Elliott Wave Theory Rules, Guidelines, and Basic Structures PDF

 Login Start 14-Day Trial You are here: Home / Elliott Wave Theory : Rules, Guidelines and Basic Structures Elliott Wave Theory 1) Elliott Wave Theory: Modern Theory for 21st Century Market 1.1 What is Elliott Wave Theory? 1.2 Basic Principl...

 Login Start 14-Day Trial You are here: Home / Elliott Wave Theory : Rules, Guidelines and Basic Structures Elliott Wave Theory 1) Elliott Wave Theory: Modern Theory for 21st Century Market 1.1 What is Elliott Wave Theory? 1.2 Basic Principle of the 1930’s Elliott Wave Theory 1.3 Five Waves Pattern (Motive and Corrective) 1.4 Wave Degree 1.5 The Rise of Algorithmic / Computer- Based Trading 1.6 The New Elliott Wave Principle 2) Fibonacci 2.1 Introduction 2.2 Fibonacci Summation Series 2.3 Fibonacci Ratio Table 2.4 Fibonacci Retracement and Extension 2.5 Relation between Fibonacci and Elliott Wave 3) Motive Waves 3.1 Impulse 3.2 Impulse with extension 3.3 Leading Diagonal 3.4 Ending Diagonal 3.5 Motive Sequence 4) Elliott Waves Personality 4.1 Elliott Wave 1 and wave 2 4.2 Elliott Wave 3 4.3 Elliott Wave 4 4.4 Elliott Wave 5 4.5 Elliott Wave A, B, and C 5) Corrective Waves 5.1 Zigzag 5.2 Flat 5.2.1 Regular Flats 5.2.2 Expanded Flats 5.2.3 Running Flats 5.3 Triangles 5.4 Double Three 5.5 Triple Three 6) 14 Day Trial 1) Elliott Wave Theory: Modern Theory for 21st Century Market 1.1 What is Elliott Wave Theory? Elliott Wave Theory is named after Ralph Nelson Elliott (28 July 1871 – 15 January 1948). He was an American accountant and author. Inspired by the Dow Theory and by observations found throughout nature, Elliott concluded that the movement of the stock market could be predicted by observing and identifying a repetitive pattern of waves. Elliott was able to analyze markets in greater depth, identifying the specific characteristics of wave patterns and making detailed market predictions based on the patterns. Elliott based part his work on the Dow Theory, which also defines price movement in terms of waves, but Elliott discovered the fractal nature of market action. Elliott first published his theory of the market patterns in the book titled The Wave Principle in 1938. 1.2 Basic Principle of the 1930’s Elliott Wave Theory Simply put, movement in the direction of the trend is unfolding in 5 waves (called motive wave) while any correction against the trend is in three waves (called corrective wave). The movement in the direction of the trend is labelled as 1, 2, 3, 4, and 5. The three wave correction is labelled as a, b, and c. These patterns can be seen in long term as well as short term charts. Ideally, smaller patterns can be identified within bigger patterns. In this sense, Elliott Waves are like a piece of broccoli, where the smaller piece, if broken off from the bigger piece, does, in fact, look like the big piece. This information (about smaller patterns fitting into bigger patterns), coupled with the Fibonacci relationships between the waves, offers the trader a level of anticipation and/or prediction when searching for and identifying trading opportunities with solid reward/risk ratios. 1.3 The Five Waves Pattern (Motive and Corrective) In Elliott’s model, market prices alternate between an impulsive, or motive phase, and a corrective phase on all time scales of trend. Impulses are always subdivided into a set of 5 lower-degree waves, alternating again between motive and corrective character, so that waves 1, 3, and 5 are impulses, and waves 2 and 4 are smaller retraces of waves 1 and 3. In Figure 1, wave 1, 3 and 5 are motive waves and they are subdivided into 5 smaller degree impulses labelled as ((i)), ((ii)), ((iii)), ((iv)), and ((v)). Wave 2 and 4 are corrective waves and they are subdivided into 3 smaller degree waves labelled as ((a)), ((b)), and ((c)). The 5 waves move in wave 1, 2, 3, 4, and 5 make up a larger degree motive wave (1) Corrective waves subdivide into 3 smaller-degree waves, denoted as ABC. Corrective waves start with a five-wave counter-trend impulse (wave A), a retrace (wave B), and another impulse (wave C). The 3 waves A, B, and C make up a larger degree corrective wave (2) In a bear market the dominant trend is downward, so the pattern is reversed—five waves down and three up 1.4 Wave Degree Elliott Wave degree is an Elliott Wave language to identify cycles so that analyst can identify position of a wave within overall progress of the market. Elliott acknowledged 9 degrees of waves from the Grand Super Cycle degree which is usually found in weekly and monthly time frame to Subminuette degree which is found in the hourly time frame. The scheme above is used in all of EWF’s charts. 