Wave analysis is an ideal form of technical analysis used by finance traders to analyze financial market cycles and estimate market trends, observing investor psychology, price fluctuations, and other common factors.
Elliot found out that there is a repetitive pattern in the market. He also noted that a similar repetitive pattern is there all through the time frame. Elliot divided these large patterns into smaller patterns, which he called waves.
The major success of this idea lies in the trader’s ability to divide the price movement into trend and correction.
- Trend: Trend shows the main direction where prices are moving.
- Correction: Movie against the trend
Using the Elliott Wave Theory, it is possible to profit from the wave pattern of the stock market. This indicates that the movement of stock price can be predicted because they move in recurring up-and-down patterns called waves. This recurring pattern of price occurs due to investor’s psychology.
The theory distinguishes several types of waves; they are:
- Impulse Wave or Motive: The wave moving in the direction of the trend.
- Corrective wave: Wave moving in the opposite direction of the trend is a corrective wave.
There two Phases of Elliot’s wave theory.
- Phase 1 or Impulse or motive phase: This phase consists of five waves: three trending waves and two corrective waves. This collection of three trending waves is referred to as an impulse wave, and they remain two correction waves referred to as a corrective wave. Here the trending waves or the impulse wave appears longer than the corrective waves as per observation
- Phase two or corrective phase: This phase consists of three waves: one trending wave and two corrective waves. Here the corrective waves appear to be longer.
This collection of 8 waves is called the 5-3 moves. And each phase of the wave can act as one trending and one corrective wave. This pattern can be seen in the different time frames as 5-8 move.
Ideally, you can identify smaller patterns within a bigger pattern and the same otherwise. Elliott Waves are like a piece of cauliflower, where the shorter piece looks like the big piece if broken off from the larger part. This information (about smaller patterns fitting into larger patterns), linked with the Fibonacci sequence links between the waves, allows the traders a new level of expectation and prediction when seeking and identifying trading opportunities with stable reward/risk ratios.
It is subjective; not all traders evaluate the theory in the same manner or agree to a prosperous trading strategy. The whole concept of wave analysis itself does not balance to a standard formation, where you follow the instructions, unlike most other price formations. Wave analysis suggests insights into trend dynamics and helps you understand the movement of price in a profound pattern.
Additional Basic Rules in Wave Analysis: The Advanced Guidelines
As we got to know how to identify and calculate waves covering the vital chapters in the process of wave analysis from the information above, now, we are going to explain a new system to make an analogy of wave. So here are the additional basics rules for wave analysis:
Rule of Time
Rules of Time are a vital factor when the wave analyst analyses the world of investment. According to the theory of Elliott on the wave, s in price, time the two non-extended waves tend to be similar, or both in an impulsive structure. The zig-zag pattern with its waves C and A are similar to one another for time In corrective waves.
In simpler terms, the rule of time proves that in the same degree, there can not be three adjacent waves that are equivalent or similar in time in a pattern that is simultaneous.
The tangency rule
This rule assists wave analysts with the identification process of corrective and impulsive waves. The tangency rule confirms that in a five segments pattern, only four internal movements will be touched simultaneously. This rule applies to triangular and impulsive formats of waves.
An important observation in the rule of time
- If the first two sections are identical to a pattern, then in terms of time and price or both, the third section will be different. The theory suggests that the third move will surpass the summation of the second and the first section.
- If the second section lapses further than the movement of the first one, the third section will be 61.8% or 161.8% concerning the first place shifting.
- In terms of time, if none the waves match, then Fibonacci ratio could be adjusted these
So here is the representation of two standard rules of advanced wave analysis. The first rule resembles an elongation of the process of canalization. The use of provides a visualization along with an objective approach to the wave analyst to determine what sort of arrangement could be arranging the action of price.
The second rule represents a guide through which a wave analyst can predict the next route of the market.
Complex Corrective Waves Analysis: The Ultimate Guidelines
This is the most challenging portion of the entire Elliott Waves theory. Rules and types of impulsive waves are simple and easy to understand, but complex corrections are unique. There is a logical method to use when approaching a complex correction, and one should start with the basic principle. The opening point should be the fact that a complex correction is formed out of various simple corrections. If the simple corrections are zig-zags, flats, and triangles, it means that a complex correction is derived out of variations of these simple corrective waves.
Elliott discovered complex correction couldn’t have more than three simple corrections of a lower degree. And this characteristic of correction wave was restricting the possibilities for such corrections. Using probabilities, combining zig-zags, flats, and triangles, forming a complex correction was not possible. However, something was missing. How do we combine such patterns to form complex corrections?
The missing link is called an x-wave. X wave is an intervening wave that comes and connects two or three simple corrections that form a complex correction wave. An x-wave is invariably a corrective wave of a lower degree. It holds the key to correctly creating a complete complex correction wave.
An example of a complex correction wave is a zig-zag wave with an x-wave attached to a flat wave. This complex correction mentioned above has the following structure: point a-b–c of zig-zag wave– attached to x wave, which connected to point – a–b–c Flat wave. In this formation, waves a and c of the first correction wave are impulsive waves, and the b wave is a corrective wave. The x-wave is either a simple or complex correction. In a–b–c point of the flat wave or the second wave, b wave is an impulsive wave, and the other two a and b waves are correction waves.
Like the zigzag-flat wave, there are more examples, such as a double zig-zag wave where two zig-zag waves are connected with three internal waves. And these patterns can go on like triple zig-zag waves or double zig-zag flat or extended flat waves.