Elliott Wave Principle: Key to Market Behavior

by A.J. Frost and Robert Prechter

Overview

Originally published in 1978 and updated in subsequent editions, this book is the authoritative text on the Elliott Wave Principle. A.J. Frost and Robert Prechter present Ralph Nelson Elliott's theory that stock market prices, as expressions of mass psychology, unfold in recognizable patterns that are fractal in nature -- the same structures appear at every degree of trend.

The Basic Pattern

The fundamental Elliott Wave pattern consists of five motive waves in the direction of the larger trend (labeled 1, 2, 3, 4, 5) followed by three corrective waves (labeled A, B, C). This eight-wave cycle is the building block of all market movement. Each wave subdivides into waves of lesser degree following the same pattern, creating a self-similar fractal structure.

Motive Waves

Motive waves subdivide into five waves and drive the market in the direction of the larger trend. Rules govern motive waves: Wave 2 cannot retrace more than 100% of Wave 1; Wave 3 cannot be the shortest of waves 1, 3, and 5; Wave 4 cannot overlap the price territory of Wave 1. Extensions (elongated waves), diagonals, and truncations are cataloged.

Corrective Waves

Corrective waves subdivide into three waves (or variations thereof) and move against the larger trend. The book catalogs zigzags, flats (regular, expanded, running), triangles, and complex corrections (double and triple combinations).

Fibonacci Relationships

Elliott discovered that wave relationships often conform to Fibonacci ratios. The book explains how these ratios (0.382, 0.500, 0.618, 1.000, 1.618, 2.618) help forecast the length and proportion of waves.

Practical Application

The authors demonstrate wave counting on historical charts of the DJIA from the 1700s through publication, provide guidelines for identifying the current wave position, and discuss the implications for market forecasting. Elliott's original prediction of a great bull market from the 1940s (when the Dow was in the 100s) serves as dramatic evidence of the principle's predictive power.

Limitations

The book acknowledges that wave counting can be ambiguous, particularly in real-time, and that multiple valid interpretations often exist. The skill lies in assigning probabilities to competing counts.