Elliott wave principle
Elliott wave principle, this theory is very popular among traders. And has become one of the technical analysis bases called Elliott wave trading.
In fact, these principles and trading strategies are older theories by Ralph Nelson Elliott in 1871-1948. Elliott wave Principle is Elliott’s basic theory analyzing the psychological reaction of market participants to changes in market price movements.
Ralph Nelson Elliott is a professional accountant who introduced Elliott Theory in the 1930s.
According to him, the overall market price movement forms a specific pattern. And the pattern always repeats itself within a certain period. At first, Elliott proposed this theory in a book entitled The Wave Principle, which actually was to analyze the stock market.
In the book, Elliott explains that prices are driven by market participants in a wave cycle that is often repeated. This condition is due to the influence of psychology and the collective emotions of market participants to form a wave swing up and down.
By studying these patterns it will be easier to predict the direction of the next market price movement. Because basically the nature of market participants is the same: greed and fear.
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Elliott wave trading principles and trading strategies
As explained in Ralph Nelson Elliott’s essay, Basic Wave Principles, October 1940. Elliott Wave Principle reveals that the collective psychology of investors, or also known as crowd psychology, moves between optimism and pessimism in the natural order.
These psychological changes create patterns that are express in market price movements at each level of trend or time scale. In the Elliott wave method, market prices always change between the impulsive phase, or motive, and the corrective phase on all-time trend scales.
The rising and falling wave impulses are divided into a set of waves 5 degrees lower. Then change again between motive and corrective characters. Waves 1, 3, and 5 are impulses, and waves 2 and 4 are small retrace of waves 1 and 3.
Corrective waves are divided into 3 waves with a smaller degree starting with a five-wave trend impulse, retrace, and other impulses. When the bearish trend is dominant the wave pattern will go down, so the pattern is the opposite of the bullish trend, where five waves go down and three go up.
The motive waves always move in the direction of the trend, while corrective waves move counter-trend. Below is the illustration.
Wave 1 Elliott wave theory principle
How to identity Elliott wave 1. The basic theory is that when the first wave of the new Trend upmarket begins, the fundamental news is almost entirely negative.
Previous trends are still considered strong. Fundamental analysts continue to revise their lower-income estimates; the economy might not look strong. Volume may increase slightly due to rising prices, but not enough to warn many technical analysts.
Wave 2 Elliott wave theory principle
Wave two is a correction from wave one, but can never exceed the starting point of wave one. It is higher than the starting point in the bull market. The theory is that the news is still bad. When prices retest previous lows, bearish sentiment is quickly absorbed.
But, positive signs appear for traders who are looking for lower volumes during wave two than wave on. Prices usually do not retrace more than 61.8% (Fibonacci Ratio) of wave one, and prices must go down with a three-wave pattern.
Wave 3 Elliott wave theory principle
In the 3rd wave, it is often the longest and strongest wave in a trend. However, the tendency is not absolute, because in research on commodity stock prices it is precisely on the fifth-longest wave.
The basic theory of the third wave is that fundamentals have given a positive reaction which causes prices to rise rapidly. But with short correction.
When the third wave began to decline, most market participants pushed prices down. But when it reaches the midpoint of wave three, the “crowd” will often join the new bullish trend. Wave three usually moves upwards beyond wave one with the Elliott wave theory Fibonacci ratio of 1.618: 1.
Wave 4 Elliott wave theory principle
The 4th wave is a corrective wave. The 4th wave which is a corrective wave usually corrects less than 38.2% of the third wave based on Elliott wave theory Fibonacci.
Compared to wave 3, in wave 4 this trading volume is lower usually. At the turning point of wave 4, this becomes the trader reference for the Buy option by looking at the potential going forward at wave 5.
But sometimes the pattern does not go smoothly. But that is the biggest possibility as an entry point.
Wave 5 Elliott wave theory principle
The 5th wave is a leg in a trend. The basic rule is that everyone perceives positive news and presses price movements in the direction of the dominant trend. But sometimes investors take action before the peak point of wave 5 which is their fault.
The volume trading of wave 5 is often lower than wave 3. But until finally the indicator gives a divergence signal where the price is no longer able to continue its movement, even though the indicator is still giving a signal there.
These patterns are connected to form a five and three-wave structure which automatically underlies the wave structure which is almost the same as the greater degree.
Wave classifications generally use the standard degree order as follows
- Grand supercycle: multi-century.
- Supercycle: about 40–70 years.
- Cycle: one year to several years.
- Primary: a few months – a few years.
- Intermediate: weeks to months.
- Minor: weeks.
- Minute: days.
- Minuette: hours.
- Subminuette: minutes.
Elliott wave ABC correction
After the 5-wave trend is weakened, then corrected and reversed by 3-wave countertrends. In this correction wave marked using letters to replace numbers to mark corrections. We call them ABC correction patterns.
Wave A Elliott corrective patterns
In wave A in a bearish condition, fundamental news supports positive. But many analysts see a decline in the bull market which is still active.
Some technical indicators accompanying wave A indicate rising volume. That then chooses to switch to reverse options at higher prices in the market supply.
Wave B Elliott corrective patterns
At this wave, the price went up again as the bull market returned, which had long since begun to weaken. But the trading volume during wave B is lower than the volume in wave A.
Implicitly the fundamentals have improved somewhat and are likely to have a negative impact.
Wave C Elliott wave corrective patterns
In wave C the price is lower in five waves. Trading volume increased in wave C, almost all investors thought that the bear market had firm roots.
