Elliott wave theory in examples and indicators. Elliott waves

Elliott Wave Theory is a development of the famous Dow Theory. It applies to any freely traded asset, liability or commodity (stocks, bonds, oil, gold, etc.). The wave theory was put forward by accountant Ralph Nelson Elliott in his monograph " Wave principle", published in 1938.

After retiring during a serious illness, Elliott began studying market price charts in the hope of finding a method that would allow him to determine market patterns. Having done serious work, he came to the conclusion that the market, as a product of mass psychology, obeys a certain law.

The Elliott Wave Theory is based on some constant cyclical pattern in human behavioral psychology. According to Elliott, the behavior of market prices can be clearly defined and highlighted on a chart in the form of waves (a wave is a clearly visible price movement). Elliott Wave Theory states that the market can be in two broad phases - a bull market and a bear market.

Elliott also assumes that all price movements in the market are divided into:

• five waves in the direction of the main trend (waves 1-5 in Fig. 1);
• three waves in the opposite direction (in Fig. 1 waves A, B, C).

In this case, the waves are divided into:

• impulse waves that create a directional trend (bullish or bearish) and lead the market into significant movement (in Fig. 1 - waves 1, 3, 5, A, C);
• corrective waves (rollbacks), which are characterized by movement against the trend (in Fig. 1 – waves 2, 4, B).

Picture 1.

Elliott Wave Theory uses the nesting principle of waves. That is, any wave is part of a longer wave and is itself subdivided into shorter waves (Figure 2). Each wave is divided into 3 or 5 waves. This breakdown depends on the direction of the larger wave of which it is part.

The basic principle in Elliott theory is that each impulse wave consists of five smaller waves, and each corrective wave (against the trend) consists of three waves, which is clearly visible in Figure 2. For example, Wave 1 in Figure 2 consists of 5 smaller waves, because it is an impulse wave that creates a trend.

The longest cycle according to Elliott theory is called the Great Supercycle, which consists of 8 waves of the supercycle, these waves, in turn, also consist of 8 waves of a smaller cycle, etc. For example, Fig. 2 shows 3 main cycles. You can notice the proportionality of the impulse waves and the correction waves that follow them. The stronger the impulse wave, the stronger the correction wave, and vice versa.

The difficulty in Elliott Wave Theory is the identification of Waves. Corrective Waves are usually very difficult to identify.

Elliott Wave Theory and Fibonacci Numbers

To mathematically present his theory, Elliott used the principle of Fibonacci numbers. Fibonacci numbers play an important role in the structure of the complete market cycle described by Elliott waves. The number of waves that form a trend coincides with the Fibonacci numbers.

If you look closely at Figure 2, you will notice that a complete market cycle consists of two large waves, eight medium waves, and 34 small waves. Similarly, if we look at a bear market, we can see that a large bear supercycle consists of one large wave, five medium waves, and 21 small waves. If we continue this list, the next number of bearish waves will be 89, etc.

Accordingly, a large bullish supercycle consists of one large wave, three medium waves and 13 small waves. If we go to an even lower level, then there are already 55 very small waves, etc.

Figure 2.

The usual application of this principle in Elliott Wave Theory is based on the idea that a movement in a certain direction should continue until it reaches a certain number according to the Fibonacci summation sequence.

For example, a movement that lasted longer than 3 days should not reverse until the 5th day. A movement lasting more than 5 days must last 8 days. A 9 day trend should not end until day 13 and so on. This basic scheme for calculating trend changes is equally applicable to hourly, daily, weekly and monthly data. However, this is only an “ideal model”, and no one has the right to expect that commodity prices will behave in such a certain and predictable way. Elliott noted that deviations can occur in both time and magnitude, and individual waves are unlikely to always develop in these regular patterns.

Wave Characteristics

The calculations of Elliott Wave Theory suggest a road map. Each wave has a set of characteristics. These characteristics are based on arrays of market behavior.

In Elliott Wave Theory Special attention is given to the individual characteristics of each wave. In addition, there are certain rules for the proportions of the construction of Elliott waves (table below). These rules help to correctly determine the moments when waves begin to form and their duration. Wavelengths are measured from high to low of the corresponding wave.

Wave	Classic wave ratio
	0.382, 0.5 or 0.618 Wave 1 length
	1.618 or 2.618 Wave 1 lengths
	0.382 or 0.5 Wave 1 length
	0.382, 0.5 or 0.618 Wave 1 length
	0.382 or 0.5 Wave A length
	1.618, 0.618 or 0.5 Wave A length

The given classical relationships between waves are confirmed by actual ones with an error of 10%. This error can be explained by the short-term influence of certain technical or fundamental factors. In general, these ratios are quite conditional. It is also important that the ratio of the sizes of all waves to each other can take values ​​of 0.382, 0.50, 0.618, 1.618. Here the ratios of both wave heights and durations can be calculated. Let's look at the characteristics of each wave:

• Wave 1
  Occurs when the “market psyche” is almost entirely bearish. The news is still negative. As a rule, it is very strong if it represents a sharp change in the current situation (a change from a bearish trend to a bullish one, a breakthrough of a powerful resistance level, etc.). In a calm situation, it usually shows a slight price movement against the background of general indecision.

