retraced exactly 38.2
from wave analysis perspective. and one we ndors what perconlol the entire up-movelrom 1319050 expect the
economic or political development will take place to minor 3rd wave. hopefully the 31d wave we have been
trigger that devastation in motion. This flip-flop process waiting for. or at least a pan ol it. So stay long and move
I am talking about is slmllar lo the origiasti: run from stoploss to 1.3130. Add up to your longs at a break ol
DEM 13218490, than a panic drop to 1 5150. verso,
may Monday Tmmny ' wean-nay' mum-y may 1.8350. And wait patiently meantime.
Tuesday 0710 GMT
Wednesday 0700 GMT Friday 0700 GMT
The dollar's flat trajectory over the past 3 days is beginning to
make a lot oi people itch and trot. To say the least. I haven't got The Dollar is in the process of finalizing a live—wave. C phase or Thats it. the dollar has lust confirmed the rosumplion of the rally
that many calls before asking 11 haven't changed my mind. or if
I an lrrogularcorroction and should encounter solid support at the by breaking above 1 .N40. The breakthrough is not as dramatic
the 3rd of 3rd scenarlo hasn't been rnvalldated by the non-per~ 18190418180 area, in accordance with the scenario drawn up as it would normally be. because a very minor livewave so
lormaHCo over the past Iwo days. old. Truth rs, I was while yesterday. While thelive-wave decline lrom 1.8340 opens up the quence ended at t 8360 from 1.8260. Alter a few hours of
knuckles myself bull think the market action still supports me possibility ol lurther losses to 1.30. the web bl inter-related consolidation. expect the rally to pick up speed. The stop-ladder
scenario of a much higher Dollar. although we have to bear with fibonacci relationships within the price activity from the 1.8150 process, which some wave analysts are pointing at as evidence
the market lor sometime while it makes up its mind. The short recent low makes the 1 .80 target unlikely. Full technical discus- 01 weakness, is actually a very bullish phenomenon. it you don't
term picture, the next 43 hours. is somewhat tricky and will sion below. For day-traders. there is a high-probability long object to doing some research. look al the way the Dow-Jones
depend much on how the buck performs atcenairr critlcal levels. Dollartradelromthc181Soareaeveniliamwrongonlheshort- Industrial average painfully inched up lrom the August 1984 low
Full technical discussion below. lltho Dollar rises above 1 .6340 term wave count The buck should rise to at least 1.8265 in doing a series ol quick. sharp rallies followed by long and boring
during Europe trading. it has better than 70 percent chance ol Europe as a consequence 01 finishing a live wave sequence at consolidation- which was eventually followed by the phenome-
pushing above 1 84. But if the Dollar has fallen below 1.3260 by 1.3190. If the buck goes through 1.8275 today. the rally wrll nal bull rally that had no equal in history. Make no mistake about
New York openlng. then expect a drop lunher lo 1 824.3190. almostcertainlyconlinue. For medium-tormms,the dipto 3190 1 it -this rally is no flash in the pan. lwould gel worried it the buck
belore hitting solid support. But regardless of brle1 dips testing provides opponunitias to buy Dollars. or to add more in case moves up 5 plemigs rn a day at this stageof wave development.
the low at mld~1 .8t 's. the bullish outlook remains unless or until initial buying was done 311.3150. As the adage goes, what goes up too fast, would‘nt last.
1.815015 breached This will postpone the rally for a few days as
the zigzag concept prevails and entails a prior test of 1.80.

If??? Wave Analyst Case Studies VII - 9

US$/DEM Hourly
151141113 —10]uly 87
l' ‘ (High-Low-Closc) .

