Elliott Wave Principle

Elliott Wave Principle - A Must Read For All Investors

The Elliott Wave Principle by A. J. Frost and Robert Prechter, Jr. is the definitive treatment of the Elliott Wave Principle developed by R. N. Elliott.

The book is a must read for all professional and retail investors and should be included in any financial or investment library. See my book review below.

Review of Elliott Wave Principle - Summary

The Elliott Wave Principle is the definitive work on Elliott waves and how they apply to stock markets, individual securities and commodities. The book was first published in 1978. I am reviewing the Tenth Edition, published in 2005.

The book is organized into two parts and eight chapters. Part I: ELLIOTT THEORY presents the basic ideas and terminology of the Elliott Wave Principle. PART: II ELLIOTT APPLIED describes how to apply the theory. Many illustrated charts accompany the well-written text.

The basic tenets of the Elliott Wave Principle are very clearly described in the first two chapters. The next two chapters are heavy on the mathematics behind Elliott waves and were a challenge for me. However, the material is well written with many examples that helped me to understand the math. The next three chapters were an easier read. I found the very end of Chapter 8, the last chapter, very disconcerting as the authors seemed to veer off course and ramble more about political and social issues than analyzing price patterns.

But overall I liked the book and highly recommend it to anyone interested in the stock market and investing. The book is quite thought provoking but it is not a particularly easy read so you will need to spend time and some effort with it.

Complete Review of Elliott Wave Principle

I normally start reading a book at its beginning and work my way to the end. But with this book I started with the Appendix: Long Term Forecast Update, 1982-1983, which includes verbatim text of articles published in Robert Prechter's newsletter called The Elliott Wave Theorist. In these articles, the first of which is dated January 1982 and the last one is dated August 18, 1983, Prechter used his knowledge of Elliott waves to accurately predict the upward direction of the stock market in the 1980s. At that time he was alone in saying there was "the potential for a bull market bigger than any in fifty years." The articles make for fascinating reading. They are loaded with the Elliott wave jargon and interpretation but even a person unfamiliar with the Elliott Wave Principle can understand Prechter's reasoning.

Next I turned to Chapter 1: The Broad Concept. Here the authors present basic Elliott wave concepts and terms including five-way pattern, motive phase, corrective phase, impulse, diagonal waves, extension, truncation, zigzag and many more. If you are new to Elliott waves, a wave is simply a progression of prices in one direction, either up or down. A wave can last for minutes, hours or hundreds of years.

As I read the text and studied the sample charts, I compared the Elliott wave terminology to the simple terms that I use to describe price patterns such as steep upside, three-stage upside, steep downside, double top, sideways pattern and the like. Although I think my descriptive terminology is easier for the average investor to understand, the Elliott wave methodology is much more precise and includes more information for the technically-oriented investor. The notion of waves within waves within waves at different scales captured my interest. As a student of fractals I began to understand how to visualize successive Elliott wave patterns.

Chapter 2: Guidelines of Wave Formation builds on the Elliott wave concepts presented in the first chapter. Here the authors show the ideal Elliott wave progression with an excellent annotated chart and supporting text. Next they present a very detailed set of rules and guidelines for the five main wave patterns and their variations plus combinations of patterns. Copy the lists and tape them to you computer screen for reference when you study price charts.

The most difficult material for me was the treatment of Fibonacci numbers and sequences and ratio analysis. I found the subject matter a bit obtuse so I skimmed much of Chapters 3: Historical and Mathematical Background and Chapter 4: Ratio Analysis. I am sure that the mathematically inclined person would find the material fascinating buy it was a bit much for me. However, the chapter's end provides us with real insights about the behavior of markets, "What the Wave Principle says is that mankind's progress (of which the stock market is a popularly determined valuation) does not occur in a straight line, does not occur at random, and does not occur cyclically. Rather, progress takes place in a "three steps forward, two steps back" fashion, a form that nature prefers." The authors are telling us that on a grand scale markets follow the same general law of ordered progression that occurs in the universe. This is heady stuff but it provides a grand theory that attempts to describe market fluctuations.

The progression of "jerks and jolts" is the central theme of Chapter 5: Long Term Waves. Believe it or not but the authors cobbled together one thousand years of prices and discuss them in terms of the Millennium Wave, an extremely long wave that is composed of a series of multi-century Grand Supercycles. These long waves are composed of supercycles which in turn include many cycles between five and 20 years or more. You can begin to visualize the wave within a wave within a wave pattern when you see charts of very long-term waves. Finally, the authors speculate that even longer waves could exist because "the theory of the spiraling Wave Principle suggests that there exists waves of larger degree than Epochal. Now that is one huge wave!

Chapter 6: Stocks and Commodities is a very important chapter for traders and retail investors. The authors tell us that the Elliott Wave Principle does not work particularly well for all individual stocks because the price movement of many individual stocks is subject to factors specific to a stock and not to the mass psychological phenomenon that drive markets - "Elliott will tell you if the track is fast but not which horses will win."

However, cyclical stocks and emerging growth stocks tend to be well described by the Elliott Wave Principle. The 1998 - 2000 bubble in the Internet and technology stocks was certainly driven by mass investor euphoria as they suspended disbelief and bid up prices to unsustainable levels. Similarly, Elliott waves work for some commodities and not so well for others. But gold prices tend to unfold in Elliott waves since gold fundamentals are driven largely by human sentiment

Viewers of the financial news channel CNBC routinely see and hear stock market pundits giving their views of where the market is headed and why. In a single day you will hear that the market is headed to new highs or that it is on the verge of a significant correction. Each argument is presented with vigor and conviction and some with actual data. So what is an investor to believe? Chapter 7: Other Approaches is a survey of the most popular explanations of what drives market prices: Dow Theory, Kondratieff cycles, price cycles, decennial pattern, current news, Random Walk theory, technical analysis, economic analysis and exogenous forces. The reader is left to decide whether a particular explanation merits consideration.

Chapter 8: Elliott Speaks begins with "While it may be quite dangerous to attempt the 'impossible,' a long term prediction for the stock market, we have decided to run the risk...." From their perspective in early July 1978 the authors reasoned that the then current bull market would run its course for a few years and then turn bearish in the early or middle 1980s. Later they say the current Cycle wave "should not develop into a steady, prolonged 1942-66 type of bull market ..." They then begin to develop their bearish case, which by the end of the chapter, turns out to be a market collapse of possible epic magnitude.

The chapter ends with a disconcerting essay on individual responsibility, freedom versus rights, socialist spending policies, laws of nature and more. How these rambling thoughts relate to the Elliott Wave Principle, a very objective discipline, escapes me.

I highly recommend Elliott Wave Principle. To purchase it and other Elliott Wave based books please visit the Elliott Wave International bookstore.

Also, be sure to view History's Hidden Engine, a free entertaining and informative video all about the Elliott Wave Principle and much more.

Reviewed by Richard Howard.

Posted December 12, 2006. Updated October 30, 2007.