• Wave 2
  Occurs when the market pulls back sharply from recent, hard-won, profitable positions. It can retrace almost 100% of Wave 1, but not below its origin. Typically around 60% of Wave 1, it develops against the backdrop of a dominant predominance of investors who prefer to take profits.
• Wave 3
  Is what "Elliottians" live for. There is a sharp increase in optimism among investors. This is the most powerful and longest wave of increase (can never be the shortest), in which prices accelerate and volumes increase. A typical Wave 3 exceeds Wave 1 by at least 1.618 times and can be even greater.
• Wave 4
  Often difficult to identify. Usually it rolls back no more than 38% of Wave 3. Its depth and duration are usually small. Optimistic sentiment still prevails in the market. Wave 4 should not overlap Wave 2 as long as the five-wave cycle is part of an ending triangle.
• Wave 5
  Often identified by impulse divergence (momentum divergences). Rising prices on average trading volumes. It takes place against the backdrop of massive public excitement. Towards the end of the wave, there is often a sharp increase in trading volumes.
• Wave A
  Most continue to believe that growth will soon continue with renewed vigor. But players have already begun to appear who are convinced of the opposite. The characteristics of this wave are often very similar to Wave 1.
• Wave B
  Often very similar to Wave 4 and very difficult to identify. Shows a slight upward movement on the remnants of optimism.
• Wave C
  A strong downward wave against the backdrop of a general belief that a new downward trend has begun. Meanwhile, some investors are starting cautious buying. It is characterized by high impulsivity (five waves) and an extension of up to 1.618 times wave 3.

Unfortunately, Elliott waves are very visible in the “old” market and are vaguely visible for the future. In this regard, practical use wave theory Elliott is often problematic and requires special knowledge.

We continue our series of articles on technical analysis and today we will talk about Elliott waves. This tool will help you better understand the nature of the market, since in fact it reflects the deep fundamental processes occurring in the market - fear of participants, greed, euphoria, etc. By understanding the behavior of the market, you will begin to understand what is currently happening with a particular security or the market as a whole and draw conclusions about future trends.

Elliott wave theory

In the thirties of the twentieth century, the American accountant Ralph Elliott discovered the principles of the movement of stock prices. He determined that the nature of price changes obeys certain rules. If you look at any graph, you can see the alternation of different segments of the completed movement in the form of a wave. The price moves to the top of the wave, then goes down, and so on continuously. The wave theory was known earlier, but it was based only on the behavior of market participants, and Elliott used historical data for 80 years.

By studying market charts, Elliot developed the wave theory, which is now known to everyone involved in investing and stock trading. This theory is applicable to any markets, since price movements are determined by people and society, subject to the laws of nature (psychology, sociology, physics, etc.). Market activity rolls in like sea waves, breaking up into smaller waves. Elliott came to the conclusion that the wave theory is a special case of the fundamental laws of the universe.

In 1938, the book “The Law of Waves” was first published with a detailed presentation of this theory. However, Elliott wave theory found practical application only in the eighties, when the famous analyst Robert Prechter wrote a book about the use of wave theory for technical analysis of market prices.

Elliot based his theory on Fibonacci numbers. The Fibonacci numbers 3, 5 and 8 form a complete wave cycle. These are five waves of the growth cycle, a correctional cycle of three waves, and the full cycle is eight waves. There are three rising waves and two falling waves in a growth cycle. There are two downward waves and one upward wave in a correctional cycle.

All these waves have external distinctive features. The cycle consists of two different movements. The first is impulse, the main direction of the market, and the second is correction, wave rollback or temporary stop in formation. Correction is always opposite to the trend, the strength of the correction is usually shorter in length or equal to the impulse. Both concepts are relative and interdependent. That is, after any impulse there follows a correction, which does not exist without the impulse. There are also differences in movement characteristics between them. The impulse is always sharply expressed, and the corrective movement can have a slow or horizontal (lateral) development.

The main difference between an impulse and a corrective movement is the internal structure of these movements. The term “impulse” itself was first used by Prechter. Elliott designated such a movement as “motive,” defining this stage of market behavior as the most important and significant. Each cycle of market movement is characterized by growth or decline. Elliott's merit is in developing a formula for the relationship between impulse and corrective movements in the structure of the cycle.

An impulse always consists of five waves. In an impulse movement, three waves go with the trend, and two go against it. There are three waves in a corrective movement. Here it’s the other way around - two are with the trend, and one is against it. To designate these models in the technical analysis system, the names “five-wave” and “three-wave” have developed. But this is still not a mathematically accurate model, and the 5:3 formula is rather arbitrary. It reflects the principle itself different types price movement. In practice, cycles can take the form 9:7, 13:11 and the like.

To display different cycles, a digital designation is used for impulse waves, and a letter designation for correction waves. That is, the impulse is waves designated by numbers from one to five, and the correction is waves A-B-C. An important part of Elliott's theory are his axioms. These are provisions on maximum and minimum wavelengths and non-crossing of waves. Axioms are the basis for correctly recognizing the nature of the wave.

