Elliot discovered that the ever-changing path of stock market prices reveals a structural design that in turn reflects a basic harmony found in nature. From this discovery, he developed a rational system of market analysis.
Under the Wave Principle, every market decision is both produced by meaningful information and produces meaningful information. Each transaction, while at once an effect, enters the fabric of the market and, by communicating transactional data to investors, joins the chain of causes of others’ behavior. This feedback loop is governed by man’s social nature, and since he has such a nature, the process generates forms. As the forms are repetitive, they have predictive value.
In markets, progress ultimately takes the form of five waves of a specific structure. Three of these waves, which are labeled 1, 3 and 5, actually effect the directional movement. They are separated by two countertrend interruptions, which are labeled 2 and 4. The two interruptions are apparently a requisite for overall directional movement to occur.
At any time, the market may be identified as being somewhere in the basic five wave pattern at the largest degree of trend. Because the five wave pattern is the overriding form of market progress, all other patterns are subsumed by it.
The 5 wave pattern is often followed by 3 corrective waves labelled as A-B-C.
There are two modes of wave development: impulsive and corrective. Impulsive waves have a five wave structure, while corrective waves have a three wave structure or a variation thereof. Impulsive mode is employed by both the five wave pattern and its same-directional components, i.e., waves 1, 3 and 5. Their structures are called “impulsive” because they powerfully impel the market. Corrective mode is employed by all countertrend interruptions, which include waves 2 and 4. Their structures are called “corrective” because they can accomplish only a partial retracement, or “correction,” of the progress achieved by any preceding impulsive wave. Thus, the two modes are fundamentally different, both in their roles and in their construction, as will be detailed in an upcoming section.
Waves can be repeatedly subdivided into lower degrees as follows:
