Hello Forex Traders,
Elliott Wave Theory has its sharp edges when learning and applying the knowledge in real life. Understanding the theoretical side of the wave theory is doable for most traders. Implementing the theory in practical situations, however, is vastly more complex. And yes, there are other patterns, tools and indicators that are easier to implement… but there are advantages of knowing basic and more advanced wave analysis.
I have long hesitated with writing an article on Elliott Wave as I believe that the interest in such an article would be low. However, I will attempt to explain the concepts in a maybe slightly different and hopefully easier way. Please let me know down below whether the article has helped – or not.
First of all, it is critical that Forex traders know of a key concept named impulsive versus corrective price patterns. This is the basic underlying concept of the market structure. No matter what tools, patterns and indicators the Forex trading community uses, there can be a consensus among us that price is a continuous motion of impulses and correction from level to level, from 1 support to another resistance. Other words used as substitutes for corrections are consolidations, consolidation zones, range(s), etc and mean the same.
The impulse versus correction is one of the basic underlying principles of market structure and understanding market structure – besides the obvious support and resistance (levels).
THE IMPORTANCE OF IMPULSIVE VS CORRECTIONS
The concept of impulsive versus corrective price action has a tremendous value for Forex traders – even without the wave analysis. So if at the very minimum Forex traders learn and understand this concept I would be happy. Why?
a) It provides traders with the ability to understand and spot market momentum and lack of momentum. Every trader should be searching and using this information.
b) Furthermore, no wave analysis can in fact be explained without this structure because price action is either impulsive or corrective.
Here are a couple of items to remember:
1) During an impulsive move, almost every candle is breaking the low (downtrend) or high (uptrend) and that most candles are with trend and close near the extreme (high or low). Read more about impulses versus corrections in this article.
2) The impulse finishes when 5 candles or more cannot break the high or low (read more on time factor here). Often enough price stalls at major support and resistance such as Fibonacci targets, tops and bottoms.
3) The correction finishes when price breaks out of its consolidation and starts an impulse. These phases of impulse and correction become seperate swing highs and swing lows or legs.
4) Price is therefore in fact moving impulsively from support to the next resistance and then falling into a consolidation, after which it will eventually break out and continue with an impulse again, which is the basic rythm or heartbeat of the market.
All wave analysis does is in fact is that it connects those swing highs and swing lows, which together make a “story line” of impulse and corrections. An example could be: impulse down, correction up, impulse down, impulse up, correction down.
Wave analysis views each swing high and swing low and then brands them an impulse or correction. Wave analysis therefore does nothing more or less than look at past impulses and corrections and estimate what the chances are of an impulse or correction developing. Simple right?
IMPULSE OR CORRECTION CHANCES
With this information, the wave analyst has a higher chance of estimating what the next swing high or swing low will be: an impulse or correction.
a) In many cases an impulse follows a correction, and a correction follows after an impulse. At its simplest level for this analysis to work, all a trader needs to do is review the previous swing and judge whether it was an impulse or correction.
b) There are cases however where impulse and correction will not alternate neatly. There are cases where an impulse follows after an impulse and a correction after a correction. This is where wave analysis can help distinguish the difference and reviewing multiple swings is needed to combine information and judge.
This realization should make the learning curve shallower. With this knowledge our minds become more focused: it is all about impulse and correction. The impulse versus corrective price structure will benefit us Forex traders because we can make an estimate what the next move will be: is it going to be an impulse or correction?
The method of enhancing the odds, whether an impulse or correction is more likely, is by assigning letters and numbers to multiples of swing high swing low according to rules and guidelines, which are explained in the Elliott Wave (EW) Theory (more on that in the sequel part 2). This then provides an even better understanding of the past market structure. The EW Theory therefore becomes an excellent method of understanding, interpreting, and estimating market structure.
Any questions or comments so far? Let us know down below!
EW MULTIPLE TIME FRAMES
To sum up: the wave analyst not only does the impulse-correction analysis once on the same chart, which is the simplest approach, but can do that multiple times on the same chart. They however can also apply analysis to multiple time frames to gain a better perspective and more in-depth understanding of the market structure.
This analysis is valid for interpreting impulse versus correction but also for identifying support and resistance. Combining the information off of multiple time frames does require experience before reaching a proficient level, but is well worth the time and effort.
THE BASIC WAVE STRUCTURE
With the above mentioned ideas, it is time to introduce the Elliott Wave Theory which states that price moves in 5 impulsive waves which are followed by 3 corrective waves in the opposite direction.
1) For upside this means: 5 waves up, 3 waves down.
2) For downside this means: 5 waves down, 3 waves up.
3) The 5 impulsive waves are numbered 1-2-3-4-5 and the 3 corrective waves are lettered A-B-C.
4) These waves can subdivide into smaller waves but also are part of bigger waves. This is the fractal nature of the market structure.
- Thus a 1-2-3-4-5 structure could be part of a bigger wave 1 for instance, and the A-B-C structure part of a bigger wave 2 (does not have to be – more on that next time).
- In fact, the 5 wave structure 1-2-3-4-5 has its own subdivisions where wave 1,3,5 are usually impulsive (wave 3 must be impulsive) and wave 2 and 4 are usually corrective. The standard sequence is therefore impulsive-corrective-impulsive-corrective-impulsive.
- Same holds true for the A-B-C where all 3 waves could be corrective but do not have to be.
Wave structure is interconnected with Fibonacci ratios. For more information on Fibonacci ratios, please read this article. For more information on Fibonacci chart patterns, please read this article on Gartley.
Next week we will continue with a sequel to this article and introduce the following:
1) Some rules and guidelines of the Elliott Wave theory
2) Time factor in wave analysis
3) Support and resistance within Wave analysis
4) Assessing probabilities of identifying waves
5) Invalidation levels of waves
6) Fibonacci relationships with waves (retracements and targets)
7) Fibonacci time factor relationships with waves
8) Gann angles with waves
9) The importance of trend channels and moving averages within waves
Thanks for sharing this article! Let us know down below if this has helped with understanding the structure of the market? Thanks, Good Trading and good weekend.
Here is part 3: http://winnersedgetrading.com/forex-wave-trading-part-3/
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