Elliot Wave Nesting Concept

The most important regularity of Elliott's theory is the nesting of waves. This state is also called fractality. Any wave can be considered part of a larger wave. And in the same way, this wave contains several smaller waves. At the same time, the principle of the nature of waves is preserved. Each impulse wave contains five waves, and all corrective waves consist of three waves.

There can be many such degrees of investment. Ralph Elliott distinguished nine levels in the trend development cycle. The "Great Supercycle" takes 200 years, and the shortest degree lasts only a few hours. The basic rule of wave theory is that no matter the degree of investment, the trend will always form in accordance with the basic eight-wave cycle.

Thus, a wave hierarchy is created, where each time frame has its own place. The basic formula of the cycle structure will be preserved at any scale of observation, right down to tick charts. Outwardly, it looks as if each cycle is reproduced on all scales in exactly the same, self-similar form. Charts of a higher scale contain the same charts of smaller scales, ending with the tick.

Elliott theory does not contain the usual concepts of time frames. He introduced the concept of degrees, the main one of which is called Cycle. Above are the Supercycle and Grandsupercycle. Lower degrees have practical application. These are Primary, Medium and Minor. Even lower are Minute, Small and Ultra-small. To understand the description of cycles, special notations were introduced that are used by specialists in wave analysis. Numbers are used to indicate waves along the trend. Latin letters are used for correction waves. If nested waves are reflected on one chart, then larger waves are indicated in large letters and numbers or in capital letters, smaller waves are indicated in capital letters.

Basic price movement patterns

In developing the theory, Elliott did almost nothing to determine the individual signs of waves (the English term “wave personalities”). Robert Prechter developed this aspect of the theory in more detail. Elliott considered three impulse waves, while Prechter in his book changed the terminology and examined the individual characteristics of all waves. Knowing the signs of waves for technical analysis is useful, especially in cases where it is difficult to obtain a clear picture of the wave count.

Signs of waves will be unchanged at any hierarchical degree. Most of the first waves appear at the bottom of the market in the form of a rebound from the minimum levels. In a five-wave design, the first wave is the shortest in length. In some cases, the first wave forms very quickly, especially if it originates at the very bottom of the market.

The distance covered by the first wave is almost completely covered by the corrective movement of the second wave. Sometimes the lows of the second wave touch the initial values ​​of the first. However, it should confidently be maintained much higher than the starting point of the first wave. Traditional graphic patterns are formed from such movements. This can be a “head and shoulders” (inverted) pattern, as well as a “double bottom” or “triple bottom” pattern.

The fastest growing and longest of all, usually the third wave. This rule is most accurately followed in the stock market. When the third wave crosses the highs of the first wave, then this is considered a classic breakout and a corresponding signal to open positions. All trend trading systems from this moment begin to operate in the hope of an increase. During the development of the third wave, the increase in trading volumes grows rapidly, and frequent breaks (gaps) are indicated on the charts. This wave has the highest probability of stretching.

The fourth, that is, the correctional wave, forms more complex structures. This manifests itself in the forms of consolidation, sideways, range, various types of flags and triangles. The main rule for the fourth corrective wave is to be above the high of the first wave. Otherwise, it will already be a reversal.

The fifth wave is not as dynamic as the third and is less extended. During the formation of the fifth wave, discrepancies appear between the readings of technical analysis indicators, such as MACD, and the price movement. This phenomenon is called divergence, and it warns of a near market top. (see articles about or.

The first corrective wave, which is marked “A”, is quite difficult to correctly identify in time. Its emergence seems to be a slight retreat in the development of the fifth wave of growth. This wave can be most accurately determined by its internal structure, when it is divided into five lower-level waves. If by this time divergence is clearly visible on the indicators, then we can assume that wave A has formed.

At this moment, the formation of wave B begins. It can be characterized as the inertia of an upward movement. This wave can reach previous highs, and even slightly exceed these highs. In such cases, double and triple tops are formed, and oscillators exhibit serial divergences. Trading volumes during the growth of wave B are small, since most buyers leave the market.

Wave C completely confirms the end of the upward trend. This wave moves well below the low of wave A, giving sell signals. If the levels of wave C coincide with the levels of the fourth wave of the uptrend, a “head and shoulders” figure may form. It often serves as a strong reversal signal.

All these are signs of impulse waves and their components, which are directed along the trend. The signs of corrective waves are not so clearly expressed; their analysis and precise definition more complex. All corrective waves are united by the fact that they cannot contain five waves of a lower degree. In most cases there are three waves, but in triangles there can be more. There are four main models of corrective waves.

The most simple model- “zigzag”. This is a three-wave configuration directed against the trend. It forms five waves of the first phase and three in the rest. The second is a flat corrective wave with three waves in the first phase. This wave is also called consolidation, and it indicates the strength of the uptrend.

Triangles most often appear during the formation of the fourth wave, before the final movement in the main direction. Various triangle shapes can signal a continuation of a trend or an approach to a top. To identify a triangle, you need to find four points of minimum and maximum through which trend lines are drawn.

The last type of correction wave is relatively rare. These are double and triple wave triplets, that is, combinations of two or three a-b-c combinations. When combined, they produce seven or eleven waves. These complex patterns are very similar to a consolidation rectangle (aka trading range).

