In last month’s newsletter, I wrote about the different uses (and importance) of trendlines. Now I’d like to take the subject one step further and discuss R.N. Elliott’s Channeling Technique. Elliott saw that parallel lines often mark the upper and lower limits of impulse waves, specifically waves four and five. In other words, prices trend within a channel. And it’s a good thing they do, because it gives us yet another reliable method for identifying support and resistance. What’s more, a channel’s “life-span” – how long price action keeps within its boundaries – speaks directly to how big or small a move to expect once prices have broken the channel and a reversal is at hand.
So here’s how you draw them.
First, when you need to identify support for wave four, draw a line connecting the ends of wave one and three (see chart #1). Then, draw a parallel line that touches the extreme of wave two. These two lines are your channel and the lower line shows you the likeliest support for wave four.
A trick I have picked up over the years is to double the channel (see chart #2). To do this, place a third parallel line beneath your lower line, at the point where all three lines have equal space between them. The channel width is now double that of the Elliott channel When your original channel doesn’t hold, and evidence continues to argue for a fourth wave, this lower line will provide support.
The next channel we’ll draw serves to identify a likely target for wave five. Your first line connects the ends of waves two and four. Draw a parallel line at the extreme of wave three (see chart #3). The upper boundary of this channel identifies fifth wave resistance. If you’re contending with a third wave which is parabolic, then use the extreme of wave one.
Fifth waves are tricky, and sometimes prices will exceed this upper boundary line (called a throw-over — see chart #4) or undershoot it. R.N. Elliott noted this possibility and discovered a significant clue that helps determine when a throw-over will or will not occur: Volume. When volume is heavy as prices approach the upper boundary line of the channel, chances are high that a throw-over will occur (see chart #5). When volume is light, wave five will either meet the upper boundary line or fall short. I’ve got another hint of my own that may help. And that is, when volume is light, the center of the Elliott channel will act as resistance (see chart #6).
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