Wave C has a tendency equal or not as big as Wave A and often extends to 1,618 times that of Wave A or more.
Elliott Wave Corrective Patterns can be grouped into four patterns, as follows.
- ABC zig-zag correction pattern – 5,3,5.
- ABC Correction Pattern flat – 3,3,5
- Correction of ABCDE Triangle – 3,3,3,3,3
- COMBINATION Corrections – additional structures formed from a few simple corrections.
ABC zig-zag correction pattern – 5,3,5.
The zig-zag correction pattern is the steepest pattern of falling prices compared to the main trend (waves 1-5). The main Elliott waves for ABC correction have the following rules:
- The ABC correction pattern forms a 5-3-5 internal wave pattern.
- Wavelengths A and C tend to be equal length.
- Wave B tends to be the shortest pattern instead of Wave A and C ‘.
- The target of the Zigzag ABC correction wave is usually at the 61.8% Fibonacci retracement of the trend movement.
These rules or principles of the Zigzag correction pattern provide guidance to determine the wavelength of C with respect to wave A. So traders can place orders at the end of wave B, when the structure is finished and expect prices to resume the trend.
ABC zig-zag correction pattern – 3,3,5.
3-3-5 flat formation is a wave pattern with generally the same wavelength. Where Wave B is opposite to A and C. But sometimes the pattern formed with the wavelength B can be longer than A. Or the peak of wave B exceeds the peak of A.
ABC flat correction is different from zigzag. This correction pattern forms waves 3-3-5. The flat correction will get shorter if the trend is getting stronger. The principle of 3-3-5 flat correction rules is as follows below:
- Flat correction patterns form unique formations into 3-3-5 internal wave patterns.
- Wave C tends to be the same length as wave A. It can reach 100% wavelength A.
- This wave pattern can appear at every correction.
- The profit target of this wave usually takes from the 50% Fibonacci retracement of the previous step.
The rules above as a guide can help determine C waves using wavelength A. And traders can use the wave tip ‘b’ as a reference to enter the market and catch the resumption of trend movements.
Correction of ABCDE Triangle – 3,3,3,3,3
3-3-3-3-3 triangle correction pattern is a correction pattern where the pattern is increasingly conical to form a triangle. The principles and rules for triangle waves are as follows.
- The Elliott waves overlap to form a pattern where five ABCDE wave corrections occur.
- Triangle waves contract from the beginning to the end of the wave, where prices move in a range.
- Each internal waveforms three waves, and the triangle correction pattern is divided into 3-3-3-3-3 patterns.
- The ABCDE pattern causes a conical shape like a triangle indicating there is a decrease in volume and volatility.
- Elliott wave triangle pattern usually occurs at the position of wave B or wave 4 of a larger pattern.
- This triangle correction wave is the last step from the back in the larger Elliott wave pattern. Usually, it will lead to an explosive movement back to a bigger trend.
Elliott wave combination correction can occur as a double or triple three. The combination pattern is a wave united to form a larger structure.
All Elliott wave patterns in the picture above take the same shape in an up or downtrend. In a bearish trend, the picture is only reversed.
The way to place an order for a combination correction is to look at the end of the x wave and if the market passes this point, the trend is likely to continue.
Note: The correction pattern is just a pause in a bigger trend. After the correction pattern ends, the price usually moves back towards a stronger trend.
Elliott wave rules and guidelines
In applying the Elliott wave principle there are a number of Elliott wave rules that are correct where the rules are as follows.
- Wave 2 never corrected more than 100% of wave 1.
- Wave 3 is not the shortest wave of the three impulse waves, namely waves 1, 3, and 5.
- Wave 4 should not overlap with wave 1 price area, if there is a case this is rare except diagonal triangle formations.
- A guideline as a change of direction of the wave by observing the pattern of waves five, waves 2 and 4 often takes alternative forms.
Corrective wave patterns lie in a form known as zigzag, flat, or triangle. Then these corrective patterns can appear together to form more complex corrections. Also, a corrective pattern of a triangle often forms in wave 4 and very rarely forms in wave 2, which is the final indication of correction.
Elliott wave indicator
Knowing the principle of Elliott wave theory can provide a comprehensive insight into the concept of trading based on the Elliott wave theory. It can help traders in finding suitable patterns as a reference in opening new orders when all structures have been fulfilled.
But some traders prefer to use the Elliott wave indicator. Indeed this is not available by default on your MT4 or an MT5 platform. The way that can be taken is to download indicators from third parties and install them on your MT4.
Below I include one Elliott wave indicator that you can download. Indeed this does not include the entire Elliott wave pattern. But at least it can help you in finding Elliott patterns that can alert you to new order references.
After downloading the indicator then extract the ex.4 file which is then stored in the MT4 platform folder indicator. Below Elliott wave charts are an indicator appearance.
To aid analysis in determining orders, you can use Fibonacci retracement, you can draw it manually. But if you want to use the Fibonacci indicator you can download and install it on your MT4.
In accordance with the Elliot wave principle, you can find wave pattern 5 as a reference point in finding entry points. While Fibonacci can be used as a target by looking at Fibonacci levels as support and resistance.
The Elliott wave principle is one of the keys to stock market profits. Because it was originally used on the stock market. But as times change, the Elliott wave principle is also applied to other financial markets, such as forex and crypto.
Some traders try to use Elliott wave forecast bitcoin to predict future prices. Some use Elliott wave trading software, for automated trading.
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