Elliott Wave Theory -Trading the Elliott Waves

The Elliott wave theory is a top technical analysis method for explaining and understanding the behavior of any Financial Market.

Elliott Theory’s Background

Ralph Nelson Elliott was an American investor (1871-1948) who studied the waving behavior of the US stock market. In 1938, Elliott published its “Wave Principle”, and in 1942, he published also the “Nature Law”. As Elliott himself has explained in the “Nature Law”, the mathematical background behind the Elliott Wave Principle is the Fibonacci sequence of numbers {1,2,3,5,8,13,21,34,etc.}. Each and every important number of Elliott waves theory is also a Fibonacci number.

The Elliott Wave Theory

The Elliott Wave Theory is based on a five-wave pattern analysis that includes two phases.

Chart: The Basic Elliott Wave Pattern and the  two (2) Phases

Phase-1: Impulsive Phase

-According to the theory, any financial market is advancing in three up waves, 1, 3 and 5, which are separated by two down waves, 2 and 4.

Phase-2: Corrective Phase

-The correction of any advance is happening in three waves (A,B,C).

Chart: The Elliott Wave Pattern and its full extension in 34 waves

Elliot Wave principles:

1. The Wave-2 must not fall below the starting of Wave-1. If it falls below then the pattern is still in prior trend.
2. The Wave-3 must not be the shortest wave compared to Wave-1 and Wave-5.
3. The Wave-4 must not overlap the range of Wave-2.

Key Advantages of the Elliott Wave Theory

Here are some key points of the Elliott Wave Theory:

• It can be applied in any Financial Market to analyze any Financial Instrument
• It is able to identify formations in any timeframe (historical trends, long-term, mid-term, or even short-term trends)
• It can identify trends in both upward and downward price movements
• It offers a fully visualized framework of analysis
• It is very useful when combined with indicators, or other technical analysis tools
• It provides steady stop-loss levels

Implementing the Elliott Wave Strategy & Tips

As in the case of any other theory, the Elliott Wave Theory doesn’t unfold clear patterns in real conditions. Therefore, traders must be patient and trade very selectively.

Here are some basic steps to apply the Elliott Wave Strategy:

1: Selecting the Right Timeframe

In general, the longer the timeframe used the more reliable it becomes technical analysis. Therefore, avoid very short-term patterns. Moreover, you can combine two different timeframes and design a multi-framework. For example, you can use a daily chart (D1) for tracking the main Elliot waves and an hourly chart (H1) for tracking the sub-waves. In that way, your analysis will be more reliable and more accurate regarding your entry/exit levels.

2: Trading only the 5th Impulsive Wave or the 3rd Corrective Wave

The 5th Impulsive Wave when you trade long, and the 3rd Corrective Wave when you trade short, are by far the most reliable and most dynamic waves of the Elliott Theory.

■ 5th Impulsive → when you trade long (↑)

■ 3rd Corrective Wave → when you trade short (↓)

Waiting for this ideal entry is tough and requires patience. In order to make things easier, you may use an alert on your platform or you can enter a Pending Order that will be executed only if your conditions are met.

3: Improving your Entries by Combining Elliott Waves with Indicators

In order to avoid false signaling, you may confirm your entries with one or two indicators.

■ Using the Zig-Zag Indicator

The Zig-Zag Indicator is pre-installed on MT4 and may help beginners to identify easier the Elliott Waves.

■ Combining Elliot Waves with Customized MACD

Adjust the MACD settings to {5, 34, 5} and seek for extreme indications and /or for divergences between price pattern and MACD pattern.

• MACD Line: (5-day EMA - 34-day EMA)
• Signal Line: 5-day EMA of MACD Line
• MACD Histogram: MACD Line - Signal Line

■ Combining Elliot Waves with CCI

The Commodity Channel Index (CCI) was originally developed by Lambert in order to spot trends in commodity prices. Actually, CCI can be applied when trading any Financial Market, including Forex, stocks, and indices.

You can adjust CCI to settings 34, and test the strength of any trend.

• CCI = (Typical Price - 34-period SMA of Typical Price) / (.015 x Mean Deviation)Typical Price = (High + Low + Close)/3
• Constant = .015

CCI measures the strength of the current trend relative to a median over a given period of your time. CCI favors bullish trends when it is positive (CCI>0) and bearish trends when it is negative (CCI<0).

In addition, when CCI retraces above -100 in a downtrend, or below +100 in an uptrend, it indicates a potential price reversal. This can provide confirmation that a new Elliott Wave is emerging.

■ Using the Fibonacci Retracement for Interpreting Corrective Waves

In order to define the end of a corrective wave, you may use the Fibonacci Retracement Tool.

4: Exit Plan (Stop-Loss and Take-Profit)

As for your exit strategy, you may use a simple trailing stop order. The number of pips entered in the trailing stop should reflect the recent price volatility but also the profit potential of the trade.

Manually, take-profit orders can be placed before a major resistance or above major support. The Fibonacci Retracement may provide support and resistance levels. Pivot points can be used as well.

The 5th Impulsive Wave and the 3rd Corrective Wave are long and very dynamic, and therefore, don’t be in a rush to take your profits.

You can also set-up your price objectives by applying the Fibonacci Expansion tool.

In any case, if the counting of waves changes to something else than the Elliot wave-5 pattern, you must adjust your stops, or you must get ready to exit the trade soon.

5: Entering the Right Order-Size

As is the case of any other trading strategy, money management is the key. In other words, you must apply the right rate of capital leverage. Here are two practices for applying effective money management:

MM Practice-1

An easy way to apply the right money management is to execute any order on a Demo Account. Then you may open the same order on a Live Account by adjusting the size according to the desired risk exposure.

MM Practice-2

First of all, decide how much of your available funds you are willing to risk on a trade. Let’s say \$200.

Afterward, calculate how much space you need for your stop-loss order. Let’s say 30 pips.

Finally, execute a pilot order before you open your main order. For example, you can execute an order of 0.1 lot size. Then, place a 30-pip stop loss (or else) and check how much money you are risking to lose. If you are risking \$25 on the 0.1 sizes and you want to risk \$200 in total then your optimal order size is 0.8 lot. Therefore, you have to open an additional order 0.7 lot. This is the simplest way to trade accurately.

Elliott Wave Theory

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Fibonacci mathematics aims to reveal the hidden proportionality of market behavior. Find Fibonacci trading tools and tutorials:

eBOOKTRADING WORLD MARKETS USING PHI AND THE FIBONACCI NUMBERS (2018)

Guide to Fibonacci Trading with Reference to Elliott Waves, Gann Numbers, and Harmonic Patterns