Wave theory signals

The fact that a trend movement consists of five waves is typical only for ideal market conditions. It often happens that some impulse wave stretches, taking on an elongated shape and forming 5 additional waves. First wave stretching occurs quite rarely. In equity markets, the third wave extension is most common.

The stretching property of pulse waves provides opportunities for forecasting. As a rule, one wave of the formation always stretches, which means that the other two will be similar in length and time. This leads to another possibility for forecasting, since the market does not create waves that are similar in shape two times in a row. In this case, the alternation rule tells you what next waves can be expected. In practice, this can determine what type of correction may occur. For example, after a simple model, a triangle is possible and vice versa.

A very important feature of wave theory is the ability to construct price channels. By constructing a channel, you can identify distant price targets, as well as confirm the completion of the wave count. The lower boundary of the channel is drawn through the lows of the waves, and the upper boundary is drawn through the top of the first wave. With further development of the trend, prices rarely go beyond these limits. If the border confidently breaks through, then this is a signal for a change in trend. We see a similar blow on the VTB stock chart:

Driving forces of wave formations

Elliott created his theory based on index analysis stock market, more precisely, the Dow Jones index. He tried to find connections between the economy and the “mood of the masses.” The market is the result of the social and economic activity of human society; it is the driving force behind market changes. The wave theory quite accurately reflects the processes occurring in the stock market.

The more confidently stock prices rise, the more buyers appear, and when prices fall, more and more people want to get rid of them. Since the movement is determined by the behavior of a large number of players, the joining of a mass of players to the main movement causes an increase in the corresponding intensity. And when the price reaches a certain (fair) level, a correction process appears.

The behavior and composition of market participants can explain the intensity of movement and the length of waves. This is clearly seen in the growth of the share price of the famous company Tesla Motors. Here the picture emerges from $17, the share price at the time of market entry. On the chart we see that five waves of growth have been formed, then three waves of correction and the beginning of a new rise:

The main buyers of the first wave were large funds that could afford to take risks with a new company, and investors who appreciated the potential of new technologies and growth opportunities.

Then a corrective second wave began, when shares were sold by investors who were unsure of a further rise. When it became clear that the company was developing steadily, the flow of buyers, including speculators, increased, creating the effect of increasing traffic intensity. In three years, Tesla Motors shares rose to $265. The third wave, exactly according to theory, turned out to be the longest and with gaps.

At this stage, primary investors and speculators began to take profits. The fourth corrective wave lasted to $180. By this time, the company had become widely known, and the stability of its work and prospects were not in doubt. Massive buying of shares began and the fifth wave grew to the level of $290.

After reaching the ceiling (fair price), a natural correction began, consisting of three waves. The situation on the daily chart shows that the correction is ending, since the price has risen above the bottom of wave A.

Results and conclusions: pros and cons

At first glance, Elliott's theory may seem difficult to understand and study. Of course, there is no point in doing it for amateurs in the market. But for stock exchange professionals, knowledge and ability to use this tool is simply necessary. This is the only system that can analyze market movements in accordance with clear rules.

However, there is no mathematical formula that can be used to calculate the waves. Therefore, wave analysis is a subjective concept and depends on the experience and beliefs of the trader or investor. The wave principle provides a certain theoretical framework in which various options for the development of the market situation are possible, which, together with other analytical methods, makes the market situation clear for the investor. You can get practical experience with us at. If you are still a novice investor, you can start by attending free introductory webinars.

If the article was useful to you, like it and share it with your friends!

Profitable investments for you!

– a graphical method of technical analysis that allows you to evaluate the behavior of market players based on studying the waves of price movement. The basic postulates of the system were formulated in the mid-thirties of the last century.

The creator of the theory is Ralph Elliott, but the famous financier Robert Prechter made an equally significant contribution to its development and popularization.

Description of Elliott Wave Theory

The basis of Elliott's theory is the observation that every trend consists of certain basic sections (waves) that are constantly repeated.

There are two types of waves on the market – impulse and corrective.

The former move in the direction of the main trend. The second ones, accordingly, are corrections to them. The main figure of wave analysis consists, in fact, of one impulse and one corrective wave (1-2-3-4-5/ABC). It, in turn, is divided into impulse and correctional waves of the lower order.

Impulse waves are designated by numbers from 1 to 5, corrective waves by letters A, B and C. According to Elliott theory, each trend is a combination of such “fives” and “threes”.

Any trend lasts until five waves are formed, after which it either unfolds, or is being adjusted. In the latter case, three correction segments are then formed. In total, eight waves occur within such a growth-decline cycle. If a reversal occurs, then we observe two impulse waves formed by ten segments.

Let's break down the structure in the above screenshot. Elliott waves 1,3 and 5 are pulsed. They follow the general trend. Waves 2 and 4, respectively, correctional.

In the correctional structure ABC, the situation is changing somewhat. Since this structure is part of a general downward wave (corrective), waves A and C are considered impulse here, and wave B, directed upward, will be corrective.

Elliott wave advantage

is that such structures can be found in both upward and downward markets. In the latter case, we are talking about a mirror image of the bullish structure. That is, all impulse waves 1,3 and 5 will be downward, and 2 and 4 will be upward corrections. Accordingly, in the correctional wave A and C will be upward, and B will be downward.

It is important to note that the structure of the trend does not depend on time scales.

