The Wave 2 Rule Collides With Reality

I’ve saved the blockbuster ending for the last, with a chart. But first, let’s see how we got there.

Here’s what the experts have said about the the Elliott Wave Principle’s Wave 2 rule.

“Wave two rarely cancels all of the ground gained by wave one.” –R.N. Elliott, The Wave Principle (1938)

“Wave 2 never moves beyond the start of wave 1.” –Robert Prechter and Alfred J. Frost (2005 edition)

“Wave 2 can never retrace more than 100% of wave 1.” –Wayne Gorman and Jeffrey Kennedy (2013)

And yet, on Tuesday, August 18, 2020, at 9:48 a.m. New York time, Primary wave 2 of the S&P 500 index, a upward correction within a descending Cycle wave 1, broke the rule, rising above the start of Primary wave 1 — 3393.52 — by 1.54 points.

Perhaps it is a fitting footnote to the 20th year of the 3rd Millennium, an era when broken rules, like promises, littered the social and economic landscape of our lives.

And later in the day, at 2:56 p.m. New York time, as if to thumb its imaginary nose at the norms of Elliott wave analysis, wave 2 did it again, breaking to 3393.81 before reversing back below.

It was soon joined by the most heavily traded member of the family: SPY, an exchange-traded fund tracking the S&P 500. It moved above the start of Primary wave 1 on Tuesday at 3:15 p.m. New York time.

The third major member of the family, the S&P 500 E-mini futures, reached the closing bell while remaining below the beginning of Primary wave 1. The futures trade all night, providing an opportunity for European and Asian traders to have their say.

As I discussed in July, in my post “A Funny Thing Happened“, the S&P 500 is an extended family, although a bit dysfunctional at this point, at least from an Elliott wave standpoint.

The authors of the quotes above have credibility.

R.N. Elliott was the developer of the wave-counting method that bears his name: The Elliott Wave Principle.

Robert Prechter and the late A.J. Frost wrote an updated description of the method in 1978, and it has since gone through many editions, with Prechter as the modern face of Elliott wave analysis.

Wayne Gorman and Jeffrey Kennedy are both analysts at Elliott Wave International, the analysis company Prechter started in Gainesville, Georgia.

They are all expert at Elliott wave analysis, and when they say it’s a rule, I believe them.

Yet, there is that small matter of reality. The index reflects the market second-hand, through the trades of the symbols that make up the index. The futures and the exchange-traded fund SPY trade separately, in their own right. They are managed so as to track the S&P 500, but no system is perfect.

Years ago, when Prechter’s Elliott Wave International was taking questions from subscribers, I asked about discrepancies between the index and the exchange-traded fund. I was told that each analysis applies to the vehicle it is analyzing, without reference to anything else.

Yet, it seems monstrous for three closely related products to diverge for any length of time. My rule in July was that I needed unanimity among the three major vehicles of the S&P 500 family: Index, futures and the ETF.

The difference, I think, comes down to the basic nature of the vehicles.

The E-mini futures contracts represent an expectation of future prices. The index represents the current prices of the underlying stocks.

The exchange-traded fund, SPY, buys and sells shares of the underlying stocks in order to track the index. It’s a process, and so there can be times when the tracking isn’t perfect.

Moreover, the Dow Jones Industrial Average index, which tracks the same blue-chip segment of the markets as the S&P 500 does, remains well below the beginning of Primary wave 1 to the downside. A serious divergence between the Dow and S&P 500 is unthinkable.

So where does this leave us?

Accepting for a moment the application of the Wave 2 Rule to today’s S&P 500, then the decline from February into March must have been a downward correction to the Primary wave 5 uptrend. I count the index as being within Intermediate wave 5 to the upside, and what happened since February as a 5th wave, probably the final wave of Primary wave 5, in the form of a diagonal triangle. I’ve added a six-week moving average in garish purple as a smoothing device to better see the waves.

Screen Shot 2020-08-18 at 2.31.16 PM
S&P 500 index, weekly bars

If this is in fact a correct count of the chart,  then the S&P 500 is on the final wave of the triangle, and once that is complete, Primary wave 5 to the upside will be over and the price will drop sharply as Primary wave 1 to the downside begins, not in February as the leading Elliotticians thought, but in August, or maybe September.

The proof of the count, as always, will rely on what the price does next.

As of Tuesday’s closing bell, we don’t have unanimity among all three major members of the S&P 500 family. So, although my prior principle count is no longer valid, neither is the alternate count. We’re left in suspense at “Too close to call”.

Although, I don’t see much that can disprove the message of the count, which is that the downtrend will begin anew in the near future.

If the price continues to rise, then it’s a continuation of the last leg of the triangle, which, at its end, will usher in a major decline. The Wave 2 Rule remains intact.

If the price falls sharply, then February was the end of Primary wave 5, Primary wave 3 to the downside has begun and the Wave 2 Rule needs a caveat.

Either way, it’s seems to me to be a solid expectation that the rise from 1974 is almost over.

And back to the quotes: Elliott did include a caveat in his statement of the Wave 2 Rule. He said “rarely” — “”Wave two rarely cancels all of the ground gained by wave one.” So maybe the principle count since February is still intact, and this is one of those rare occasions when the wave 2 price bumped above the start of wave 1.

Learning and other resources. Elliott Wave International has long been the leading analytical house based on Elliott wave theory. They make available a number of free educational materials and other resources, in addition to their for-pay subscriptions.

I recommend two books, both by people associated with EWI.

First, Elliott Wave Principle by Robert Prechter and A.J. Frost is the book that, along with Prechter’s analyses, that created the revival of Elliott wave theory. I first read it in 1984, and it has had a profound influenced on my thinking about markets ever since.

Second, I’ve found Visual Guide to Elliott Wave Trading by Wayne Gorman and Jeffrey Kennedy, both of EWI, to be a useful book that relates Elliott wave theory to practical trading. The authors are hands-on Elliotticians, and for an active trader, that’s exactly what’s needed — less theory and more how-to. The first chapter of the book gives a very nice thumbnail run down of what Elliott wave theory is all about.

Terminology. Here are some links to information about some of the technical jargon I use.

Charts. On my charts, waves have a subscript showing the degree above or below the Intermediate degree. Here are the subscripts and the degree each represents:

  • {+3} Supercycle
  • {+2} Cycle
  • {+1} Primary
  • No subscript: Intermediate
  • {-1} Minor
  • {-2} Minute
  • {-3} Minuette

By Tim Bovee, Portland, Oregon, August 18, 2020


Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.

No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decisions for his or her own account, and take responsibility for the consequences.

Creative Commons License

All content on Tim Bovee, Private Trader by Timothy K. Bovee is licensed under a Creative Commons Attribution-ShareAlike 4.0 International License.

Based on a work at

2 thoughts on “The Wave 2 Rule Collides With Reality

Comments are closed.