You have probably heard of the Elliott Wave concept but without careful study it can be a difficult concept to understand or apply. However, it is a very interesting system that identifies cycles in the markets. All traders and investors should at least be aware of Elliot's Principles. Just keep in mind that no one really can explain why it works despite having many followers who have used it successfully.

The graphic below shows the basic pattern of five waves that are ultimately bullish along with three that ultimately are bearish. Then the pattern repeats itself and heads even higher to start a new cycle, in theory. The Elliott Wave Principle was developed in the 1930's purely through observation of price patterns. Elliot devised a complex set of rules and additional patterns to explain alternate movements, contradictions and reversals that all have their basis in this original pattern.

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While it is important to remember that defining exact Elliott Wave patterns is very subjective, they are easy to spot on some charts, especially when they occur on slow-moving large cap stocks or indexes. That is actually what prompted the writing of this article today. I noticed that since the opening of the markets on February 8, the indexes (especially the DOW) have made movements similar to the first five waves of Elliott's pattern. You can see this marked in the chart below.

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Now several of Elliott's rules invalidate this specific pattern example. One of them being that in the purest form of the pattern, the third wave is usually the longest but never the shortest as it appears to be here. However, the pattern might hold to Elliot's principles. If it does then over the next few days the market will drop slightly, come back slightly and then drop back down to about the top of the first wave before surging up higher then the top point on this chart.

The principle can be applied to any time period. The following chart is for the NASDAQ100 back to April 2006. It appears to have created one full cycle, which ended in October and is just about to start its fifth wave on a second cycle.

As we said above and as you have seen on these charts, this is highly subjective analysis. We prefer to stick with our proven, mechanized strategies but there is a large following of Elliott Waves among traders and investor out there and it is a good idea to be aware of. If you would like to know more about Elliott Waves and have a more detailed explanation of all of the rules and patterns involved, there is an extensive section devoted to it in the book The Psychology of Technical Analysis by Tony Plummer.

David J. Kosmider is the President and cofounder of TimingResearch.com which provides advice and recommendations to stock and options traders worldwide. View all of his articles and services here: http://www.timingresearch.com/