Elliott Waves Theory were introduced by Ralph Nelson Elliott in the 1930 for stock trading. The theory is based on the phenomenon of mass psychology, which more often than not predetermines the outcome of the market behavior.
Elliott wave is one of the few study that able to tell where the market is now, where it is likely to go next and, of course, what are the opportunities there for traders.
Who Use Elliott Waves
Basically Elliott waves are more popular among which are many top technical analysts from banks and leading investment institutions, like to use the knowledge of Elliott wave principles to understand mass investor behavior and thus make forecasts about the market behavior.
Elliott Waves Theory Basics
Every complete Elliott Wave consists of 5 impulsive move and 3 corrective moves (move and wave both are different). Therefore that Impulsive move there are 3 impulsive wave and 2 corrective waves.
This is an Uptrend, where: 1,2,3,4,5 is an impulsive move. Where waves 1,3,5 are Impulsive waves, and 2,4 are corrective waves. A-B-C – is a corrective move, where A-C are impulsive waves, B is corrective wave.
Why does this impulsive/corrective waves form?
To understand we have to go back to the psychology phenomenon, and here is how it works according to Elliott:
Wave 1 –
It is represents an impulsive optimism among the first group of Buyers – they have found a good reason to Buy (for technical or fundamental reasons), and so they begin pushing the market higher.
Wave 2 –
The impulsive wave hit a resistance now the original buyers find some reason to close the position and begin to close trades with profits, while other investors who missed the train, stay outside waiting for a new opportunity.
Wave 3 –
Usually the longest and the strongest wave. Every investor who want to buy (those who miss Wave 1 and those who didn’t) will start buying now. In other hand to that in the middle of the wave 3 those who weren’t convinced about an uptrend will be convinced by now and will bring a large acceleration to the main trend.
Wave 4 –
Sooner or later it’s time to take profits, an impulsive move starts to fade again. However, the correction will be shallow as there are still many Buyers who want to join the trend.
Wave 5 –
Now it is uptrend restores, but the markets are already overbought and it becomes obvious that a reversal is due. The end of wave 5 is often marked by oversold (in an uptrend) and divergence.
Waves A, B, C –
These wave develop in the counter trend style to the major trend and at this point a new trend may develop. But it may also not and the new sequence of 1, 2, 3, 5, A-B-C waves may begin.
Elliott Waves Theory cycles
According to Elliott every completed set of 1, 3, 4, 5, A, B, C waves becomes a wave of a larger degree (a wave of a larger cycle). Bellow is the table with all known Elliott Wave cycles and their corresponding styles of wave numeration.
Elliott Wave Patterns
There are two types of pattern are
1) Impulsive Wave Patterns 2) Corrective Wave patterns
Impulsive Wave Patterns
- Extended Waves
Extended waves that is elongated in nature with smaller sub-waves that are distinctively visible. Among the impulsive waves 1, 3 and 5 only one wave should become an extended wave.
- Diagonal Triangle
This wave basically is 5th wave, which is producing a weaker move/wave and as a result the sub-waves within it can evolve into a diagonal triangle.
- Complete 5th wave failure
Applies to wave 5, where it can be so week that it fails to create new high the wave 3, resulting in a double top formation.
Corrective Wave patterns
Corrective Wave forms are more complicated in nature. It can be categorized into six major forms:
Zig-Zag: ABC pattern composed of 5-3-5 sequence, where wave B doesn’t exceed the start of wave A while Wave C moves far beyond the end of wave A.
Flat: ABC pattern composed of 3-3-5 sequence, where all three waves are of the same length.
Irregular : ABC pattern compose of 3, 3, 5 sequence. Where wave B exceeds the start of wave A while wave C moves close to (or beyond) the end of wave A.
Horizontal Triangle : 5 wave triangular pattern compose of 3, 3, 3, 3, 3 progressively smaller waves. Usually triangles happen in the 4th wave in the impulsive sequence.
Double Three: ABC-x-ABC pattern composed of any two patterns (zigzags, flats, irregulars or triangles) and linked by x wave.
Triple Three: an ABC-x-ABC-x-ABC pattern composed of any three patters (zigzags, flats, irregulars or triangles) and linked by two x waves.Triple Three wave example:
Double three and triple three are very difficult corrective patterns. Don’t be discourage if you can’t count them accurately. So be sure to use additional technical analysis (or indicators) if your waves aren’t lining up for the moment.
Always looking for the clarity in any elliott wave pattern before pulling a trigger. But don’t get stuck if the patterns don’t form instead use another other analysis methods that can offer a better edge in challenging market conditions.
ABC corrections ( That is ZigZag, Flat, Irregular, Double Three, Triple Three) Wave C consists of a 5-wave pattern. Thish knowledge is very useful when planning entries after wave C on an new impulsive wave.
The Rules of Elliott Waves Theory
- The wave 2 should not break below the beginning of Wave 1
- The wave 3 should not be the shortest wave among Waves 1, 3 and 5
- and wave 4 should not overlap with Wave 1.
These are the only 3 unbreakable rules that can’t be alter. Although the rest of the Rules, and there is a considerable number of them, can have alterations, substitutions etc, which again explains the fact that markets can’t be totally predictable.
The Principle of Alteration
Waves 2 and 4 within an Impulsive wave will unfold in different forms: if wave 2 is a simple ABC form ( zigzag), Therefore the 4th wave is likely to be a complex wave (triangle, double three etc.)