1.83

1.82

1.81
Jun015-19 June 22 - 26 Juno 29 - July 3 July6 - 10
 l
Monday 0700 GMT ‘ 35m Thursday 0700 GMT
Week of July 6 '87

i,/
The dollar claws its way up inch by inch. but we preier i So we had the linal move to 1.0475 -unlonunately
it that way. We are looking at a phenomenon where missing the minimum target by 5 points» which was
waves oi small degrees are showing lull resolution, lollowed by a dramatic sellofl. Lets take the Dollar drop
instead 01 being distorted by the efiect ol waves 01 larger
magnitude. It is a thrilling sight to anyone who has
training to appreciate and interpret it the right way. 1.85
r 5150 will yesterday in proper perspective. It stopped at 1 8350 in
early Europe. exactly where the previous minor 4th wave
or smaller degree ended. a typical support area tor
DEM is not so lormidable anymore, tor that matter not corrective moves such as this one. The pattern at the
even 1 £750. Otcourse. nowthal weareclose to the so slide is a Zigzag, which alternates nicely wlth the irregular
called 1 .85 resistance, the breakout artists are crawling pattern 01 the 1.831919 correction. The drop lrom the
out at the woodwork again. advocating caution at cur- raw) 15475 minor top should not go below 1.83 to preserve

“ifl
rent Ievels and going in only at a break through 1.85. our scenario cl a decisrve upside break 01 1.85 next
Actually. I should not complain. If enough traders take . Ll .
week. otherwise, an alternate scenario of lurther losses
the breakout artists seriously. that should create 8 gm)
up situation above 1.85. launching the 3rd of the 3rd ill ii 1 to 1.81 gains ascendancy. Assuming the worst short-
term picture. the Dollar should move back to about
phase with some fireworks. Labelling the count at this 111350
1.8420 palore moving down in earnest, with an eventual
point is a bit tedious because or potential extensions of objective 01 1.8150. Tactic lor the day. wait tor a move
extensions. But it is not even necessary to get a precise y“ above 1 8410 initiate short-bucks. with astop at 1.8480.
handle on the count. The wave structure is bullish. time Reverse at arty break oi 1.35, expecting at least 1.8650.
cycles are supportive, and momentum/rate-ol-change The conditions we are looking tor to conduce a spectacu-
1

indicators are tar trom overbought situ aliens. Stay long. lar breakout are still absent, so it is desirable to look lor
10300:
rm, ' Monday l Tuesday lW-mvsm‘ Thursday ' Frlflfly alternatives.
Tuesday 0130 GMT
Wednesday 0700 GMT Frlday 0700 GMT
The drill to 1.8350 retraced 50 percent or the rally lrom the
1.8260 minor 2nd wave low, so we can salely assume that a The dollar is Sllll playing by the book. so there is no reason to The tactics I proposed yesterday which says wait lor a move
mlnordthwave is overandthe buckis enroutelothe illth and last change yesterday‘s prognosis. Price action lrom the 10350 above 1.84 to inmate shartbucks... was not well thought out. and
phase 01 a minor live-wave sequence. This minor 51h wave minor low has rellned the upside target at a minimum 01 1.13450 was unduly influenced by the worst-case scenario. It doesn't
should at least equal the recent peak at 1.8490. and possibly and optimum of 1 £51 0. Maximum target is undetinabie because mean one couldn‘t make money out of it but it is risky in the light
even make a marginally higher top at 1.8510. I1 it does, please it the buck goes on an extension mode at this point, the ofour basic premise that there will be a decisive upside break oi
disregard calls to buy upon a break at 1.85. as the Dollar at that quantumlzed move wrll end anywhere between 1.57 and 1.90. 1.85 next week. We need one More rally, probably to marginal
point is susceptible to a Sizable downward retracemenl. Only in But we assign a low probability to an extension occuring at this peaks. to compl a livewave sequence lrom the June 24 -
the event oi an extension do we see the buck going beyond time. so we will draw up tactics based on a pivot at the 1.85 area. 1.81501ow. This linal rally should be composed cl 5 waves itSelt,
1.8550 immediately. and the first indication Is a break through The only thing that is keeping me trom discarding the possibility and the first might be ending at the 1 0450 area in Europe today.
1 11530. Tactics tor the next 48 hours. keep long bucks until 1.35 is the peculiar pattern oi the Sterling lrom the 1 5870 level, which Short term traders who have gone short Wlll probably lind
or thereabouts. Take profit, and reverse with a downside target is quite similar to the small triangle with apex at 1.63. The opportunities to cover at the 1.84 area later in the day, but its
01 1.8375 and a stoploss level at 1.8550. The ' is not ‘this small lr‘ ,' it Is Poundtodrop 5 cents. clear that short bucks is the more dangerous proposition today.
attractive and goes against the main trend. You are probably The triangle-like pattern lrom t 5870 is much bigger. so there is Lets take a look at the medlum~term. The prelered scenario at a
better oil staying out while waiting lor cheap Dollars again. more room tor potential trouble tor the pound here. This tnargle medium-term rally to 1.90-1.95 is still intact. But it is haying
Needles to say. rnedlumdermars should stay long bucks. The -i1 it is one— overlaps wtlh the 15050167 consolidation. which structural problems. The alternate scenario oi a wedge-like C
market is drawing closer to a point where an upside break will is a delinite negative. The only way it can maintain its integrity as wave calls lor more whipsaw consolidation between 1 3550 and
settle the bulibear issue once and for all. At this stage 01 wave a triangle. in an overlap. is tor it to be pan ct a wedge from the 1.83. The thing to remember IS that a break of 1.8150 anytime
development, don't trade the corrections. as you might miss out. 1 69 top -which raises more disturbing questions. Lets leave it at abons all 01 the above and is very bearish.
that, but watch out lor it.

