2009-08-14: The Wave Principle
The Elliot wave principle was established by R.N. Elliott and was first published in a series of articles in Financial World in 1939. The basis of the Elliott wave theory developed from the observation that rythmic regularity has been the law of creation since the beginning of time. Elliott noted that all cycles in nature, the tide, the planets, day and night, or even life and death, had the capability for repeating themselves indefinitely.These cyclical movements were characterized by two forces: one building up and the other tearing down.

This concept of natural law also embraces an extraordinary numerical series discovered by a thirteenth-century mathematician named Fibonacci. This series is derived by taking the number 2 and adding it to the previous number in the series. Thus, 2+1=3, then 3+2=5, 5+3=8, 8+5=13, 13+8=21, 21+13=34 and so on.

Elliott argued that because humans are themselves rhythmical, their activities and decisions could be predicted in rhythms, too.
Combining his observation of natural cycles with his knowledge of the Fibonacci series, Elliot noted that the market moves forward in a series of five waves and than declines in a series of three waves. He concluded that a single cycle comprised eight waves (3,5 and 8 are Fibonacci numbers) .

The upper part of the cycle consists of five waves. Waves 1, 3 and 5 are protrend moves and are called impulse waves. Wave 2 and 4 are called corrective waves because they correct waves 1 and 3. The declining part of the cycle consists of three waves, known as a, b and c. The longest cycle in the Elliott concept is called the grand supercycle. Each grand supercycle can be subdivided into eight supercycle waves, each of which is then divided into eight cycle waves. The process continues to embrace primary, intermediate, minute, minuette, and subminuette waves.
The idea of trading using Elliott Wave patterns may sound simple. The trader identifies the main wave or Supercycle, enters long, and then sells or shorts, as the reversal is determined. This continues in progressively shorter cycles until the cycle completes and the main wave resurfaces. The caution to this is that much of the wave identification is taken in hindsight and disagreements arise between Elliott Wave technicians as to which cycle the market is in.

Elliott's market model relies heavily on looking at price charts. Practitioners study developing price moves to distinguish the waves and wave structures, and discern what prices may do next; thus the application of the wave principle is a form of pattern recognition.It may be said, that a challenge with Elliott is interpretation. Wave theorists may become entangled with the question of where one wave finished and another started. It is difficult to use this principle as a basis for forecasting. Its subjectivity in itself can be dangerous because the market is very subject to emotional influences.