In the late 1920’s, Ralph Elliott discovered that markets have a rhythm and markets travel in a series of wave patterns. Elliott suggested markets move in 5 strength wave (impulse) and 3 correction waves.

The Elliott Wave theory is complex and is very subjective for each trader. This pattern occurs in all markets and in all time-frames. The Elliott Wave has few complex rules. The wave patterns are briefly described below:

Wave 1 (Wl): The smallest of the Elliott waves and the start of the “fractal wave” pattern.

Wave 2 (W2): A retracement wave. Wave 2 should not trade below lows of Wave 1.

Wave 3 (W3): Longest and strongest of the entire wave count. Must trade above the “high” of Wave 1.

Wave 4 (W4): Usually called the “profit wave.” Traders, who came in at Wave 1, will take profits. Wave 4 does not trade below Wave 2’s high.

Wave 5 (W5): Also called “greed wave” or “overpriced wave.” Exhaustion price movements occur before a serious correction.

After 5 wave patterns, markets fonn an ABC pattern in a three corrective waves fashion before another series begins.

Trading Elliott Wave Pattern

Trading Elliott Wave Pattern

The basic Elliott Wave theory dictates that markets move in waves in the direction of primary trends. There will be 5-Action and 3-Reaction waves to complete a cycle. There are many variations and key aspects of these waves. However, the main concept is 5 “waves” up/down followed by 3 down/up cycles. Wave ranges can be determined by Fibonacci numbers for time/price ranges. Some traders plot “wave” channels to determine the “entry” and “target” areas. The Elliott Wave theory is very subjective and requires a very careful understanding of the entire wave theory thesis to be successful.

Trading Elliott Wave Pattern

Trading Elliott Wave Pattern

The Elliott Wave suggests that markets are always in progress and they correspond to 5 “up waves” and 3 “down waves” in a trend direction of “up or down.” The above chart shows major waves consisting of smaller, minor waves in each. Trading Elliott Wave is not very easy. Nevertheless, when the rules are noted and the key origin wave (WO-W 1) is found, then Elliott trading could be carefully applied. The example above illustrates an Elliott Wave from S&P 500 futures chart. Once W1 is identified, look for a retracement to W2. Most Elliotticians trade W3 and W5 as their identification becomes easier to follow and establish fixed rules. W3 is the longest wave. The W4 retracement stops above W1. W5 will be an extension wave of W3. There are many other Elliott Wave trading rules that can be found in other trading books and websites.