Video - Elliott Waves

Elliott wave rules

It is not so difficult to identify five or three areas in any trend by eye. Roughly speaking, anyone who can count to ten can do this. The problem is that two traders analyzing the same chart may well come to absolutelyopposing opinions regarding its structure. To remove the subjectivity of visual assessment, the basic rules for wave formation were developed. Some of them were created by Elliott himself, some were added subsequently by other theorists.

Let's start by listing the basic rules:

• The second wave of the impulse should not fall to the level of the starting point of the first wave. If this happens, then it is worth questioning the very fact of trend development.
• The third wave of the impulse must exceed the extremum of the first. In addition, it cannot be the shortest of the three pulses if we are talking about large-scale time periods.
• The fourth wave of impulse cannot fall below the extreme of the first. This rule is sometimes neglected in real market trading, but in such cases the following condition must be met.
• The fifth wave of the impulse should be above the extremum of the third.

Additional

• Corrections within an impulse must differ in complexity, nominal size or formation time. If there are no differences in at least one of these parameters, the development of the trend should be questioned. There is a possibility that some complex correction model is being formed at the moment.
• In a pulse structure that meets all the requirements, one of the driving waves must be extended, that is, exceed the other two in nominal size.
• Three adjacent waves that are part of the impulse must be formed at different times.

Based on the above rules, a trader can distinguish between impulse and correction structures. If the wave meets all the requirements, thenshe belongs to the first type. If the conditions are not fully met, it is either a correctional structure or an impulse that has not yet formed.

• If the third wave is larger than the fifth and first, then the latter will be approximately equal in length. This recommendation may be useful when analyzing the end of the fifth wave. Even if the fifth wave is longer than the third, and the third is longer than the first, we will still be able to calculate the end of the fifth wave. To do this we need the top of the fourth wave.
• In the process of observing wave structures, another interesting pattern was revealed - the sizes of correctional waves 2 and 4 can be different, and they alternate from time to time. For example, if the correction in wave 2 was quite strong, then in wave 4 it will be insignificant and vice versa. Using this recommendation, you can approximately calculate the time of correction in the fourth wave. If, for example, in the second wave there was a significant and rapid correction, then in the fourth it will be calmer.
• Another interesting fact. The completion of the correctional wave ABC should take place at the level of wave 4 (the minimum value).

Elliott wave theory in practice begins with plotting a graph. To solve this problem, it is better to use indicators; we will talk about some of them below. Experts recommend using a standard candlestick chart for analysis, as it is the most informative and objective. Elliott waves on the chart:

• The first step is to identify a significant turning point. To do this, you can use a tool such as a signal line. From the moment it crosses, the period that we will consider begins.
• Once the reversal point has been determined, we should assign names to all the waves of interest to us. This is a rather complex process, the correct execution of which directly affects the quality of subsequent analysis. It is important to remember that the assigned structural designation cannot subsequently be revised unless there are compelling reasons for doing so. The choice of time scale is up to the trader, but it is recommended to use segments no longer than thirty monowaves. Next, movement marks are placed.
• At the final stage, the wave is compressed, that is, it is assigned the appropriate structural designation in a similar system on a larger scale. Thus, gradually the entire chart will be assembled into one of the basic Elliott models.

Now the trader sees the construction of the market and can predict how it will develop further.

Elliott waves in practice

The most common reason for trading the Elliott system is the presence of an impulse wave from a trend reversal point. Positions must be opened in one of the three driving subwaves, but you should be careful, as there is always a possibility that the chosen structure will be part of a larger corrective pattern. After the formation of an impulse wave, you must wait for the first correction. Its completion is a signal to enter the market.

Conservative method

After the movement towards the initial impulse has resumed, a signal line is drawn through the reversal point and the point of expected completion of the correction. A buy position is opened at the high of the first driving wave. If the price movement does not reach the order and reverses, breaking through the signal line (this happens in the case of a complex correction), you need to make sure that it does not fall below the reversal point. When growth resumes, the line is adjusted to the new low.

If the position was opened immediately, you need to continue to monitor the signal line. As soon as the price drops and touches it, the deal is closed and a new order is placed at the level of the extreme maximum. You should not be upset if, after touching the “signal”, the price curve immediately goes back in the direction of the trend. This is a working moment that should be taken philosophically; moreover, the resulting loss can still be compensated by a new contract.

Moderate and aggressive methods

The initial conditions for opening a position with a moderate strategy are similar to conservative trading. The difference is that the order is placed at the end point of corrective wave B. You must always remember that the expected correction may be delayed. Adjusting the signal line and exiting a position is carried out according to the same principle as in the previous method. This option is recommended for novice traders.

With an aggressive strategy, an order is placed only after the signal line is broken. It is believed that the very fact of such intersection indicates the completion of the structure and the beginning of the formation of a new model.

Indicators for Elliott Waves

There is no ideal indicator for plotting Elliott waves, but a variety of modifications allows each trader to find the option that best suits his style. Let's look at a few popular tools.

Elliott Wave Oscillator

This is an indicator whose chart displays a histogram (similar to). The highest peaks correspond to the third driving wave of the impulse. Can be used on almost any timeframe, however, too short intervals are not recommended.

