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Elliott Wave Principle and Volume


Elliott used volume as a tool for verifying wave counts and in projecting extensions. He recognized that in a bull market, volume has a natural tendency to expand and contract with the speed of price change. Late in a corrective phase, a decline in volume often indicates a decline in selling pressure. A low point in volume often coincides with a turning point in the market. In a normal fifth wave below Primary degree, volume tends to be less than in the third wave. If volume in an advancing fifth wave of less than Primary degree is equal to or greater than that in the third wave, an extension of the fifth is in force. While this outcome is often to be expected anyway if the first and third waves are about equal in length, it is an excellent warning of those rare times when both a third and a fifth wave are extended

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At Primary degree and greater, volume tends to be higher in an advancing fifth wave merely because of the natural long term growth in the number of participants in bull markets. Elliott noted, in fact, that volume at the terminal point of a bull market above Primary degree tends to run at an all-time high. Finally, as discussed earlier, volume often spikes briefly at the throw-over point of a parallel trend channel line or the resistance line of a diagonal. (Upon occasion, such a point can occur simultaneously, as when a diagonal fifth wave terminates right at the upper parallel of the channel containing the price action of one larger degree.)


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In addition to these few valuable observations, we have expanded upon the importance of volume in various sections of this book. To the extent that volume guides wave counting or expectations, it is most significant. Elliott once said that volume independently follows the patterns of the Wave Principle, a claim for which the authors find no convincing evidence.

Figure 2-13

The "Right Look"

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The overall appearance of a wave must conform to the appropriate illustration. Although any five-wave sequence can be forced into a three-wave count by labeling the first three subdivisions as a single wave A, as shown in Figure 2-13, it is incorrect to do so. Elliott analysis would lose its anchor if such contortions were allowed. If wave four terminates well above the top of wave one, a five-wave sequence must be classified as an impulse. Since wave A in this hypothetical case is composed of three waves, wave B would be expected to drop to about the start of wave A, as in a flat correction, which it clearly does not. While the internal count of a wave is a guide to its classification, the right overall shape is, in turn, often a guide to its correct internal count.

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The "right look" of a wave is dictated by all the considerations we have outlined so far in the first two chapters. In our experience, we have found it extremely dangerous to allow our emotional involvement with the market to let us accept a wave count that reflects disproportionate wave relationships or a misshapen pattern merely on the basis that the Wave Principle’s patterns are somewhat elastic.

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Elliott cautioned that "the right look" may not be evident at all degrees of trend simultaneously. The solution is to focus on the degrees that are clearest. If the hourly chart is confusing, step back and look at the daily or weekly chart. Conversely, if 77 the weekly chart offers too many possibilities, concentrate on the shorter term movements until the bigger picture clarifies. Generally speaking, you need short term charts to analyze subdivisions in fast moving markets and long term charts for slowly moving markets.

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      Figure 2-15
      downswing. Nearly everyone was proclaiming a new bull market. Services were extremely bullish, and the upside volume was running higher than at the peak in 1929.
      — The 1961-1962 rise was wave (b) in an (a)-(b)-(c) expanded flat correction. At the top in early 1962, stocks were selling at unheard of price/earnings multiples that had not been seen up to that time and have not been seen since. Cumulative breadth had already peaked along with the top of the third wave in 1959.
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      8) C waves — Declining C waves are usually devastating in their destruction. They are third waves and have most of the properties of third waves. It is during these declines that there is virtually no place to hide except cash. The illusions held throughout waves A and B tend to evaporate and fear takes over. C waves are persistent and broad. 1930-1932 was a C wave. 1962 was a C wave. 1969-1970 and 1973-1974 can be classified as C waves. Advancing C waves within upward corrections in larger bear markets are just as dynamic and can be mistaken for the start of a new upswing, especially since they unfold in five waves. The October 1973 rally (see Figure 1-37), for instance, was a C wave in an inverted expanded flat correction.
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      10) E waves — E waves in triangles appear to most market observers to be the dramatic kickoff of a new downtrend after a top has been built. They almost always are accompanied by strongly supportive news. That, in conjunction with the tendency of E waves to stage a false breakdown through the triangle boundary line, intensifies the bearish conviction of market participants at precisely the time that they should be preparing for a substantial move in the opposite direction. Thus, E waves, being ending waves, are attended by a psychology as emotional as that of fifth waves.
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      Because the tendencies discussed here are not inevitable, they are stated not as rules, but as guidelines. Their lack of inevitability nevertheless detracts little from their utility. For example, take a look at Figure 2-16, an hourly chart of the most recent market action, the first four Minor waves in the DJIA rally off the March 1, 1978 low. The waves are textbook Elliott from beginning to end, from the length of waves to the volume pattern (not shown) to the trend channels to the guideline of equality to the retracement by the "a" wave following the extension to the expected low for the fourth wave to the perfect internal counts to alternation to the Fibonacci time sequences to the Fibonacci ratio relationships embodied within. Its only atypical aspect is the large size of wave 4. It might be worth noting that 914 would be a reasonable target in that it would mark a .618 retracement of the 1976-1978 decline.
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      There are exceptions to guidelines, but without those, market analysis would be a science of exactitude, not one of probability. Nevertheless, with a thorough knowledge of the guidelines of wave structure, you can be quite confident of your wave count. In effect, you can use the market action to confirm the wave count as well as use the wave count to predict market action.
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      Notice also that Elliott wave guidelines cover most aspects of traditional technical analysis, such as market momentum and investor sentiment. The result is that traditional technical analysis now has a greatly increased value in that it serves to aid the identification of the market’s position in the Elliott wave structure. To that end, using such tools is by all means encouraged.
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