A: Wave Analyst Case Studies Vll - 10

U5$lDEM Hourly
11 May » 31 Aug 37
| (Close)

June July August

7.10 1\ US$IDEM Dain
1Oct86- 30 Sept 87
(High— LorrPClosc)

2. 00-1

1.90

1.50

1.70 !

Oct 86 Nov Dec Jan 87 Feb March April

i May June
at
July Aug Sep

m Wave Analyst Case Studies wr - 11

Conclusion

”I know that most men, including those at ease with problems

of the greatest complexity, can seldom accept even the sim-
plest and most obvious truth, if it be such as would oblige
them to admit the falsity of conclusion which they have
delighted in explaining to colleagues, which they have proudly
taught to others, and which they have woven, thread by
thread, into the fabric of their lives.”

Leo Tolstoy

One of the mostexcitin g developments in science in recent years has

been the discovery of innovative techniques for unravelling the structure of
“disorder”. This is the irregular side of nature, the discontinuous and erratic
side — chaos — which has always baffled science. Chaos has posed problems
that have defied established ways of doing things; it can be said that classical
science stops where chaos begins.

This new understanding of the “law of disorder” has been dubbed

the “theory of chaos” or “non-linear dynamics”. It is a fast growing inter-
disciplinary exploration of complex systems ranging from the weather to
economics, and from the beating of the human heart to the clustering of cars
in the highways. When scientists speak of chaos, they mean erratic behavior
that appears to be random but is not. Recent discoveries are challenging
conventional approaches to random—seeming phenomena.

All: Wave Analyst

 The essence of this new approach to chaos is a search for underlying
patterns of a kind that have been discovered in a variety of seemingly
random systems. Scientists studying chemical reactions, wildlife projec-
tions, and electronic circuits have found that these systems can produce
streams of data that will rise and fall as erratically as the stock and forex
markets, indicating that they may be governed by the rule of “chaos”.

Recent findings indicate that even in the most seemingly chaotic

processes, there is always a fine geometrical structure; there is order
masquerading as randomness. No matter what the chaotic phenomenon is,
the behavior obeys the same newly discovered laws. Chaos has been found
to be ubiquitous, stable and the factual representation of reality. The neat
solutions of classical science's “deterministic probability” championed by
Laplace and a long line of science personae, has so long dominated the way
we look at nature that only a few still remember that orderly, linear systems
were the aberrations. Only a few still understand that the core of nature is
non-linear.

Recent advances in understanding chaos promise to modify that

long neglect. “The heart of chaos in mathematically accessible. Chaos now
presages the future as none will gainsay. But to accept the future, one must
renounce much of the past”; thus declared Robert Mays, a biologist -
chaologist in the September 1980 issue of Nature magazine. The implica-
tion is clear: It is now a time for a paradigm shift, a transformation in our
way of thinking of and looking at the world.

One of the first areas of endeavor that will benefit from this new
science is economic forecasting. The field has made recent headways, but
with the “globalization” of monetary flows, the parameters are starting to
become unwieldly. Economic forecasting, to put it mildly, is in big trouble.