When the histogram crosses the zero mark from below/from above, a divergence is formed, signaling the completion of the next wave cycle. If at the time of the first corrective movement the oscillator breaks through zero in the opposite direction, the formation of wave 3 should be supported by another divergence. If it is absent, we can assume that the starting point of the model is determined incorrectly.

A drop in the histogram by 30-50% relative to the local extremum indicates the end of the third wave and the beginning of the formation of the second correctional segment. Divergence also indicates the completion of the formation of the fifth wave - the rise/fall of the price chart is accompanied by a decrease/increase in the bars.

According to the first trading rule, first you need to wait for confirmation of the final crossing of the zero level. If the trend is upward, the indicator histogram is displayed above the middle level, if downward, it is displayed below the middle level. The position is entered after the first divergence. A rising price and a falling oscillator indicate a sale, and a reverse divergence indicates a purchase. You can enter after the corrective movement has gone down/rise by about a third relative to the first impulse wave. Stop loss is usually placed at the extreme level and the trade is closed immediately after the formation of a new divergence.

Elliott Wave Prophet and Watl

The Wave Prophet indicator is quite popular among traders who use Elliott waves. With its help, you can not only see completed movements, but also predict the future direction of the price. The wave model on the chart is built automatically. If a trader believes that the initial conditions were determined by the system incorrectly, he can always set them himself.

Watl is a convenient indicator that not only visually displays wave patterns, but also draws trend lines. The user can see the trends of different timeframes and forecast the future trend. As mentioned earlier, the optimal indicator for implementing Elliott’s theory has not yet been invented. The listed tools can be considered the most effective at the moment, but they are still far from perfect. However, this in no way detracts from their advantages and benefits for traders.

Criticism of Elliott Wave Analysis

Elliott waves are often criticized. Many opponents of this method believe that there is little practical benefit from it, since it is quite subjective. Moreover, there are opinions from actually practicing traders that this type of market forecasting is more likely to contribute to losses than profits.

What exactly do critics of wave analysis pay attention to?

First of all, they note that price movements cannot be predicted using such a framework. The price may deviate significantly from the drawn waves. In addition, there is a subjective factor here. After all, waves, like other types of graphic patterns, can be seen in literally any formation, if desired.

Some critics note that wave analysis is a method with a lot of nuances that are not clear to most traders. For example, it is not always possible to determine in the trading process where the waves begin and where they end.

Critics also point out that the best Elliott waves can only be identified on historical charts. As for working with this theory in practice, it is almost impossible due to a large number of factors.

Video about moving and corrective Elliott waves

If you find an error, please highlight a piece of text and click Ctrl+Enter.

Cyclicity is inherent in all natural processes: ebb and flow of tides, changing seasons, phases of the moon and many other examples confirm this. Similar phenomena are observed in economics, which was first noticed by Charles Dow, and the first theory that can actually be applied in stock trading was Elliott wave analysis.

Let us immediately note that, despite the apparent simplicity of the basic principles, wave theory is one of the most complex sections of technical analysis and its full presentation is beyond the scope of this article. We will consider only the basic concepts that will help beginners continue to study it using the books of Ralph Elliott and his followers.

Here is a summary of what will be described below:

1. Interpretation of basic Elliott wave patterns and their components.
2. The basic principle of wave theory and an overview of its popular patterns.
3. Trading signals in combination with other tools, as well as the main advantages and disadvantages of Elliott theory.

So, for an initial understanding of the essence of the Elliott wave theory, you first need to understand the principles of constructing its main models, namely: what waves they consist of and how they are formed on the price chart.

Basic wave theory models

It is believed that all price movements at any financial market and a trading asset can be represented in the form of an eight-wave model, according to which it is possible to predict with high probability the further price movement and the optimal points for opening and closing positions.

Wave theory considers sections 1, 3, 5, a and c to be impulse sections, and sections 2, 4 and b to be corrective, and each of them indicates a certain market state:

• No. 1. Typically, the first movement represents a rather weak impulse, since at the beginning of the trade a small percentage of traders open, and market makers prefer a wait-and-see position. Having reached its peak, small players begin to take profits, and as a result, the first corrective wave begins to form.
• No. 2. At the starting point there are positions opposite to the main movement in the expectation that the first wave was false and the market will return to its original positions. The Elliott wave theory confirms the presence in this zone of a strong one, created by large players to “squeeze” smaller and newcomers out of the market. Reversal patterns such as “ ” and “Double/Triple Bottom” are often formed here.
• No. 3. The largest wave in terms of time and dynamics. Almost all of the previous wave has been worked out and market makers become masters of the situation, pushing the price in the direction they need. Market volumes increase sharply, price gaps appear (), and the movement begins to be supported by the main market crowd. Trading practice shows that even the majority of positive fundamental events occur precisely during the third wave.
• No. 4. The first profit taking after an active movement, as evidenced by the market moving sideways with the appearance of the “triangle” graphic pattern.
• No. 5. The last impulse to open positions in the direction of the main trend due to traders who were late for the beginning of the third wave, after which the trend finally ends and a global reversal begins. In different markets, the wave theory gives its typical fifth waves: in stocks it is often the shortest, even less than No. 2, and in commodity futures, on the contrary, it is the longest. In Forex it is close to the classical model.

