Goodman Wave Theory (‘GWT’ ‘Goodman’) was developed by trader Charles B. Goodman in the 1940s and 1950s. He used it very successfully in commodity futures and equities. GWT is derived from four simple and transparent concepts. In this article I discuss these – The Axiom of 1-2-3, the Propagation Principle, the Intersection Principle and the 3-C Principle. These will also demonstrate how Goodman differs from the more well-known Elliott. Finally, I will show the basic GWT trade setup.
The Axiom of 1-2-3:
In Goodman Wave Theory everything is a 1-2-3 – a swing in the primary direction (1), a swing in the secondary direction (2) and a second swing in the primary direction (3). The 1-2-3 is the building block of all markets. The Principles and Rules of GWT tell us how these 1-2-3 at multiple price levels combine to form a price chart we see of any given market. Small 1-2-3s are said to propagate into larger 1-2-3s and are said to nest within the larger 1-2-3s.
The Ideal Matrix:
A 1-2-3 is called a matrix. Let’s begin with a look at the Ideal Matrix which is familiar to many traders as the 50% Rule and Measured Move Rule. The 50% Rule states prices will find support or resistance at the 50% retracement of a price swing. The logic is easy enough to understand. At the 50% point all the buyers and sellers in the swing are – in the aggregate – even. Half of the buyers and half of the sellers have profits; half of the buyers and half of the sellers have loses.
Mr. Goodman taught me the importance of being able to detect the underlying logic in any chart formation or indicator tool I studied and contemplated using. The RSI for example, is, after all, a flavor of the slope-intercept equation from high school algebra, y = mx + b. Charlie could draw the RSI on a chart without calculating it and be very accurate. ‘Everything is in the charts,’ he would say.
Much has been written about the 50% retracement. Mr. Goodman cut his trading teeth and spawned GWT from Burton Pugh’s Secrets of Wheat Trading series. Trident by Charles Lindsay and The Trading Rule That Can Make You Rich by Edward Dobson are other works covering this old but very sound idea. In GWT a ‘swing’ is a price trend without more than a 25% retracement.
When these buyers and sellers unwind, it will create a measured move with the third swing, at which price point, ceteris paribus, either all of the buyers have profits and all of the sellers have losses (up swing) or all of the sellers have profits and all of the buyers have losses (down swing).
A matrix is composed of three swings, two Primary (First Primary Swing – FPS) and Second Primary Swing – SPS) and one Secondary (Secondary Swing –SS). A matrix need not conform to the ideal measurements as long as the SS is a swing that represents at least 25% of the value of the FPS. The beginning price of any swing or matrix is the Beginning Point, BP. The ending price of any swing or matrix is the Ending Point, EP. The 50% measurement of any swing or matrix is the Tipping Point, TP.
The Propagation Principle:
This is the most important principle in Goodman Wave Theory. Just looking at charts as propagations of 1-2-3s will give you a fresh perspective. Matrices are said to propagate. Once a 1-2-3 forms it becomes a ‘1’ for a larger 1-2-3.
In GWT a propagated matrix is a Goodman Wave.
Goodman versus Elliott:
All wave theories of course share common ideas. But between Goodman and Elliott there are three important differences. The first of these is GWT sees a 1-2-3 as the primary building block whereas Elliott sees a 1-2-3-4-5 as primary. This is not simply syntax. Since matrices propagate there is a critical difference in the ‘4’ swing.
In Elliott the ‘4’ swing is related to the ‘3’ swing. In GSCS the ‘4’ swing is the beginning of a propagation and is related to the entire 1-2-3 matrix. In GWT the ‘4’ swing is called the Return or Return Swing. The End Point (EP) of the previous Secondary Swing is the Return Point. The price area between the Return and Return Point is very strong and often results in a reversal or at least a powerful ‘bounce’ in prices – it is called the Return Zone and is a factor in all three Goodman trade setups.
If you have studied Elliott you may have discovered that problems – usually resulting in multiple forecasts – begin with that key ‘4’ swing. The reason for this, according to GWT, is that the ‘4’ is not related to just ‘3’ but to the entire ‘1-2-3’ which has become a ‘1’ in propagation.
Continue Reading: Goodman Wave Theory: Part 2
- Goodman Wave Theory – Part 1 By Michael Duane Archer