The whole theory of Elliott Wave can be classified into two parts:
�Impulse patterns
�Corrective patterns
Elliott Wave Basics � Impulse Patterns
The impulse pattern consists of five waves.
The five waves can be in either direction, up
or down. Some examples are shown to the
right and below.The first wave is usually a
weak rally with only a small percentage of the
traders participating. Once Wave 1 is over,
they sell the market on Wave 2. The sell-off in
Wave 2 is very vicious. Wave 2 will finally end
without making new lows and the market will
start to turn around for another rally.
The initial stages of the Wave 3 rally are slow,
and it finally makes it to the top of the
previous rally (the top of Wave 1).
At this time, there are a lot of stops above the
top of Wave 1.
Traders are not convinced of the upward trend and are using this rally to add more
shorts. For their analysis to be correct, the market should not take the top of the
previous rally.
Therefore, many stops are placed above the top of Wave 1.
The Wave 3 rally picks up steam and takes the top of Wave 1. As soon as the Wave
1 high is exceeded, the stops are taken out. Depending on the number of stops,
gaps are left open. Gaps are a good indication of a Wave 3 in progress. After taking
the stops out, the Wave 3 rally has caught the attention of traders.
The next sequence of events are as follows: Traders who were initially long from the
bottom finally have something to cheer about. They might even decide to add
positions.
The traders
who were
stopped out
(after being
upset for a
while)
decide the
trend is up,
and they
decide to
buy into the
rally. All this
sudden
interest
fuels the
Wave 3 rally.
This is the time when the majority of the traders have decided that the trend is up.
Finally, all the buying frenzy dies down; Wave 3 comes to a halt.
Profit taking now begins to set in. Traders who were long from the lows decide to
take profits. They have a good trade and start to protect profits.This causes a
pullback in the prices that is called Wave 4.
Wave 2 was a vicious sell-off; Wave 4 is an orderly profit-taking decline.
While profit-taking is in progress, the majority of traders are still convinced the trend
is up. They were either late in getting in on this rally, or they have been on the
sideline.
They consider this profit-taking decline an excellent place to buy in and get even.
On the end of Wave 4, more buying sets in and the prices start to rally again.
The Wave 5 rally lacks the huge enthusiasm and strength found in the Wave 3 rally.
The Wave 5 advance is caused by a small group of traders.
Although the prices make a new high above the top of Wave 3, the rate of power, or
strength, inside the Wave 5 advance is very small when compared to the Wave 3
advance.
Finally, when this lackluster buying interest dies out, the market tops out and enters
a new phase.
======
Corrections are very hard to master. Most Elliott traders make money during an
impulse pattern and then lose it back during the corrective phase.
An impulse pattern consists of five waves. With the exception of the triangle,
corrective patterns consist of 3 waves. An impulse pattern is always followed by a
corrective pattern. Corrective patterns can be grouped into two different categories:
Simple Correction (Zig-Zag)
There is only one pattern in a simple correction.
This pattern is called a Zig-Zag correction. A Zig-
Zag correction is a three-wave pattern where the
Wave B does not retrace more than 75 percent of
Wave A. Wave C will make new lows below the
end of Wave A. The Wave A of a Zig-Zag correction
always has a five-wave pattern. In the other two
types of corrections (Flat and Irregular), Wave A
has a three-wave pattern. Thus, if you can identify
a five-wave pattern inside Wave A of any
correction, you can then expect the correction to
turn out as a Zig-Zag formation.
Fibonacci Ratios inside a Zig-Zag Correction
Wave B
Usually 50% of Wave A
Should not exceed 75% of Wave A
Wave C
either 1 x Wave A
or 1.62 x Wave A
or 2.62 x Wave A
A simple correction is commonly called a Zig-Zag correction.
Complex Corrections (Flat, Irregular, Triangle)
The complex correction group consists of 3 patterns:
�Flat
�Irregular
�Triangle
Flat Correction
In a Flat correction, the length of each wave is identical. After a five-wave impulse
pattern, the market drops in Wave A. It then rallies in a Wave B to the previous high.
Finally, the market drops one last time in Wave C to the previous Wave A low.
Irregular Correction
In this type of correction, Wave B makes a new high. The final Wave C may drop to
the beginning of Wave A, or below it.
Fibonacci Ratios in
an Irregular Wave
Wave B = either 1.15 x
Wave A or 1.25 x Wave A
Wave C = either 1.62 x
Wave A or 2.62 x Wave A
Triangle Correction
In addition to the three-wave correction patterns, there is another pattern that
appears time and time again. It is called the Triangle pattern. Unlike other triangle
studies, the Elliott Wave Triangle approach designates five sub-waves of a triangle
as A, B, C, D and E in sequence.
Triangles, by far, most commonly occur as fourth
waves. One can sometimes see a triangle as the
Wave B of a three-wave correction. Triangles are
very tricky and confusing. One must study the
pattern very carefully prior to taking action. Prices
tend to shoot out of the triangle formation in a swift
thrust.
When
triangles occur in the fourth wave, the
market thrusts out of the triangle in the
same direction as Wave 3. When triangles
occur in Wave Bs, the market thrusts out of
the triangle in the same direction as the
Wave A.
Alteration Rule
If Wave Two is a simple correction, expect
Wave Four to be a complex correction.
If Wave Two is a complex correction,
expect Wave Four to be a simple correction.
=========
Elliot discovered that the ever-changing path of stock market prices reveals a
structural design that in turn reflects a basic harmony found in nature. From this
discovery, he developed a rational system of market analysis.