Conclusion VIII - 1
 Starting from the 1970’s, economic forecasting has begun to re-
semble the manner by which meteorologists predict the weather. Sets of
theoretical but arbitrary mathematical equations — models — attempt to
approximate the mechanics of weather or the economy by turning out
measurements of “initial conditions” into projections of future trends.
There are unavoidable simplifications during the process; modellers hope
that this distortions are kept to a minimum. Otherwise, the model is fine-
tuned until the desirable quantities are winnowed out of the system.

The principle was: given an approximate measurement of a system’s

“initial conditions”, and given an understanding of the applicable natural or
mathematical laws, one can always calculate the approximate behavior of
the system. But there’s a catch to it. Recent discoveries in chaos theory have
brought out the fallacies of these linear suppositions into the open.

In any set of equations describing a dynamical system, it is assumed

that in accordance with linear cause-and-effect, large changes in parameters
can cause large changes in a system. Similarly, small changes cause only
small quantitative adjustments. Recent findings in the study of chaos
proved that wrong. Tiny differences in input could quickly become over-
whelming differences in output — a phenomenon given the name “sensitive
dependence on initial conditions” (SDIC). In weather forecasting, meteor-
ologists talk about the so-called “Butterfly Effect” — the counter-intuitive
concept that abutterfly stirring the air in the Amazon jungle today can have
a material effect on the weather in California next month.

Edward Lorenz, a weather forecaster who lives in Southern Califor-

nia, discovered the Butterfly Effect in 1961 after making a slight error in
typing out the initial set of conditions in a computer simulation of the
world’s weather. After this day, Lorenz concluded that long-range weather
forecasting, in its present form, must be doomed.* And that fear holds true,
too, for any long—term economic forecasting.

m Wave Analyst
 The Butterfly Effect is the culprit. In weather, as well as economics
forecasting, certain assumptions are taken at the starting point. Care is taken
that the data is as precise as instruments or statistical sampling can provide.
But there is always a compromise, one so small that modellers usually
forget that it is there: measurements can never be perfect or exact. Inevita-
bly, errors and uncertainties multiply, working their way upwards through
a chain of amplifications and replications rendering the result practically
meaningless. After the globalization of monetary flows, economic modell-
ers were similarly confronted with vastly increased number of “conditions”
to track. And as the number of conditions increased, the interaction —
together with potential for error — increased exponentially. That is why
economic modelling can be so maddeningly frustrating.

The Lorenzian effect of “sensitive dependence on initial condi-

tions” cuts a wide swath across our everyday life. Someone gets stuck in the
traffic on the way to the airport; he misses his plane, which eventually
crashes. There are less dramatic examples, but the picture remains the
same: small perturbations in our daily life's trajectory can have large
consequences.

In economics, as in life, it is also true that chain of events can, at

crisis points, magnify small changes out of proportion to their face value.
The best recent example is the series of small purchases in an obscure New
York stock market futures index at the darkest hour of the crash of
October 1987. It has been largely credited for halting the wide-spread
panic; it may have saved the world markets from a more calamitous fate.
This sensitive dependence may have been the cause of the crash in the first
place. The initial drop caused a computer program to issue a sell order,
which triggered another, which set off the next...

" ”CHAOS Making a New Science”, James Gleick, 1988, Penguin Group, London
—

Conclusion VIII - 2
 Most people assume that crisis points like this one are few and far
in between in dynamic processes. But chaos study showed that such points
are everywhere. In systems like the economy or the weather, “sensitive
dependence on initial conditions” was an inescapable consequence of the
way small patterns intertwine with, indeed even determine, the course of the
large ones.

The New York Times described it as the “financial equivalent of

water flowing uphill”. At the height of the October 1987 panic, prices of
futures contracts and their underlying equity baskets were seen moving in
precisely the wrong direction, as the computer-controlled relationships
broke down in the face of rapid swings. The wildness offered a vivid
example of how large—scale behavior are shaped from the microscopic
details of trading. As stock prices began to plummet, the turmoil had no
bearing to the grand trends of budget deficits, interest rates, or governmental
policy. At that time, “sensitive dependence on initial conditions” was the
sole determinant of the fortune —or misfortune —of millions of shareholders.

