Elliot waves, like any other technical analysis tool, do not guarantee a future movement based on previous patterns.
However, when combined with other tools, they help capitalize on these wave patterns in future forecasting.
Steve attempts to make this theory simple so that most traders stay away from it as they find it overwhelming and complicated.
Elliot Waves in a Glance
The Elliot Waves were conceptualized by Ralph Nelson, it is believed to work not only in the financial markets but also in social interaction and natural phenomena. So the Elliot Waves is not only going to help you understand the trend in financial markets but also the outside world.
It works similarly to the Fibonacci magical sequence that could explain the behavior of the crowds. They expose the fight between optimists and pessimists and the strength they show.
Basics of Elliot Waves
Steve explains the different phases of the Elliot Waves simple manner. The waves move in two phases the motive phases and the correctives phases.
There are 4 patterns that we can identify moving with the larger trend. The patterns formed in the motive phase are labeled 1,2,3,4, and 5.
Some specific rules guide you to identify these waves and patterns. A fair bit of understanding is needed in identifying trends and forecasting future movements.
A detailed explanation of each of the four-wave patterns is provided with pictorial examples. This makes understanding the concept easy. The author has included rules coupled with examples that make learning simple.
As the markets don’t move in one direction, they move in patterns that are identified with Elliot Waves. As the name suggests, the corrective phase involves price moving away from the primary trend. A three-phase move is conceptualized as the corrective phase.
The patterns that are either minor corrections or pullbacks are labeled as A, B, and C.
The author has segregated some patterns for ease of learning and practice. When you segregate patterns that have similar structures, it is easier to identify them and work on them. He has segregated these corrective patterns into simple and complex corrections.
Simple Correction – Simple corrections are straightforward patterns. You can easily identify them by the first look if you have learned the simple concepts.
1. Zig-Zag Correction (5-3-5)
2. Flat correction (3-3-5)
a. Regular flat correction.
b. Expanding flat correction.
c. Running flat correction.
3. Triangle correction (3-3-3-3-3)
a. Contracting triangles.
b. Expanding triangles.
c. Barrier triangles.
d. Running triangles.
Complex Correction – Complex corrections have many options within themselves when they are formed within the trend.
The author advises against venturing into these complex corrections before thoroughly understanding simple corrections.
1. Double three (3-3-3)
2. Triple three (3-3-3-3-3)
Elliot Wave optimization
The simple uses of Elliot waves help anticipate the market's direction. As you can identify how many waves have been and how many are yet to form, you can predict the next price fluctuations.
Steve explains that entry and exit questions arise once you can identify trends and patterns. He says using Elliot waves with other technical tools helps produce better results.
Elliot Waves and Fibonacci Combination
Combining Elliot Waves with Fibonacci tools can enhance your predictions. You are not only able to anticipate the direction and patterns but can judge to what extent these patterns can form.
When combined with Elliot Waves, Fibonacci tools can provide more options in trading with the trend and determine potential trade setups.
Elliot Waves with Chart Patterns and Technical Tools
You can start looking for patterns with the help of simple chart patterns. You should be able to validate these patterns with counts that form the motive or corrective phase along with these patterns.
The main three steps to find major setups.
1. Use the High-Low method.
2. Watch for Simple Patterns.
3. Validate counts with Indicators.
Elliot Waves and Charts
Combining Elliot Waves with chart formations like higher highs and lows or lower highs and lows lets you identify simple patterns. The same can be compared with simple chart patterns like double tops/bottom or head & shoulders patterns to foresee upcoming price patterns.
Elliot Waves and indicators
Steve says the use of Elliot waves with indicators helps gauge when the potential move can happen. A simple use of RSI divergence lets you predict a potential pause of reversal from the larger trend.
This lets you form a view to either remain in the motive phase or look forward to the corrective phase.
Trading with Elliot Waves
The author says different traders opt for different trading strategies depending on their trading style.
A Scalper will not find a swing trading strategy suitable for scalping for obvious reasons. So it is only wise to use strategies based on how conservative or aggressive you are.
Conservative Trading Style
Conservative traders are normally the ones who don’t trade more than 10 trades a month. The best waves to trade in the Motive phase are waves 1 and 3 only. Within the Corrective phase, the only tradable wave is Wave C if we are in a Zig-Zag formation.
You can plan to combine waves with Fibonacci to your entries and exits. A conservative entry for wave 3 would be at the 50% Fibonacci retracement level of the Impulsive wave.
Your Stop would be the start of wave 1, and your exit or take target would be 100% and 161% extensions of wave 1.
You can use the rules described in the book to trade wave 5 of the impulsive wave and wave C in the corrective phase.
Aggressive Trading Style
Aggressive trading is designed for traders who want high returns in a short period. You are usually a scalper or a day trader who normally takes 2-3 trades daily.
The best waves to trade in the motive phase are waves 1 and 3. The only tradable phase in the corrective phase is wave C in a Zig-Zag correction.
The author says successful trading requires a clear determination and a consistent application of the rules and techniques presented.
Successful trading is about identifying the right setup that suits your temperament. It is about trading by the rules you have set for yourself day in and day out.
I’m sure you would be convinced by now that Elliot Waves' concept and combining it with other technical tools make a great trade setup.
Get your copy now if you want to see examples of trades using aggressive and conservative trading styles using Elliot Waves.
(Amazon paid link)
Guest Post - Written by Mr. Lal Bajaj, Bangalore