Elliott Wave Theory is one of the most prevalent forms of technical analysis used by traders and investors globally, teaching that prices move in cycles consisting of impulse waves with corrective waves occurring periodically across timescales.
To identify an Elliott wave accurately, there are certain rules you must abide by. Most importantly, corrective waves must not overlap with the price territory of their predecessor waves.
Wave 1: Impulse Wave
Elliott wave theory provides traders with an effective tool for identifying trends and reversals in markets. This concept is grounded in the belief that market prices follow cycles of sentiment, with impulse and corrective waves making up each movement.
Elliott wave theory begins with identifying an overall trend in the market. Once this has been accomplished, traders can look for five-wave impulse patterns which correspond with this direction of travel; typically this pattern includes three impulse waves and two corrective waves.
Corrective patterns may be difficult to detect due to their lack of momentum, but traders can use some simple rules to identify corrective waves as they form. For instance, corrective waves cannot exceed previous impulse waves in length and typically don’t overlap with wave 5. Keeping an eye out for these potential corrections as they develop can help traders identify potential corrections that might develop more easily than anticipated.
Wave 2: Primary Wave
Elliott Waves provide traders with great flexibility when identifying trading opportunities. Smaller patterns fit neatly into larger ones like pieces of broccoli; combined with Fibonacci ratios, traders can use these to anticipate and predict events with great accuracy.
An impulse sequence typically exhibits two waves. The second will generally show only a short-term correction – usually within 38-78% of the previous wave i; for triangles this figure may even be lower. Once this c wave has completed it is not uncommon for strong moves upward to occur once its completion; to see this take place draw a channel from wave 2 and wave 4 along their endpoints and project upwards; this projection method gives an excellent way of anticipating wave 5.
Wave 3: Intermediate Wave
Elliott Wave Theory is one of the most beloved trading strategies among finance traders. This theory holds that stock prices move in repeating patterns that can be predicted using these patterns as trends.
First and foremost in successful trading lies in identifying patterns as they form. Doing this allows traders to book profits immediately when an appropriate pattern emerges, increasing your odds of success and success in making investments.
An Elliott Wave can be validated by looking at its lengths; usually the third wave of an impulse will be longest and strongest, and correction waves 2 and 3 should not retrace more than 38-78% of original wave length, or overlap wave 1 or wave 4.
Wave 4: Corrective Wave
According to the Elliott Wave Principle, market prices tend to follow natural rhythms that include both an impulsive phase and corrective one for every degree of trend or time scale.
Corrective waves depend on the degree of the trend; depending on its intensity they can take different forms including flats, zigzags or triangles; they also occur as combinations such as double zigzags.
Corrective waves have one defining characteristic – alternation. This should be evident within its internal structure and it’s vital to recognize an X wave connecting two or more corrective waves with equal degrees, such as zigzagging or flattening and triangleing; but no overlap should occur with prior four waves.
Wave 5: Final Wave
Elliott Wave Principle requires that, during most impulsive moves (both uptrends and downtrends), wave 5 cannot exceed the peak of wave 3. This phenomenon is commonly known as fifth wave failure.
Typically, Wave 5 is equal in length to Wave 1, covering 61% of its net length as measured from its beginning point to completion point.
Trades and investors who purchased during Wave 1 begin taking profits during Wave 2, leading prices to decrease in the direction of their previous trend – known as a sharp retracement. Wave 3 then resumes that trend before concluding with prices retracing back up through Fibonacci retracement levels in Wave 4.
