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Can you illustrate how knowledge of “wave structure” comes into play when trading?

For instance, the bottom of the fourth wave, which is a pullback, cannot overlap the peak of the first rally. If it does, then it’s not a fourth wave. The fourth wave is still ahead of you, and the third wave is subdividing. Knowing this tenet can keep you out of a lot of trouble that an armchair wave counter would encounter. Another very basic tenet is that wave three is never the shortest. It is usually the longest. Wave three is the recognition stage when most people get aboard.

But if there is always a correct pattern, and it is only a matter of seeing it, why aren’t accuracy levels higher than the 40%, 50%, 60% or even the 80% ratios of hits to misses?

First, just because R.N. Elliott discerned that the market follows rules as in a chess game doesn’t mean you can predict the market’s next move. All you can give are probabilities. But the psychological difficulties are at least an equal impediment. Hamilton Bolton once said that the hardest thing he had to learn when using Elliott was to believe what he saw. Despite all I know, I have fallen prey to that problem more than once. The fact that even perfect analysis only results in the best probability provides the uncertainty that feeds the psychological unease. As Frost is fond of saying, “The market always leaves its options open.” So when you combine human weakness with a game of probability, the result is many errors in judgment. Nevertheless, I must stress that the ratio of success with Elliott is better than that with other approaches, and that is the only rational basis for judging its value. Besides, the inestimable value of the Wave Principle is not so much that it provides a high percentage of correct “calls” on the market, but that it always gives the investor a sense of perspective.

Is it possible that the system merely takes into account every possible pattern and thus allows the practitioner to force things into a satisfactory wave count retrospectively — but not prospectively?

No, for two reasons. First, if that were true, then there would be no record of success such as the Wave Principle has over the decades. There are numerological approaches to the market, ones based on fantasy that may as well be dealing with a random walk, and they produce worthless results, as they should. As Paul Montgomery likes to say, a good test of a theory is whether it can predict. Second, there are many non-Elliott patterns that the market could trace out if it were a random walk; but it has never done it. I have never seen a market unfold in other than an Elliott Wave pattern.

Have you ever had a sure thing — a case where the market absolutely had to go up or down?

All Elliott can do is order the probabilities, and they are never 100%. But there have definitely been times when my own mind felt that the probability was 100%. I get so excited I can barely contain myself when that happens. I’m usually right then, but not always!

Keep in mind that while one can never say that a certain event must happen, there are times when one can say that a particular market event is impossible. There’s always an alternate count, but there are certain things that can’t happen under Elliott. And that is a very useful fact.

The calls you made on stocks, bonds and gold helped you to establish yourself as a media presence in the 1980s. But one response to the record is to say that the Wave Principle is not behind your success. Some say it is gut feel or instinct, rather than the method. In other words, it’s not the theory, it’s the theorist. You’ve always insisted that it is the Wave Principle. How can you be sure it’s giving you the edge and not the other way around?

Gut feel and instinct will get you clobbered in the market. The market is the collective gut, which means you have to be counter-instinctual to beat it. The only way to do that is with a method that takes that reality into account.

Looking in more detail at an Elliott wave, what is the progression that takes place over the course of an "impulse," which is Elliott’s term for the classic five-wave pattern?

If you watch any of these wave structures, whether over the last 40 weeks, 40 years or 40 minutes, you see the same progression recurring. After a market reaches its low, so-called strong hands — people who have been around a long time, do some buying. Psychology has passed its low point. News remains scary because it is the tangible result of the prior downtrend in psychology. That is the first wave up.

Then the second wave, the correction of the first move, takes place. The vast majority of investors are convinced that wave 1 was merely a bounce in the previous bear market and that wave 2 is the beginning of the next phase of decline. Usually, the fears that were around at the actual bottom recur at the bottom of wave 2. Again, news is very dark, but the prices are ahead of news. They do not fall to a new low.

From that base, wave 3 begins, which is the middle portion of the larger advance, and that third wave is almost always accompanied by increasingly positive news and "fundamentals." Those better fundamentals are the result of the increase in optimism, and they reinforce the psychological upturn. That is why wave 3, as Elliott noted, is most often the longest, strongest and broadest in the sequence. Every day, there is reason to be optimistic. All of those people who thought during waves 1 and 2 that the long-term trend was down finally become convinced that the long-term trend is up.

That change persists all the way to the top of wave 3. Then comes wave 4, which is a correction of that long third. Most people have finally become convinced by the top of wave 3 that the long-term trend is up. Wave 4 is a surprising disappointment.

From the fourth wave correction low, the market stages the final wave up. The fifth wave is generally easy to recognize because the psychology tends to be more speculative and euphoric, while at the same time, the internal strength, or momentum, of the market is not as strong as it was during wave 3. The psychology goes through its final binge in the fifth wave. That’s when, figuratively speaking, the last guy puts his last nickel in, and that’s the end of the sequence.

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