Trading with The Elliott Wave – The Basics

December 12, 2018

The basics of the Elliott Wave Principle

The basis of the Elliot wave analysis is this. The market moves in a fractal pattern of waves. Its basic model is formed by a pair of waves: An impulsive wave and a corrective wave. Finally, the end of the correction marks the beginning of another impulsive wave. Trading with The Elliott Wave - The Basics

Trading with The Elliott Wave - The Basics

Within this idealized Elliott world, the impulsive phase is a pattern of five waves. Three of them of impulsive nature and two corrective.

The corrective wave pattern is a mixture of 3 waves, two impulsive and one corrective, which elliotticians identify using letters.

N. R. Elliott observed the price action form larger and smaller versions of the main wave pattern. This repetition means that price behaves in a fractal manner. By keeping the wave count, traders can identify how old the current trend is and the likely place of a new beginning.

Points about Elliott Wave Analysis that helps in trading:

1. Identifying the main trend direction

2. Visualizing counter-trend legs

3. Determining the trend maturity.

4. Defining potential targets

5. Specific invalidation points

6. The most profitable waves to Trade

Identifying the main trend and why is it important

Impulsive waves are the easiest to trade. It’s the path of less resistance, and where reward to risk is the highest. Corrective segments are difficult to trade. They depict a lot of volatility and noise, because it’s a place where bulls and bears fight to take control of the price. Fig. 5 shows a risk to reward study on both waves. We observe that corrective waves are noisy, with limited rewards for the risk. Impulsive waves are exuberant and optimist, price segments where we can optimize reward. Therefore, it’s wise to trade with the trend.

The identification of the primary trend is quite straightforward. It’s the direction pointed by one or several previous impulsive legs, in the case of Fig. 5 it’s obvious we are at an uptrend.

Visualization of countertrend legs

Corrective segments are places of recess from the impulsive phase. The impulse has traveled too far, according to participants, and some of them take profits, while others sell short.

But, corrective waves are continuation patterns. Therefore, a C-wave edge identifies a place of low risk and high reward to start trades aligned with the primary trend. Examples of what I mean is the end of c waves in fig 5 that signs the beginning of a new and tradable impulsive pattern in the main trend direction.

Trend maturity determination

As we observe in Fig 4, Market waves form wave patterns within wave patterns in a continuous fractal fashion. We see that wave [1] subdivides into five small waves. Therefore, we can identify the maturity of prices by looking at where they are on the wave map.

On the next article, we will discuss target definition, invalidation points, and the most profitable waves to trade.

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