Under the Wave Principle, every market decision is both produced by meaningful
information and produces meaningful information. Each transaction, while at once an
effect, enters the fabric of the market and, by communicating transactional data to
investors, joins the chain of causes of others’ behavior. This feedback loop is
governed by man’s social nature, and since he has such a nature, the process
generates forms. As the forms are repetitive, they have predictive value.
Wave Patterns
In markets, progress ultimately takes the form of five waves of a specific structure.
Three of these waves, which are labeled 1, 3 and 5, actually effect the directional
movement. They are separated by two countertrend interruptions, which are labeled
2 and 4. The two interruptions are apparently a requisite for overall directional
movement to occur.
At any time, the market may be identified as being somewhere in the basic five wave
pattern at the largest degree of trend. Because the five wave pattern is the overriding
form of market progress, all other patterns are subsumed by it.
The 5 wave pattern is often followed by 3 corrective waves labelled as A-B-C.
Wave Mode
There are two modes of wave development: impulsive and corrective. Impulsive
waves have a five wave structure, while corrective waves have a three wave
structure or a variation thereof. Impulsive mode is employed by both the five wave
pattern and its same-directional components, i.e., waves 1, 3 and 5. Their structures
are called “impulsive” because they powerfully impel the market. Corrective mode is
employed by all countertrend interruptions, which include waves 2 and 4. Their
structures are called “corrective” because they can accomplish only a partial
retracement, or “correction,” of the progress achieved by any preceding impulsive
wave. Thus, the two modes are fundamentally different, both in their roles and in
their construction, as will be detailed in an upcoming section.
Wave subdivision
Waves can be repeatedly subdivided into lower degrees as follows:
Some observations
Wave 4 never overlaps or enters the area of wave 1. An overlap means one shd
consider the possibility of A-B-C corrective
An exception to the above is a 5th wave ending diagonal
Wave 3 is never the shortest.
Wave 3 & 5 are related to wave 1 by a Fibonacci ratio (equality or 1.618 or 2.618)
In any corrective, wave C is related to wave A by a Fibonacci ratio (equality or 1.618
or 2.618)
In any corrective, wave B is related to wave A by a Fibonacci ratio (0.618 or equality)
Compared to impulses, correctives are difficult to trade. There are more than 23
types of patterns. Sometimes the best thing to do is let the market make up its mind and then
decide what to do.
In an impulse, it is common for a wave 3 or wave 5 to extend.
Any correction following a 5th wave extension will typically end at wave 2 of the
extension
Alternation: if wave 2 is a sideways correction, wave 4 will be fast/ straight/ swift (and
vice versa).
Waves are fractal and principles apply across all time frames. A 1-2-3-4-5 impulse
could be a part of larger A which in turn can be a part of a larger 1
=====
What is support
Support is the price level at which demand is thought to be strong enough to prevent
the price from declining further. The logic dictates that as the price declines towards
support and gets cheaper, buyers become more inclined to buy and sellers become
less inclined to sell. By the time the price reaches the support level, it is believed that
demand will overcome supply and prevent the price from falling below support.
Support does not always hold and a break below support signals that the bears have
won out over the bulls. A decline below support indicates a new willingness to sell
and/or a lack of incentive to buy. Support breaks and new lows signal that sellers
have reduced their expectations and are willing sell at even lower prices. In addition,
buyers could not be coerced into buying until prices declined below support or below
the previous low. Once support is broken, another support level will have to be
established at a lower level.
What is resistance
Resistance is the price level at which selling is thought to be strong enough to
prevent the price from rising further. The logic dictates that as the price advances
towards resistance, sellers become more inclined to sell and buyers become less
inclined to buy. By the time the price reaches the resistance level, it is believed that
supply will overcome demand and prevent the price from rising above resistance.
Resistance does not always hold and a break above resistance signals that the bulls
have won out over the bears. A break above resistance shows a new willingness to
buy and/or a lack of incentive to sell. Resistance breaks and new highs indicate
buyers have increased their expectations and are willing to buy at even higher
prices. In addition, sellers could not be coerced into selling until prices rose above
resistance or above the previous high. Once resistance is broken, another resistance
level will have to be established at a higher level.
Support becomes resistance (and vice versa)
Another principle of technical analysis stipulates that support can turn into resistance
and visa versa. Once the price breaks below a support level, the broken support
level can turn into resistance. The break of support signals that the forces of supply
have overcome the forces of demand. Therefore, if the price returns to this level,
there is likely to be an increase in supply, and hence resistance.
The other turn of the coin is resistance turning into support. As the price advances
above resistance, it signals changes in supply and demand. The breakout above
resistance proves that the forces of demand have overwhelmed the forces of supply.
If the price returns to this level, there is likely to be an increase in demand and
support will be found.
Conclusion
Identification of key support and resistance levels is an essential ingredient to
successful technical analysis. Even though it is sometimes difficult to establish exact
support and resistance levels, being aware of their existence and location can
greatly enhance analysis and forecasting abilities. If a security is approaching an
important support level, it can serve as an alert to be extra vigilant in looking for
signs of increased buying pressure and a potential reversal. If a security is
approaching a resistance level, it can act as an alert to look for signs of increased
selling pressure and potential reversal. If a support or resistance level is broken, it
signals that the relationship between supply and demand has changed. A resistance
breakout signals that demand (bulls) has gained the upper hand and a support break
signals that supply (bears) has won the battle.