1.5 The Rise of Algorithmic / Computer-based Trading The development of computer technology and Internet is perhaps the most important progress that shape and characterize the 21st century. The proliferation of computer-based and algorithmic trading breed a new category of traders who trade purely based on technicals, probabilities, and statistics without the human emotional aspect. In addition, these machines trade ultra fast in seconds or even milliseconds buying and selling based on proprietary algos. No doubt the trading environment that we face today is completely different than the one in the 1930’s when Elliott first developed his wave principle. Legitimate questions arise whether Elliott Wave Principle can be applied in today’s new trading environment. After all, if it’s considered to be common sense to expect today’s cars to be different than the one in the 1930’s, why should we assume that a trading technique from 1930 can be applied to today’s trading environment? 1.6 The New Elliott Wave Principle – What is Changing in Today’s Market The biggest change in today’s market compared to the one in 1930s is in the definition of a trend and counter- trend move. We have four major classes of market: Stock market, forex, commodities, and bonds. The Elliott Wave Theory was originally derived from the observation of the stock market (i.e. Dow Theory), but certain markets such as forex exhibit more of a ranging market. In today’s market, 5 waves move still happen in the market, but our years of observation suggest that a 3 waves move happens more frequently in the market than a 5 waves move. In addition, market can keep moving in a corrective structure in the same direction. In other words, the market can trend in a corrective structure; it keeps moving in the sequence of 3 waves, getting a pullback, then continue the same direction again in a 3 waves corrective move. Thus, we believe in today’s market, trends do not have to be in 5 waves and trends can unfold in 3 waves. It’s therefore important not to force everything in 5 waves when trying to find the trend and label the chart. 2) Fibonacci 2.1 Introduction Leonardo Fibonacci da Pisa is a thirteenth century mathematician who discovered the Fibonacci sequence. In 1242, he published a paper entitled Liber Abacci which introduced the decimal system. The basis of the work came from a two-year study of the pyramids at Giza. Fibonacci is most famous for his Fibonacci Summation series which enabled the Old World in the 13th century to switch from Roman numbering (XXIV = 24) to the Arabic numbering (24) that we use today. For his work in mathematics, Fibonacci was awarded the equivalent of today’s Nobel Prize. 2.2 Fibonacci Summation Series One of the most popular discoveries by Leonardo Fibonacci is the Fibonacci Summation series. This series takes 0 and adds 1 as the first two numbers. Succeeding numbers in the series adds the previous two numbers and thus we have 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89 to infinity. The Golden Ratio (1.618) is derived by dividing a Fibonacci number with another previous Fibonacci number in the series. As an example, 89 divided by 55 would result in 1.618. 2.3 Fibonacci Ratio Table Various Fibonacci ratios can be created in a table shown below where a Fibonacci number (numerator) is divided by another Fibonacci number (denominator). These ratios, and several others derived from them, appear in nature everywhere, and in the financial markets. They often indicate levels at which strong resistance and support will be found. They are easily seen in nature (seashell spirals, flower petals, structure of tree branches, etc), art, geometry, architecture, and music. Some of the key Fibonacci ratios can be derived as follow: 0.618 is derived by dividing any Fibonacci number in the sequence by another Fibonacci number that immediately follows it. For example, 8 divided by 13 or 55 divided by 89 0.382 is derived by dividing any Fibonacci number in the sequence by another Fibonacci number that is found two places to the right in the sequence. For example, 34 divided by 89 1.618 (Golden Ratio) is derived by dividing any Fibonacci number in the sequence by another Fibonacci number that is found 1 place to the left in the sequence. For example, 89 divided by 55, 144 divided by 89 2.4 Fibonacci Retracement and Extension Fibonacci Retracement in technical analysis and in Elliott Wave Theory refers to a market correction (counter trend) which is expected to end at the areas of support or resistance denoted by key Fibonacci levels. The market is then expected to turn and resume the trend again in the primary direction. Fibonacci Extension refers to the market moving with the primary trend into an areas of support and resistance at key Fibonacci levels where target profit is measured. Traders use the Fibonacci Extension to determine their target profit. Below is the list of important Fibonacci Retracement and Fibonacci Extension ratios for the financial market: …rading Education | Elliott Wave Foreca 2.5 Relation Between Fibonacci and Elliott Wave Theory Fibonacci Ratio is useful to measure the target of a wave’s move within an Elliott Wave structure. Different waves in an Elliott Wave structure relates to one another with Fibonacci Ratio. For example, in impulse wave: Wave 2 is typically 50%, 61.8%, 76.4%, or 85.4% of wave 1 Wave 3 is typically 161.8% of wave 1 Wave 4 is typically 14.6%, 23.6%, or 38.2% of wave 3 Wave 5 is typically inverse 1.236 – 1.618% of wave 4, equal to wave 1 or 61.8% of wave 1+3 Traders can thus use the information above to determine the point of entry and profit target when entering into a trade. 