Technical analysis 101: Introduction into how the waves work in Elliott's wave theory
Some traders think Ralph Elliott's wave theory is a load of old rubbish. Others love it. But it has its uses. As a predictive tool for both entering and exiting trades, once you've mastered it, Elliott wave theory can be very effective. Let's take a closer look at some basic Elliott wave counting…
Before going any further, it's worth mentioning from the off that many books have been written on this vast subject, Max Munroe in Forex Round-Up
So this is just a snippet of this vast subject.
At the same time, even a slight appreciation of the basics of wave counting in accordance with key rules is still a very powerful piece of knowledge. Where you take it from there is up to you.
Let's get started...
Looking for the waves
So the core concept of Elliott wave is the repetition of clearly defined and countable wave cycles.
These cycles are divided into two categories: Impulse waves and corrective waves.
They can be broken up in many different ways, however, let’s just look at the basic 5-3 pattern as shown below in white:
This chart shows the typical 5-3 wave, with a five wave impulse pattern up (1,2,3,4 and 5), followed by a three wave correction (A, B and C).
There are very few hard rules in Elliott Wave. These are:
1. Wave 2 can never exceed the start of wave 1
This just means that if the retracement of wave one moves beyond the start of wave one (i.e. a greater than 100% retracement) then the cycle has failed and should be recounted an alternative way.
2. Wave 3 can never be the shortest impulse wave
Although the third wave is normally the longest wave in the cycle it does not have to be, but it definitely cannot be the shortest of the impulse waves.
3. Wave 4 can never overlap wave 1 (except within a diagonal triangle)
A similar concept to rule 1, but the exception for this rule is for drawing triangle formations.
So there you have it, a closer look at some basic Elliott wave counting.