Channeling
Wave Equality
One of the guidelines of the Wave Principle is that two of the motive waves in a five-wave sequence will tend toward equality in time and magnitude. This is generally true of the two non-extended waves when one wave is an extension, and it is especially true if the third wave is the extension. If perfect equality is lacking, a .618 multiple is the next likely relationship (the use of ratios is covered in Lessons 16-25).
When waves are larger than Intermediate degree, the price relationships usually must be stated in percentage terms. Thus, within the entire extended Cycle wave advance from 1942 to 1966, we find that Primary wave [1] traveled 120 points, a gain of 129%, in 49 months, while Primary wave [5] traveled 438 points, a gain of 80% (.618 times the 129% gain), in 40 months (see Figure 5-3), far different from the 324% gain of the third Primary wave, which lasted 126 months.
When the waves are of Intermediate degree or less, the price equality can usually be stated in arithmetic terms, since the percentage lengths will also be nearly equivalent. Thus, in the year-end rally of 1976, we find that wave 1 traveled 35.24 points in 47 market hours while wave 5 traveled 34.40 points in 47 market hours. The guideline of equality is often extremely accurate.
Charting the Waves
A. Hamilton Bolton always kept an "hourly close" chart, i.e., one showing the end-of-hour prices, as do the authors. Elliott himself certainly followed the same practice, since in The Wave Principle he presents an hourly chart of stock prices from February 23 to March 31, 1938. Every Elliott Wave practitioner, or anyone interested in the Wave Principle, will find it instructive and useful to plot the hourly fluctuations of the DJIA, which are published by The Wall Street Journal and Barron's. It is a simple task that requires only a few minutes' work a week. Bar charts are fine but can be misleading by revealing fluctuations that occur near the time changes for each bar but not those that occur within the time for the bar. Actual print figures must be used on all plots. The so-called "opening" and "theoretical intraday" figures published for the Dow averages are statistical inventions that do not reflect the averages at any particular moment. Respectively, these figures represent a sum of the opening prices, which can occur at different times, and of the daily highs or lows of each individual stock in the average regardless of the time of day each extreme occurs.
The foremost aim of wave classification is to determine where prices are in the stock market's progression. This exercise is easy as long as the wave counts are clear, as in fast-moving, emotional markets, particularly in impulse waves, when minor movements generally unfold in an uncomplicated manner. In these cases, short term charting is necessary to view all subdivisions. However, in lethargic or choppy markets, particularly in corrections, wave structures are more likely to be complex and slow to develop. In these cases, longer term charts often effectively condense the action into a form that clarifies the pattern in progress. With a proper reading of the Wave Principle, there are times when sideways trends can be forecasted (for instance, for a fourth wave when wave two is a zigzag). Even when anticipated, though, complexity and lethargy are two of the most frustrating occurrences for the analyst. Nevertheless, they are part of the reality of the market and must be taken into account. The authors highly recommend that during such periods you take some time off from the market to enjoy the fruits of your hard work. You can't "wish" the market into action; it isn't listening. When the market rests, do the same.
The correct method for tracking the stock market is to use semilogarithmic chart paper, since the market's history is sensibly related only on a percentage basis. The investor is concerned with percentage gain or loss, not the number of points traveled in a market average. For instance, ten points in the DJIA in 1980 meant nothing, a one percent move. In the early 1920s, ten points meant a ten percent move, quite a bit more important. For ease of charting, however, we suggest using semilog scale only for long term plots, where the difference is especially noticeable. Arithmetic scale is quite acceptable for tracking hourly waves since a 300 point rally with the DJIA at 5000 is not much different in percentage terms from a 300 point rally with the DJIA at 6000. Thus, channeling techniques work acceptably well on arithmetic scale with shorter term moves.
Channeling Technique
Elliott noted that parallel trend channels typically mark the upper and lower boundaries of impulse waves, often with dramatic precision. The analyst should draw them in advance to assist in determining wave targets and provide clues to the future development of trends.
The initial channeling technique for an impulse requires at least three reference points. When wave three ends, connect the points labeled "1" and "3," then draw a parallel line touching the point labeled "2," as shown in Figure 2-8. This construction provides an estimated boundary for wave four. (In most cases, third waves travel far enough that the starting point is excluded from the final channel's touch points.)
Figure 2-8
If the fourth wave ends at a point not touching the parallel, you must reconstruct the channel in order to estimate the boundary for wave five. First connect the ends of waves two and four. If waves one and three are normal, the upper parallel most accurately forecasts the end of wave five when drawn touching the peak of wave three, as in Figure 2-9. If wave three is abnormally strong, almost vertical, then a parallel drawn from its top may be too high. Experience has shown that a parallel to the baseline that touches the top of wave one is then more useful, as in the illustration of the rise in the price of gold bullion from August 1976 to March 1977 (see Figure 6-12). In some cases, it may be useful to draw both potential upper boundary lines to alert you to be especially attentive to the wave count and volume characteristics at those levels and then take appropriate action as the wave count warrants.
Figure 2-9
Figure 6-12
Throw-over
Within parallel channels and the converging lines of diagonal triangles, if a fifth wave approaches its upper trendline on declining volume, it is an indication that the end of the wave will meet or fall short of it. If volume is heavy as the fifth wave approaches its upper trendline, it indicates a possible penetration of the upper line, which Elliott called "throw-over." Near the point of throw-over, a fourth wave of small degree may trend sideways immediately below the parallel, allowing the fifth then to break it in a final gust of volume.
Throw-overs are occasionally telegraphed by a preceding "throw-under," either by wave 4 or by wave two of 5, as suggested by the drawing shown as Figure 2-10, from Elliott's book, The Wave Principle. They are confirmed by an immediate reversal back below the line. Throw-overs also occur, with the same characteristics, in declining markets. Elliott correctly warned that throw-overs at large degrees cause difficulty in identifying the waves of smaller degree during the throw-over, as smaller degree channels are sometimes penetrated on the upside by the final fifth wave. Examples of throw-overs shown earlier in this course can be found in Figures 1-17 and 1-19.