In economics, as well as in genetics and fluid dynamics, hypotheses

that account for the fluctuations in a system are divided into two camps. One
camp argues that phenomena must be regulated by some deterministic
mechanism. In other words, linear cause-and-effect accounts for most of the
behavior. The other group insists that proceSSes are naturally erratic;
movements are therefore caused by largely unpredictable environmental
factors. Whatever deterministic “tendency” — if present at all — will
therefore be cancelled out by random fluctuations. The choice was either:
(1) deterministic mathematics produced steady behavior, or (2) random
external noise produce random behavior. Chaos cuts across the heart of the
debate. It has been shown that what looked like random behavior can be
produced by simple deterministic models. And what looked like erratic
behavior actually had an exquisite structure; yet any part of it can be
indistinguishable from “noise”.

£2]: Wave Analyst

 One example of that “exquisite structure” is what has become
known as “fractals”, which means “self-similar”. Self-similarity is symme-
try across various scales. The term was coined by Benoit Mandelbrot in his
book “Fractals: Form, Chance, and Dimension” published in 1978. Recur-
sive process operates across various dimensions in fractals; certain patterns
are present inside patterns. The recursion does not only produce similar
details at finer and finer scale; it also produces detail with certain constant
measurements and diffractions within certain patterns. If transformation is
part of the process, transformation is repeated at smaller and smaller scales.

In the next few years, “fractals” are bound to become the catchword
in economic forecasting. It is the phenomena that will eventually provide
a key to understanding non-linear dynamics, and perhaps subsequently
open the door to real understanding of the dynamics of the economies of the
world.

Fractals are the basis of Elliott Wave Theory. The concept of

recursive patterns across finer and finer scales in the stock market was
proposed by Ralph N. Elliott in 1930's, antedating the formal study of non-
linear dynamics. His discovery that pattems made by taking very short-term
“snapshots ” of stock prices in, say, once every hour, are similar to patterns
formed by snapshots of once a week, or once every month; or forthat matter,
once a year. Elliott also hypothesized that the variation in the amplitude of
price fluctuations and the timing of peaks and bottoms of these swings
follow certain patterns. He. was almost certainly correct; latest advances in
chaos study tend to confirm these behaviors.

One of the most suggestive findings so far was brought about by the
collaboration of Mandelbrot with Hendrick Houthakker, an economics
professor at Harvard. James Gleick relates in his book how Houthakker had
tried to fit eight years of cotton prices to the Gaussian bell-shaped curve.
This curve represents the standard normal distribution of random processes.

Conclusion VIII - 3
The point is that when things vary, they try to stay near an average point and
they manage to scatter around the average in a reasonably smooth way. But
Houthakker was having no success; there was something strange about the
chart. There were too many large jumps. Most price changes were small of
course, but the ratio of small changes to large was not as high as he had
expected. The distribution did not fall off quickly enough. The bell curve
had too long a tail. The cotton chart did not pass the random test.

Mandelbrot was invited to Harvard by Houthakker to give a talk

about distribution of large and small incomes in an economy. When he
arrived, he was startled to see his findings already charted on the older
man’s blackboard. Houthakker explained that those were cotton prices; he
also related his inability to fit the data to the bell-shaped curve. Mandelbrot
instantly made a connection between Houthakker’s chart with his income
distribution data and other silhouettes from surprisingly disparate places. It
confirmed his idea that other laws, with different behavior, could govern
random stochastic phenomena.

Economists have little to go on when analyzing stock, commodity

or foreign exchange data. But that does not mean that they do not have a
fundamental viewpoint about price changes. One was the belief that small
transient changes had nothing in common with large, long—term changes.
The small-scale ups and downs during a day’s trading are just random
“noise” — unpredictable and uninteresting. But long-term changes are a
different matter altogether. Broad swings of prices over months or years are
determined by deep macro—economic forces, trends of wars, or recessions.
To economists, these are forces that should give way to understanding, and
therefore, predictability.