The dynamics of changes in market volumes begin to lag behind the price movement; oscillators appear, confirming the imminent end of the trend.

• a. Beginners often interpret it incorrectly, assuming just another correction, after which the trend will resume again. In fact, the market situation has changed radically and you can see this by switching to a smaller one, where divergences and discrepancies in volumes and prices will be more clearly visible.
• b. The situation is completely similar to the second wave – the first correction of a new trend. In addition to opening new positions, those who made a mistake in entering sections No. 4 and No. 5 can exit the market here with minimal losses. a correction may test or even break through previous local highs or lows to form a Double Top pattern.
• c. Confirms the complete one and can be considered the beginning of a new model.

Like any other, models in their classical form are very rare on the real market, and wave analysis includes special sections on working with such “non-standard” patterns and false signals:

The nesting principle and basic Elliott wave patterns

Each wave should include a five-wave pattern on a shorter time frame for impulse ones and a three-wave pattern for corrective ones. This is the basic principle of the theory: each element of the cycle includes a subcycle and so on ad infinitum.

In addition, in this way we can confirm that this is part of the Elliott model, and not chaotic market movement. As an analogue, we can cite the popular “Three Elder Screens” strategy, where a signal on a larger time frame is confirmed by smaller intervals:

Elliott waves form a series of trend reversal and continuation patterns that allow more accurate forecasting of price movements. Examples of commonly used patterns:

Trading signals in combination with other technical analysis tools

In addition to pattern trading, Elliott models combine well with other technical analysis tools, such as Fibonacci levels, channel trading strategies, and the use of wave start and end points as support and resistance levels. For clarity, here are a few practical examples.

→ No. 1. The price rebound from the important ones confirms the beginning of a new Elliott wave. Accordingly, this combination of signals can be used to open a trade in a certain direction.

→ No. 2. In this example, the price bounced off the boundaries, which signaled the end of the correction and the beginning of a new wave. In this case, previously, after the corrective movement (b), the Buy Limit was set at the lower border of the channel.

Unfortunately, in addition to its advantages, Elliott’s theory has several significant disadvantages:

1. Long model formation time

Let us remember that Elliott created his theory during a period when trading was carried out manually and by telephone: the market was slower and the minimum period for analysis was a day, and not hours and minutes as it is today. Therefore, the best results are given by daily and weekly timeframes, which is unacceptable for traders with small deposits.

1. Ambiguity in the construction and interpretation of results

Waves are built based on price highs/lows, constantly deviate from the classical model, and the moment of their beginning and end is also difficult to determine unambiguously. All this leads to the fact that on one section of the graph it is possible to construct several completely dissimilar structures giving completely different forecasts. The experience and professionalism of a particular analyst or trader, for example, comes to the fore. Beginners should study the theory for at least a year before starting to plot Elliott waves on a real chart.

1. Impossibility of automation

Despite the fact that there are special indicators for plotting Elliott waves, the quality of their work remains questionable due to the factors described in the previous paragraph.

Elliott Wave Theory brings order to many disparate methods of technical analysis and hypotheses about how stock cycles relate to the actions and reactions of the market crowd, and this is its undoubted advantage. But her complexity limits her effective application It was not for nothing that the phrase “where there are two wavemakers, there are at least three opinions” was coined by a narrow group of professionals.

Finally, here’s a video about the main principles of the Elliott wave theory:

So, fellow traders, today you have received introductory and practical information on Elliott waves, learned the essence and principles of this theory, as well as the basics of constructing and using its models in trading.

In one of the following publications, I will supplement this topic with a selection of technical tools for automatically plotting Elliott waves on a chart. Don't miss this material and stay tuned.

Best regards, Alexander Siver

If the technique is correct, its formula should fit on back side postage stamp. (With)

Often Elliott wave theory considered complex, but in fact, it is based on principles that can hardly be called such. In many ways, main provisions of Elliott theory coincide with the principles Dow theory and classical methods of graphical analysis, but Elliott in his concept he went far beyond traditional technical analysis of the Forex market. His theory makes it possible to see the full perspective of market movements, and with its help you can easily explain the reasons why certain graphical patterns are formed and what they mean. Armed Elliot wave theory a trader can easily determine at what point in its cycle the market is.

Three basic concepts Elliott wave theories are- model, ratio and time. A wave model is usually called the configuration that a combination of waves takes. Ratio analysis allows you to determine possible correction levels and price targets by measuring the relationships between different waves. In addition, there are certain temporary connections between the waves, which are the subject of wave analysis. They serve to confirm wave patterns and wave relationships.

Let's look at an example of one complete cycle, which consists of eight waves - five waves of growth and three waves of decline (Fig. 1). Five waves make up the growth phase. Rising waves (1, 3, 5) called impulse waves. Downward waves 2 and 4 are developing in the opposite direction to the trend. Their called corrective waves, because they make corrections to the movement of waves 1 and 3. After the growth phase ends, a three-wave adjustment begins. Three corrective waves are marked in the figure with the letters “a”, “b” and “c”.

