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Elliot Meets Dart
by: Lan H. Turner, 7-31-01

Lately, I’ve been brushing up on my Elliot Wave Theory, a casual bedtime read for most of you I know, but for those who would like to see my adaptation of the Elliot Wave Theory, please read on.  I will say this; I have so much enjoyed learning, testing and trading with the Elliot Wave, that I have included a new Elliot Wave tool into the design of the next release of my software. 

The one thing I’ve noticed about the Elliot Wave, is that it tends to give its signals well after the trend has been established, but it does give us more advanced warning of tops and bottoms, which is one of the most difficult things for most of us to determine. 

The fundamental concept behind Elliot's theory is that markets have a tendency to follow a basic five-wave advance, followed by a three-wave decline; or visa-versa.  For more experienced chartists, you would of course recognize that point five could possibly be considered the number one point of a 123 formation, or the head of a head and shoulders formation.

The one thing Elliot most wanted chartists to recognize, is that his wave theory worked on long-term charts as well as intra-day charts.  It does not matter; a wave is a wave is a wave.  The idea here is that each wave is simply a subset of another wave, just to a lesser and lesser degree.  Each wave, is itself part of the higher degree wave.

Each wave has rules; here is the basic outline:

1.      The first wave is our starting point of course, and usually appears to be nothing more than a rebound from a previous trend.

2.      The second wave usually gives back, or retraces almost the entire previous trend; this is what chartists generally consider the makings of 123 formations, double tops/bottoms, or head and shoulders formations.

3.      The third wave is one of the most important; this is where you will see your trend confirmation advancement.  Traditional chartists jump on the trend and place market entry orders on the break above the number one wave.  You usually see a large jump in volume and open interest around this time as well.  One rule to remember for the third wave; this wave cannot be the shortest of the five waves.

4.      The fourth wave is a corrective wave, giving back some of the advancement of the third wave.  You will often see triangles, pennants or flags during the fourth wave.  Remember, triangles, pennants and flags are consolidation / continuation patterns and generally break out in the same direction as the overall trend.  The major rule to remember about the fourth wave; is that the bottom of the fourth wave can never overlap the top of the first wave.

5.      The fifth trend is usually the strongest of the five, giving most of the markets growth during this stage.  But it is during this stage that the markets momentum begins to slow, and many of our technical indicators begin to show signs of being overbought or oversold, an attempt to tell us that the market is beginning to lose momentum.

a.       Wave A is usually misinterpreted as a regular pullback in the trend, but this is where you could possibly start seeing new annual highs, setting us up for a 123 formation, or a head and shoulders reversal.

b.      The B wave is a small bounce back towards wave five, but of course cannot exceed that level.  This is where chartists look to exit their position, or begin to setup for an entry in the opposite direction.

c.       Wave C confirms the end of the up trend, and on its pass beyond wave A, begins the market cycle all over again in the opposite direction.

Now, I want to simply show you a quick adaptation I came up with the other day while playing with Gecko-Charts.  (I’m very fortunate in my job, since I’m the head designer of Gecko-Charts; I spend most of my day simply playing with the features of the software and analyzing the markets.  Shhh, don’t tell anyone…I call this work!  I guess you could say I trade for a living...)

In Gecko-Charts, we have a tool called the “Dart” tool, a market educator named David Duty has popularized it, but he does not call them darts, he calls them Blips.  After reading David’s course material on his Blip formation, I believe he has come up with a very unique set of rules for trading these formations.  I’ve taken David's “Blip” trading rules and combined them with the Elliot Wave theory, and this is what I’ve come up with.

You’ve all heard the phrases “The trend is your friend” and “Don’t buck the trend.”  Well, given this thought, what we want to do is rather than try to trade the markets in the traditional method of picking tops and bottoms using the long established, head and shoulders or 123 formations, I’ve been trying a more simple method of just trading the trend!  This is what I’ve been doing as of late, and I’ve found good luck in it; so I thought I would share it with you here, and let you paper trade some markets with me, using my new idea.

We just covered the Elliot Wave, and I touched on the Dart / Blip, but to give a little more detail into the Dart / Blip, please take a look at the above example.  A Dart, or a Blip formation as David Duty calls it, is one of those little three-day peaks, or points; they make a formation that looks like a little dart.  Well, what I’ve been doing is watching the Elliot Wave and simultaneously looking for Blip retracements.  I look for a Blip as the confirmation of the Elliot Wave’s No.2, No.3, and No. 4 retracement formations.  I want to catch these three moves through the Elliot Wave, and trade them. Then, I use the Blip on the number five point as my exit point, or I look for the 50% retracement of the last major move, and set a Limit order.  Always make sure to follow your entry orders with stops.  I've got a dozen variations on the same theme, but after you play with this for awhile, you'll get the hang of it, and then start developing your own strategies -- it really is quite simple, fun and profitable; thanks of course to my Gecko-Charts!

Here are several charted examples:

The above example is a basic Elliot Wave in 2001Z Soybean Oil.  The numbers six, seven and eight points correlate with Elliot's a, b, and c points.  This is a current chart as of the writing of this article, many of you may be watching that 123 bottom formation, and considering a trade.  See how they tie together!

Let's play with the Elliot Wave theory a little, and see how well we can predict market direction.  If our Elliot wave prediction is correct, we should be seeing crude prices drop in the next several months.  Did you notice the head and shoulders at the top of that wave?  If you were trading that head and shoulders formation, some of you would be shorting the market right about now.  I sold a bunch of options back in mid May, above the market; of course I was expecting a drop -- pocketed a tidy little profit.

Now it's your turn, play with your Elliot wave, use it to help predict market momentum and direction, and don't forget to watch for Dart / Blip formations at the reversal points.  Remember, the Elliot Wave is simply another indicator to help you make your trading decisions; as with any indicator or tool, it is not always totally accurate.

Happy trading...
Lan H. Turner, a.k.a. The PitMaster

PS.  After I posted my new picture on www.LanTurner.com, many of you wrote and asked me to post a picture of my wife too, so I have.  Swing by my personal website, and you can see a picture of the lovely Mrs. PitMaster.

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