That dichotomy had no place in the findings of Mandelbrot. Instead

of separating tiny changes from the big ones, his scheme bound them
together. He was looking for patterns not at one scale or another, but across

All? Wave Analyst

every scale. There was symmetry involved~ not a symmetry of left and right
or top to bottom — but rather a symmetry of large scales being similarly
shaped as small ones. A particular price change was random and unpredict-
able from the previous, but the sequence of changes was independent of
scale: curves for daily price changes and monthly price changes matched
perfectly.

The next frontier in economic forecasting will be deciphering the

patterns which govern the amplitude of fluctuations in market data. Surpris-
ingly, the instrument that may help yield these secrets is the pendulum, or
its electronic analogues. Pendulum dynamics covers such a wide area that
a large part of the research in chaos is now devoted to this field.

Take a simple pendulum. In its simple oscillations, intuition tells us

that no matter where the swing might start, the motion will eventually settle
down to a regular back and forth pattern — the pendulum coming to the same
height everytime. That can happen. Yet, the motion in reality can also turn
erratic: first high. then low, never settling down to a steady state and never
exactly repeating a pattern of swings that came before.

These counter-intuitive results are being encountered more and

more by scientists as they peer into the prism of simple chaotic models. For
instance, take. the oscillations in a certain economic data, which can be re-
produced by a particular non-linear model. One wonders what will happen
if the system receives a sudden jolt — a perturbation of a kind that might
correspond to, say, massive selling of dollars by central banks in the foreign
exchange market.

Intuition suggests that the system will change in the desired direc-
tion. But in actuality, chaos researchers found that huge oscillations are
likely to be gin. Even if the longer trend turned solidly downwards, the path
to the new equilibrium would be interrupted by surprising movements
against the trend.

Conclusion VIII - 4
 In fact, such oscillations have been seen in the forex market in
recent years. In this example, the central banks got the desired results, but
only after an uncomfortable time lag that saw the market movement going
against them initially. Yet a trader, seeing a short-term rise in the dollar after
the selling effort, would assume that the intervention has failed. This
unpredictable behavior has not been fully understood yet, but it seems to
come mainly from a non-linear twist in the flow of energy in and out of the
system.

Unpredictable, however, does not necessarily mean random. Mar-

ket constructs based on pattern analysis, like the Elliott Wave Theory, have
had these past few years success in anticipating and coping with such
puzzling market phenomenon. Crude it may be at this stage of development,
wave analysis provides a framework upon which to assess the probabilities
of possible consequent market action after such perturbations. In the
markets subsequent quest for equilibrium — a process now known to be far
from being straight forward — the path traced enroute to a stable state is
largely unpredictable. But the fact that the eventual shape of the path to
stability will conform to one of Elliott's patterns, is almost certainly beyond
doubt. That knowledge alone is sometimes enough in formulating strategies
that will effectively handle uncertainties engendered by such perturbations.

As scientists learn more about non-linear dynamics, chaos has

become not just a theory but also a method; it has become not just a canon
of beliefs but also a way of doing science. Which brings us back to Leo
Tolstoy. Acquisition of knowledge has no constraints, except those imposed
by man on his imagination and curiosity. To profit from this new science,
one must be willing to suspend disbelief until it has been given the benefit
of the doubt. The history of science is marked by twists and reversals,
reminiscent of the oscillations predicted by the logistic difference equation
in chaos theory.

”4:2 Wave Analyst

 At this stage, there is more than even chance that a non-linear view
of reality would supplant the concept of “deterministic probability” that has
so long dominated the way we think about our economic affairs. Let us
prepare for this eventuality. Let it not be said, to paraphrase Tolstoy, that we
can not accept the simplest and most obvious truth, just because it obliges
us to admit the falsity of our current suppositions. In the end, we have
nothing to lose but mental excess baggage that should belong to the rubbish
bin of history.

