MAIN COURSE ON ELLIOT WAVE
Finally, we are here in the main course, what you have been waiting for. If you didn’t go through the money management and supporting tools pages, well you miss out on 70% of the course. As I said in money management page, the biggest reason why a lot of traders don’t make money in trading is that of bad money management, I showed you with a bad strategy of 3 wins in 10 trades but your account still increases. So without wasting time let get to the Elliot wave using the diagram below.
Elliot discovered that market moves in a pattern of 5 waves in one direction, he called them motive waves and 3 waves the opposite direction and he called them corrective waves. Looking at the above diagram we can see the 5 waves that create a motive wave and the 3 waves that correct that motive price movement. After that, he wrote some guideline rules which are very important for Elliot wavers, these 3 rules you must know them by heart.
- Wave 2 must not go below start of wave 1, if it does your counting is wrong you must check where you made a mistake
- Wave 3 cannot be the shortest wave in the whole 5 wave cycle
- Wave 4 must not come to the price range of wave 1.(this one has an exception if we have diagonals, but don’t worry I’ll get to them)
I’m sure if you are new in Elliot wave you asking yourself what is this wave 1 or wave 2, I’ll explain now. The proper counting as shown in the diagram below is not important as long as your counting is correct, it won’t matter that much. The labeling that I use is 1,2,3,4,5 for motive waves and A, B, C or W, X, Y for corrective waves. What important is to know where you are in the wave, like the motive wave for 1 week can be broken down to other waves for 1 day and 4 hour till last time frame you have.
Now we know the secret code of labeling the waves so that only us Elliot wavers can understand the charts only. Let look at break down of waves themselves from wave 1 to wave C, after that it a repetition of the cycle. I’m going to take it wave by wave for easy understanding.
Wave 1 and wave 2
Wave 1 is the first wave in the change of trend in the bullish or bearish market, it forms of 5 motive waves, while wave 2 correct that to form a pullback of 3 waves. Below is a diagram showing how wave 1 and wave 2 are formed.
Looking at the diagram above we can see the start of wave 1 in point 0, we have 5 waves in red lines and we can also see the wave 2 which form 3 waves. if we use Fibonacci tool to predict the exact point for the end of wave 2 we can see that mostly it between 50% and 76,8. Wave one can be of two types namely impulse or diagonal. Impulse is the one in the diagram above, the different with impulsive wave 1 or diagonal wave one (leading diagonal) is rule number 3 on Elliot wave which state wave 4 cannot go to the price range of wave 1, in leading diagonal that rule has an exception. Don’t worry I’ll show you a diagram showing leading diagonal so that you can spot them easily.
Wave 3 aka the money wave and wave 4
This is the easiest wave to trade for us as Elliott wavers, usually it the biggest. Which mean it carries a lot of pips, and it moves very fast because the market has big energy. Some Elliot traders trade only wave 3 and are very successful. Wave 3 according to one of our rules should not be the smallest wave. Wave 3 is the safest to trade since after wave one and two has finished you are already positive about the trend, remember trend is your friend. When you trade wave 1 you are trying to pick up top and bottoms which is not very easy if you are new in trading.
Looking at the diagram above we can see that wave 3 is made up of 5 minor waves but keep in mind that wave 3 is the most likely one to be extended between wave 1, 3 and 5. After wave 3 has finished we get wave 4 which is a correction wave, wave four is usually the complex correction pattern, but don’t worry we will get to correction patterns.
A normal motive wave is made up of 5 waves which are 1, 2, 3, 4 and 5. The market does not always follow those waves only, sometimes we have an extension of one of the wave’s .looking at the diagram above we can see two extensions of wave 3 and wave 5, please note that wave 1 can be an extension as well. It very rare to have more than one wave in one motive wave, usually it one and they usually happen in wave 3. But keep in mind that they can happen in any motive wave 1, 3 and 5.
This the last wave in motive waves, wave 5 can be an impulse or diagonal (ending diagonal). The fifth wave is not always easy to trade since we can even get a truncated (that mean the fifth wave did not break above the end of wave 3. Truncated rarely happen in the markets but that what bad about it, it can get you by surprise.
As you can see in the above two pictures one shows the impulse wave 5, with 5 waves. while the second picture shows a wave 5 of an ending diagonal. the difference is that the smaller time frame of ending diagonal is in 3 waves of a, b, c. and the rules for wave 4 going to the price range of wave one is not followed in ending diagonals.
TRUNCATED WAVE 5
Truncated wave 5 basically is a fancy word for failed wave 5, as you can see in the picture above wave 5 did not finish above wave 3 is the usual thing. Wave 5 usually finishes 100% to 1.618% retracement of wave 4, if extended it can go even higher. If you count your waves for wave 5 and they finish below wave 3 just know that you have a truncated wave 5, prepare for correction waves.
Correction waves (A, B, C)
After motive wave 1-5 have completed, the 3 corrective waves begin. The first wave is wave A, which is can be an impulse wave or leading diagonal followed by wave B which is corrective with 3 minor waves, then the last wave which can be an impulse or ending diagonal wave with 5 waves. Obviously this assumption is that the corrective wave is a simple zig-zag pattern. Trading correction waves can be tricky because you not sure which pattern it is, they are a lot of patterns.
Above is a diagram showing a simple zig-zag pattern. Notice that the wave A has 5 sub waves, B wave has 3 and wave c has 5(we call it a 5, 3, 5). That is very important in distinguishing between different corrective patterns. Below is another pattern.
Other corrective patterns
Different types of flat pattern
Before I explain the difference between the 3 flat patterns in the diagram above, I hope you notice that wave A has 3 sub waves, B also 3 waves and lastly wave C has 5 (3,3,5). I’m sure you can differentiate between a flat pattern and normal zig-zag now. That good I’m happy my work is getting you somewhere. Let now look at the difference between the 3 flat patterns in the diagram.
- Regular flat pattern – The wave B here goes to 100% or close to start of wave A.
- Irregular flat pattern – here wave B exceed the start of wave A and come back to exceed start of wave B.
- Running flat pattern – wave B goes to 100% of start of wave A and wave c fails to go below start of wave B
So far we have looked at the simple zigzag pattern, now we are getting more and more advanced. Remember I mentioned that trading corrective waves is not easy, but you need knowledge that you will have after this course.
Above are diagrams showing two types of triangle corrective pattern, the first one is contracting triangle and the second one is expanding triangle. Please note that these can happen on bullish or bearish market condition I just showed the bullish one here.
Combination pattern is a combination of more than one pattern in the one corrective wave. They can appear in any order like zig-zag followed by flat and triangle. Below is a diagram showing examples.
If you are paying attention you are supposed to see in the diagram above new letters that I haven’t mentioned before in the correction patterns like W, X, Y. It good that you see them, we use those in combination patterns only. the diagram above shows a combination pattern of the flat pattern followed by a double zig-zag pattern. Let see another possible combination pattern
By now you should have realized how complicated correction wave can be, but don’t worry if we follow Elliot wave rules you will forever be in profit. It doesn’t matter whether it this combination or that combination following our rules will always give us an edge. What combination pattern does is it make your take profit day to be longer since the price keeps on moving sideways.