Introducing the Elliott Wave Principle

How Ralph Elliott’s Famous Stock Market Cycle Theory Came About

Feb 18, 2009

Ralph Elliott spent retirement convalescing. During this time he discovered pattern and predictability in the US share market, and formulated his famous Wave Principle.

Ralph Nelson Elliott (1871 – 1948) was an American born in Marysville, Kansas. In his youth, he was employed, amongst other things, as a telegraph operator, train dispatcher and station hand. In 1896 he chose to enter the accounting profession and worked in New York City for six years. He became quite familiar with the Wall Street area, preparing reports in the financial district.

Elliott then travelled extensively for the next 25 years and also worked for railroad companies in Mexico and Guatemala, until forced by illness to retire back to his native California. During three convalescent years, on his front porch, he studied the roaring bull market’s stock market charts of the past eight years.

A Wave Pattern of Markets Emerges

Elliott’s theory of markets was formulated entirely from empirical evidence. He discovered a pattern of previous share behavior that seemed to account for the many times the known patterns failed. He saw a wave rising, falling back, and rising again repeatedly and on many time scales (Fig 1).

Elliott in Action

By 1934, Elliott’s theory was sufficiently developed that he decided to present it to at least one member of the financial community, Charles J. Collins. Collins was intrigued but not convinced. However, he would be happy to monitor Elliott’s “calls” of the market.

In March 1935 the Dow Jones Rail Average was in decline. Elliott was forecasting that that the Rails would break their 1934 low but the Industrials would not. Elliott cabled Collins on the day that saw the Dow Jones touch an important low; insisting that the market correction was over and that another leg of the bull market had begun. These were forecasts that later struck Collins as uncannily accurate.

System of Labelling Wave Patterns

Elliott used his Wave Principle to map fluctuations in the stock market, which are fragments of a great rhythmic system of waves and cycles in ascending and descending orders of magnitude.

Early economists had already put forward cyclical theories, but Elliott was the first person to apply them to stock market behavior. This rhythm he argued, is repeated in the various forms of nature in the universe.

Elliott gave us an upward movement of five waves, three up (1, 3, 5) and two down (2, 4), with the former longer than the latter. After the fifth wave, the momentum is downward in three corrective waves (A, B, C), with two down (A, C) and one up between the two (B), but shorter than its predecessor.

Labelling Market Wave Scales

A market impulse begins with one major long-term market force, which Elliott subdivided into lesser short-term forces. To explain the different scales (Fig 2), he coined his own terminology:

From here, he continued down the scale with an intermediate, minor, minute, minuette, and finally a sub-minuette cycle.

Elliott's Published Works

Elliott published his findings in two articles. “The Wave Principle” was published in The Financial World in 1939. Seven years later, he published in "Nature's Law -- The Secret of the Universe" his deepened and updated thesis. Elliott died two years later in 1948.

Elliott's legacy has been the basis for trading stocks, commodities, forex, etc., according to the tenets of the Wave Principle. Today, traders map out the markets by labelling waves on stock chart paper, or using stock trading software.

The copyright of the article Introducing the Elliott Wave Principle in Investment is owned by Harry P. Schlanger. Permission to republish Introducing the Elliott Wave Principle in print or online must be granted by the author in writing.