Rules are rules, and guidelines are…well, just that. Guidelines. Earlier we outlined rules for both impulsive and corrective wave patterns. These guidelines are qualitatively different for two reasons: First, they tell us what to expect, rather than defining what is allowed and what isn’t, and second, guidelines may be broken. Of course, breaking them should only be done carefully, and with good reason.
Broadly speaking, guidelines fall into two categories:
• Alternation
• And Channeling
The Alternation Guideline
Generally speaking, the concept of alternation says that the elements in the wave pattern tend to be “different from” the previous similar pattern. Here are some graphical examples of that:
Also note, that if Wave two is complicated then wave four will be probably be simple, that said, its normally that wave two is simple and sharp and Wave four complex, with triangles, double or triple zigzags, flat corrections or triangles.
Traders look for wave two to retrace 61.8% of wave one, however its more important to trace the actual pattern of the corrective structure. Traders also look for wave four to retrace to 38.2% of wave three, however us this as a guideline only.
Note that these are only examples. To borrow a quote from Frost and Prechter:
…the guideline is very broad in its application and warns the analyst always to expect something different next time around. At times it applies to the slope, length, strength and depth of waves as well as to the clarity of wave movements
The Channeling Guideline
While alternation provides guidance in terms of forecasting how a wave structure might develop, channeling guidelines provide assistance in determining how far a given move might carry. There are two situations where this guideline is used and one of those has an exception:
Using the low of wave one in a bull market and the high of wave one in a bear market and connecting that trendline to wave two to create the channel. The exception is when wave three is powerful and takes out the top trendline, however you can then use the top of wave one. The other points here in the real world of analysis wave four will break the trendline and in fact I expected it, this helps so you know to keep the trailing stop out of the way. And if wave three takes out the top of the trend line then you know its strong and that’s a buying signal.
The jury’s out as to whether arithmetic or logarithmic scale is most appropriate for use with this guideline. Frost and Prechter say to use both – Arithmetic scale for studying the short term, and logarithmic for longer term analysis. That said, start looking a the market in logarithmic in Primary degree.
Other Considerations
There are two other things to talk about here: Volume and Wave Personality. While both of these are important, they are beyond the scope of this course. We recommend studying our course on Volume Analysis for more information on these topics, but we did want to give them a brief mention here so that students will be at least passingly familiar with them.
Volume, movement requires volume, so trend either up or down will have more volume than corrective patterns, so a corrective pattern can be confirmed because the volume in the correction will be lower than the previous trend.
Wave personality, in fact I find each market has its own personality and movement has a personality and so do patterns, trends and corrections need to have the right look and feel about them and this only comes after a long time of looking at patterns, sure there are basic
personality traits such as wave one will be different from wave three and this is because of the volume entering the market as volume creates the price.
Module #4 Summary
• Concerning the Guideline of Alteration
• If Wave 2 is a sharp correction, Wave 4 will be a sideways correction, or vice versa.
• If Wave 2 is a simple correction, Wave 4 will be a complex correction, or vice versa.
• If Wave A forms only 3 waves and is sharp, Wave B will be sideways, or vice versa.
• If Wave 3 is the longest of the 3 impulsive waves, Waves 1 and 5 will tend toward equality.
• Concerning the Guideline of Channeling
• Forecasting Wave 4:
• Draw a line through the ends of Waves 1 and 3.
• Draw a parallel channel line through the end of Wave 2.
• Wave 4 can be expected to find support or resistance at this line.
• Forecasting Wave 5:
• Draw a line through the ends of Waves 2 and 4.
• Draw a parallel channel line through the end of Wave 3.
• Wave 5 can be expected to find resistance or support at this line.
• Exception: When Wave 3 is unusually strong, use the end of Wave 1 for the channel line.
Conclusion
As this course has demonstrated, gaining proficiency with Elliott Wave Theory and putting it into practice as an analytic tool is no easy task. It requires time and patience to master.
In order to successfully put theory into practice, you’ll need access to data of different timescales, including hourly, daily, and weekly, at a minimum. This differs from the charts used on the self-assessment tests you have taken, and students will likely have to go through an adjustment period to acclimate themselves to working with “live” data.
One of the difficulties you will no doubt encounter is best summed up thus:
…the Wave Principle does not provide certainty about any one market outcome….What the Wave Principle provides is an objective means of assessing the relative probabilities of future paths for the market.
This is a crucial distinction that is too often lost on people new to EWT. In many cases, you’ll find that there are a number of alternative possible wave counts. These can sometimes be eliminated or at least given a lower probability via rigorous application of the rules set forth in this course and can be ranked in order of probability via careful application of the guidelines.
It’s always wise to keep these alternative scenarios in mind and close at hand. That way, if the preferred/dominant/most probable scenario fails to develop, the alternatives can be reassessed.
Obviously, this course is not the end itself, but rather, the end of the beginning. We recommend additional courses of study before using Elliott Wave Theory to make live trades.