Almost as important a characteristic of waves as a stable pattern of their combination is the degree of corresponding tendency. There are numerous degrees of tendency. Myself Elliott, by the way, identified nine different levels of trend development, starting with the “Great Supercycle” and ending with an ultra-short degree that lasts only a few hours.

The most important rule of wave theory is that, regardless of degree, a trend will always develop in a basic eight-wave cycle. Each wave is subdivided into smaller waves, which in turn are also broken into waves - to an even lesser extent. And from here it follows that each of the waves is actually part of a larger one, the next one in the wave hierarchy.

The market cycle, which includes the three main cycles of the Elliott wave theory, will look like this (Fig. 2)

A complete market cycle consists of two large waves, 8 medium waves and 34 small waves. Next come 144 very small waves, etc. according to the Fibonacci number series. A bull market consists of one big wave, 5 medium waves and 21 small waves. If we continue this list, the next number of waves will be 89, etc. A bear market consists of one big wave, 3 medium waves and 13 small waves. This list can be continued with 55 very small waves, etc.

The ability to distinguish between three-wave and five-wave patterns is the basis for the practical application of wave theory. All further actions of the trader depend on it. The number of waves tells you what to expect in the market. A completed five-wave configuration, for example, shows that only part of the movement of a larger wave has completed and that it will continue (unless it is the fifth wave in the structure of a higher fifth wave in the hierarchy).

The most important rule for interpreting wave structures is: a correction cannot consist of five waves. Thus, if, with a general growth trend, a five-wave fall is observed, we can state with a high degree of confidence that we are actually dealing with the first wave of a three-wave (a-b-c) fall, that is, the fall will continue. In a bear market, after a three-wave rise, the downward trend should resume. And the recovery, consisting of five waves, is a warning that we should expect a more significant upward price movement. Moreover, it may well turn out to be the first wave of a new bullish trend.

• WAVE 1

Almost half of the first waves originate at the bottom of the market. It is something like a “rebound” from the lowest levels. The first wave is usually the shortest of the five. .

• WAVE 2

The distance traveled by wave 1 is almost completely (or completely) covered by the course of wave 2. It is held above the level of the bottom of the first wave, which entails the formation of various graphic patterns - for example, such as a double or triple bottom or an inverted head and shoulders pattern. .

• WAVE 3

The third wave is the longest and most dynamic. Wave 3 crossing the level of the top of the first wave indicates all types of classic breakouts and signals to open long positions. The third wave accounts for the most significant increase in trading volume, at which time numerous gaps appear on the charts. Wave 3 can never be shorter than any of the five.

• WAVE 4

The fourth wave, as a rule, has a complex structure. Like wave 2, it represents a correction or consolidation phase, however, it differs from the latter in its structure. During the fourth wave, triangles often appear on the charts. According to the most important rule of wave theory, the bottom of wave 4 never overlaps the top of the first wave.

• WAVE 5

During the fifth wave, many confirming technical indicators- for example, On Balance Volume - begin to lag behind price movements. Also at this time, negative divergences begin to appear on some oscillators, warning that the market may be approaching a top.

Now, a few words about ABC correction.

If the first five waves are trendy in nature, and they are designated by numbers from 1 to 5, then the correction that follows them is usually designated by Latin letters: a, b, c, of which two waves are impulse, and one is correctional.

Most often, there are three types of correction patterns on charts:

Zigzag.

I note that sometimes a correction pattern can consist of 2 or 3 interconnected zigzag patterns.

Range.

Often, after strong movements up or down, sideways movement is observed. It can also be represented as an Elliott correction pattern, with the bottom of wave C coinciding with the top of wave A and the high of wave B extending beyond the bottom of wave A.

Triangle.

Also, a correction pattern can be represented in the form of triangles, which, as a rule, move against the trend or sideways. Triangles usually consist of five waves, and they can be contracting, expanding, waning, ascending or symmetrical.

Let's summarize the basic principles of wave theory, and then consider specific areas of their practical application.

— A full bull market cycle consists of eight waves: five rising waves, followed by three falling waves.

— The trend is divided into five waves in the direction of the next in the hierarchy, longer trend.

— A correction always consists of three waves.

— Simple corrections come in two types: zigzags (5-3-5) and flat waves (3-3-5).

— Triangles, as a rule, are formed on fourth waves (this pattern always precedes the last wave). The triangle can also be a corrective wave B.

— Any wave is part of a longer one and is divided into shorter ones.

— Sometimes one of the impulse waves stretches. The remaining two should remain equal in time and length.

— The mathematical basis of the Elliott wave theory is the Fibonacci sequence.

Sometimes the wave structure clearly shows the possible course of the market, sometimes not. When the course of the market is unclear, and they are trying to force it into the framework of Elliott’s theory, while completely ignoring other methods of technical analysis, then this can be called a real abuse of a method that in other conditions can be quite useful. Unfortunately, such abuses often lead to dire consequences. It is much wiser to treat Elliott waves only as a partial answer to the eternal riddle of market forecasting. The effectiveness of wave theory only increases when it is used in combination with other analytical tools, and the chances of success increase.

Finally, I would like to remind you that practical use of Elliott wave theory but without careful preparation it is still not advisable, so be vigilant and hone your market analysis skills as much as possible before trading on a real account.

Prepared by Gerchik&Co specialists