Conclusion VIII -5
Illustrations by Topic

Impulse Waves
Diagonal Triangle

hum-baud
Special Type II
Expanding Type
Fifth Wave Failure II
Extensions II
IV

Zigzag Corrections
Basic II

AWNMCQ
Double Three II
Triple Three II
Deviations III
Substitutions III
III

Flat Corrections
Basic II
ON

Double Three II
00

Triple Three II
Deviations III

Irregular Corrections
Basic
\OO\

Double Three

m Wave Analyst
 Triple Three II

OMMM
, — 1

Deviations III -
Substitutions III -
III -

Triangle Corrections
Basic II - 6
Double Three H - 9
Triple Three II - 12
Deviations III - 2
Substitutions HI - 6

Complex Corrective Forms

Double Threes II - 9
Zigzag Complex II - 7
Flat Complex II - 8
Irregular Complex II - 9
Substitutions III - 7
Triple Threes II - 12
Zigzag Complex II - 10
Flat Complex II — 11
Irregular Complex II - 12
Substitutions III - 7

Illustrations by Topic - 1
Index

Blow off IV - 2

Cardinal Phase II - 1, refer Impulse Waves

Channels IV - 6
Correction Waves II - 1, II - 2, IV - 5
Cycles II 2
—

Diagonal Triangles II 3, IV - 1]
—

Expanding II - 4
Double-top/ bottom II - 5
Double-threes IV - 5

Extensions II - 3,1V - 3

Failure II 3, VI 10
— —

Fibonacci Ratios [I - 13, IV - 1, IV - 5, IV - 6

Fifth Waves IV - 3, IV - 8
Fifth Wave measurement method IV - 3, VI - 12
Flats IV - 7
Fourth Waves II —2, IV 4, IV 6
— —

Fractals VIII - 1

Impulse Waves II - 1, II 3,1V - 2

—

Irregular Flats IV - 7

Lettered Phase II - 1, refer Corective Waves

m Wave Analyst
Non-linear dynamics VIII 3 —

Numbered Phase II - 1, refer Impulse Wave

Occams Razor refer Principle of Parsimony

Poinccare, Jules Henri V 1 —

Principle of Altemation IV - 4, IV - 9
Principle of Parsimony IV 5, V - 1—

Second Waves II -2, IV - 4, IV - -6

Sell-off IV 2
—

Supercycles II 2 —

Third Waves IV - 2
Trend line IV - 6

Triangles IV 6, —

Horizontal IV - 8
Triple Threes II - 10, II 11, II - 12, III - 8
—

Wedge refer Diagonal Triangles

Zigzags IV - 5, IV - 6, IV- 10
Double IV- 10, VI—IO

Index - 1
—
BBS Publications

THE AUTHOR
Robert Balan has become accepted as one of the most widely followed
market analysts of the forex cash markets in recent years. With back-
grounds in engineering and business, he began applying the Elliott Wave
Principle to the stock market in 1977, later on, combining the wave concept
with proprietary computer technical models. From the early 1980's Mr.
Balan began providing fund management and advisory services in various
markets, including commodity and interest rate futures, preci0us metals,
and finally foreign exchange, where he has since specialized. While based
in the Philippines, he wrote a daily forex and stock market analysis for the
region's business newspapers. In early 1985 he joined as a consultant to the
treasury and forex department of Lloyds Bank in Hong Kong. He was soon
after transfered to Lloyds Bank Plc., Geneva as Vice President in charge of
technical analysis, where he published daily commentaries through Reu-
ters pages LBGB to LBGF, and Telerate pages 3450 to 3452. As of May
1989, Mr. Balan joined Swiss Bank Corporation in London as chieitechnical
analyst of the financial markets research unit within the treasury and capital
markets trading room. His daily commentaries and market analyses appear
on Reuter pages SBLL to SBLQ.

m Wave Analyst
 Order to: BBS Publications Ltd.
Authorized Distributor
Tech Mind SA.
33, route de St-Cergue
1260 Nyon Tel: (41)22 620388
Switzerland Fax: (41)22 620396

Please send: CI copies of Elliott Wave Principle—Applied to the

Foreign Exchange Markets

D $70.00 D £40.00 [3 Str115.oo

(postage & packaging included)

Name :

Position :

Organization :

Address :

Billing: Check enclosed £ / $ / Sfr

Charge: Visa D Mastercard D

Access D Eurocard D
Signature
Account Number

Expires :
:

: r
is"

' __ ' "Hf—“WW I fl—':

FOR MARKET BOOKS AND VIDEOS CALL

800.458.0939 23:32
httpzllwwweldercom
212.432.7630 overseas
718.639 8889 fax
PO Box 20555. Columbus Circle ,

New York. NY 10023. USA v