Elliott noted that a parallel trend channel typically marks the upper and lower boundaries of an impulse wave, often with dramatic precision. You should draw one as early as possible 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.)
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 our depiction 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.
Always remember that all degrees of trend are operating at the same time. Sometimes, for instance, a fifth wave of Intermediate degree within a fifth wave of Primary degree will end when it reaches the upper channel lines at both degrees simultaneously. Or sometimes a throw-over at Supercycle degree will terminate precisely when prices reach the upper line of the channel at Cycle degree.
Zigzag corrections often form channels with four touch points. One line connects the starting point of wave A and then end of wave B; the other line touches the end of wave A and end of wave C. Once the former line is established, a parallel line drawn from the end of wave A is an excellent tool for recognizing the exact end of the entire correction.
Within a parallel channel or the converging lines of a diagonal, 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 a "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 burst of volume.
A throw-over is 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. A throw-over is confirmed by an immediate reversal back below the line. A throw-over can also occur, with the same characteristics, in a declining market. Elliott correctly warned that a throw-over at large degree causes difficulty in identifying the waves of smaller degree during the throw-over, as smaller degree channels are sometimes penetrated on the upside during the final fifth wave. Figures 1-17, 1-19 and 2-11 show real-life examples of throw-overs.
Elliott contended that the necessity of channeling on semilog scale indicated the presence of inflation. To date, no student of the Wave Principle has questioned this assumption, which is demonstrably incorrect. Some of the differences apparent to Elliott may have been due to differences in the degree of waves that he was plotting, since the larger the degree, the more necessary a semilog scale usually becomes. On the other hand, the virtually perfect channels that were formed by the 1921-1929 market on semilog scale (see Figure 2-11) and the 1932-1937 market on arithmetic scale (see Figure 2-12) indicate that waves of the same degree will form the correct Elliott trend channel only when plotted selectively on the appropriate scale. On arithmetic scale, the 1920s bull market accelerates beyond the upper boundary, while on semilog scale the 1930s bull market falls far short of the upper boundary.
Figure 2-11 Figure 2-12
Regarding Elliott’s contention concerning inflation, we note that the period of the 1920s actually accompanied mild deflation, as the Consumer Price Index declined an average of .5% per year, while the period from 1933 to 1937 was mildly inflationary, accompanying a rise in the CPI of 2.2% per year. This monetary background convinces us that inflation is not the reason behind the necessity for use of semilog scale. In fact, aside from this difference in channeling, these two waves of Cycle dimension are surprisingly similar: they create nearly the same multiples in price (six times and five times respectively), they both contain extended fifth waves, and the peak of the third wave is the same percentage gain above the bottom in each case. The essential difference between the two bull markets is the shape and time length of each individual subwave.
At most, we can state that the necessity for semilog scale indicates a wave that is in the process of acceleration, for whatever mass psychological reasons. Given a single price objective and a specific length of time allotted, anyone can draw a satisfactory hypothetical Elliott wave channel from the same point of origin on both arithmetic and semilog scale by adjusting the slope of the 75 waves to fit. Thus, the question of whether to expect a parallel channel on arithmetic or semilog scale is still unresolved as far as developing a tenet on the subject. If the price development at any point does not fall neatly within two parallel lines on the scale you are using, switch to the other scale in order to observe the channel in correct perspective. To stay on top of all developments, you should always use both.
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