• Principles of Elliott Wave Theory
  • Motive and Corrective Waves
  • Wave Structure and Degrees
  • Fibonacci Ratios and Guidelines

The Wave Theory

  • Developed by Ralph Nelson Elliott in the late 1920s
  • He noticed repetitive patterns in the market which he attributed to the psychology of masses
  • He divided these large patterns in smaller patterns which he called “Waves”
  • Every transaction is both produced by meaningful information and produces meaningful information
  • The wave principle is not primarily a forecasting tool; it is a detailed description of how markets behave

Motive Wave

  • The motive wave is the first half a complete Elliott Wave cycle
  • It advances in the direction of the trend of one larger degree and it is subdivided into 5 smaller waves
  • Three of these waves, which are labeled 1, 3 and 5, are “impulse” or “actionary” waves
  • These impulse waves are separated by two “diagonal” or “corrective” waves, labeled 2 and 4

Motive Wave Rules

  • Wave 2 cannot retrace more than 100% of wave 1
  • Wave 3 can never be the shortest of waves 1, 3 and 5
  • Wave 4 can never overlap wave 1
  • These rules are unbreakable

Corrective Wave

  • The corrective wave is the second half a complete Elliott Wave cycle
  • Corrective waves move against the trend of one larger degree
  • The corrective wave is subdivided into 3 smaller waves denoted by the letters A, B and C

Basic Cycle Structure

  • Elliott Wave pattern = Motive phase + Corrective phase
  • A cycle is illustrated as a structure with a total of 8 waves
  • The market repeated this 5-3 structure again and again – Once the cycle ends, it begins again

Repetitive 5-3 Structure

  • Incorporated expanded waves make a more detailed general Elliot Wave structure
  • 5 advancing waves make up Wave I
  • 3 declining waves make up Wave II
  • In waves 1 and 2 of wave I, the general 5-3 Elliott structure forms
  • The market repeated this 5-3 structure again and again – once the cycle ends, it begins again
  • Each wave and cycle can be part of bigger 5-3 structure

 

Elliott Wave Degree

  • Degree is used to identify the position of a wave within the overall progress of the market
  • Elliott acknowledged 9 degrees of waves from the Grand Super cycle to the Subminuette
  • The precise degree is irrelevant to successful forecasting since the relative degree matters most
  • To know a major advance is due is more important  than its precise name
  • Later events always clarify the degree…

 

Fibonacci & Elliott

  • Elliott waves relate to one another according to Fibonacci ratios
  • Fibonacci ratios are useful to measure the target of a wave’s move
  • This can help traders determine good entry levels and profit targets
  • Wave 2 = 61.8% retracement of wave 1
  • Wave 3 = 161.8% or 261.8% extension of wave 1
  • Wave 4 = 38.2% retracement of wave 3

Wave Alteration

  • Wave 2 and wave 4 will alternate in shape or style
  • If wave 2 is sharp, wave 4 will be sideways
  • If wave 2 is sideways, wave 4 will be sharp
  • This guideline is useful for potentially projecting the end of wave 4

Wave Equality

  • In a 5 wave sequence, 2 of the motive sub-waves will tend toward equality
  • Wave 5 will approximately equal wave 1 in price
  • This guideline is useful for potentially projecting the end of wave 5

Momentum Divergence

  • When 5 breaks beyond the span of wave 3 momentum oscillators show divergence
  • As the price breaks to print a new high or low, oscillators fail to do the same and diverge
  • This guideline is useful for potentially projecting the beginning of a corrective wave

Depth of Corrective Wave

  • The market will often corrects to the territory of  wave 4 of lesser degree
  • The corrective wave will not always reach the bottom of the previous 4th wave
  • This is a good place for prices to find support or resistance before the trend continues

The Theory Limitations

  • Two features of this theory can create some confusion regarding wave-count:
  • Extensions of the impulse waves
  • Alternating types of corrective waves

Wave Extensions

  • Most of the time, impulse waves will display an “extension” to their normal pattern
  • One of the impulse waves in the motive phase will be an elongated impulse with multiple subdivisions
  • Extensions occur in wave 1, 3, or 5, however, wave 3 is the most common wave to extend
  • Subdivisions of the extended wave may look similar to the other 4 waves resulting in a wave-count of 9
  • Since the extended wave is originally an impulse, extensions can also occur within extensions

Types of Correction - Zigzag

  • The zigzag is a three-wave corrective structure labeled A-B-C with a sub-wave sequence of 5-3-5
  • Waves A and C are motive waves, while wave B is corrective
  • It is a sharp style of correction that usually shows up in wave 2 of the impulse wave

Types of Corrections - Flat

  • The flat is also three-wave corrective structure labeled A-B-C but with a sub-wave sequence of 3-3-5
  • Waves A and B are corrective waves, while wave C is a motive wave
  • It develops in a sideways direction and usually shows up in wave 4 of the impulse wave

Types of Corrections - Expanded Flat

  • Not all flat corrections look perfect like this
  • A more common type of flat is the expanded flat
  • Wave B ends above the start of wave A and wave C ends below the start of wave B

Types of Corrections - Triangle

  • The triangle is a five-wave corrective structure labeled A-B-C-D-E with a sub-wave sequence of 3-3-3-3-3
  • Its sub-waves form patterns of 3’s but sometimes may take the form of complex combinations
  • Triangles may take various forms and usually shows up in wave 4 of the impulse wave