3) Motive Waves In Elliott Wave Theory, the traditional definition of motive wave is a 5 wave move in the same direction as the trend of one larger degree. There are three different variations of a 5 wave move which is considered a motive wave: Impulse wave, Impulse with extension, and diagonal. EWF prefers to define motive wave in a different way. We agree that motive waves move in the same direction as the trend and we also agree that 5 waves move is a motive wave. However, we think that motive waves do not have to be in 5 waves. In today’s market, motive waves can unfold in 3 waves. For this reason, we prefer to call it motive sequence instead. 3.1 Impulse …e and Correction | Elliott Wave Foreca Guidelines Impulse wave subdivide into 5 waves. In Figure 2, the impulse move is subdivided as 1, 2, 3, 4, 5in minor degree Wave 1, 3, and 5 subdivision are impulse. The subdivision in this case is ((i)), ((ii)), ((iii)), ((iv)), and ((v)) in minute degree. Wave 2 can’t retrace more than the beginning of wave 1 Wave 3 can not be the shortest wave of the three impulse waves, namely wave 1, 3, and 5 Wave 4 does not overlap with the price territory of wave 1 Wave 5 needs to end with momentum divergence Fibonacci Ratio Relationship Wave 2 is 50%, 61.8%, 76.4%, or 85.4% of wave 1 Wave 3 is 161.8%, 200%, 261.8%, or 323.6% of wave 1-2 Wave 4 is 14.6%, 23.6%, or 38.2% of wave 3 but no more than 50% There are three different ways to measure wave 5. First, wave 5 is inverse 123.6 – 161.8% retracement of wave 4. Second, wave 5 is equal to wave 1. Third, wave 5 is 61.8% of wave 1-3 …| Learn Elliott Wave | Elliott Wave Theo 3.2 Impulse with Extension Guidelines Impulses usually have an extension in one of the motive waves (either wave 1, 3, or 5) Extensions are elongated impulses with exaggerated subdivisions Extensions frequently occur in the third wave in the stock market and forex market. Commodities market commonly develop extensions in the fifth wave 3.3 Leading Diagonal Guidelines Special type of motive wave which appears as subdivision of wave 1 in an impulse or subdivision of wave A in a zigzag In Figure 4A, the leading diagonal is a subdivision of wave 1 in an impulse. In Figure 4B, the leading diagonal is a subdivision of wave A in a zigzag Leading diagonal is usually characterized by overlapping wave 1 and 4 and also by the wedge shape but overlap between wave 1 and 4 is not a condition, it may or may not happen The subdivision of a leading diagonal can be 5- 3-5-3-5 or 3-3-3-3-3. The examples above show a leading diagonal with 5-3-5-3-5 subdivision 3.4 Ending Diagonal Guidelines Special type of motive wave which appears as subdivision of wave 5 in an impulse or subdivision of wave C in a zigzag In Figure 5A, the ending diagonal is a subdivision of wave 5 in an impulse. In Figure 5B, the ending diagonal is a subdivision of wave C in a zigzag Ending diagonal is usually characterized by overlapping wave 1 and 4 and also by the wedge shape. However, overlap between wave 1 and 4 is not a condition and it may or may not happen The subdivision of an ending diagonal is either 3-3-3-3-3 or 5-3-5-3-5 3.5 Motive Sequence Motive waves move in the same direction of the primary trend, but in today’s time, we believe it doesn’t necessarily have to be in impulse. We instead prefer to call it motive sequence.We define a motive sequence simply as an incomplete sequence of waves (swings). The structure of the waves can be corrective, but the sequence of the swings will be able to tell us whether the move is over or whether we should expect an extension in the existing direction. Motive sequence is much like the Fibonacci number sequence. If we discover the number of swings on the chart is one of the numbers in the motive sequence, then we can expect the current trend to extend further. Motive Sequence: 5, 9, 13, 17, 21, 25, 29, … 4) Waves Personality 4.1 Wave 1 and wave 2 Wave 1: In Elliott Wave Theory, wave one is rarely obvious at its inception. When the first wave of a new bull market begins, the fundamental news is almost universally negative. The previous trend is considered still strongly in force. Fundamental analysts continue to revise their earnings Leave a message estimates lower; the economy