Waves Theory could be too complicated if studied wrong. Here you will find its basics in plain English. We also call it ABC wave theory.

What is the “Elliott Wave Theory”? Wave Patterns.

The Elliott Wave Theory is the theory named after Ralph Nelson Elliott, who concluded that the movement of the stock market could be described as rolling patterns of waves. He distinguished 2 main wave patterns:

  • 5-wave structure – impulsive or momentum wave pattern,
  • 3-wave structure – corrective wave pattern.

Both of these patterns have a main principle in nature: alternation of impulsive and corrective waves. As a consequence of this principle, all wave patterns have a feature of similarity and nesting or fractality.

The waves are marked with numbers: 1, 2, 3, 4, 5 and letters: a,b,c. Here are 1, 3, 5, a, c – impulsive waves; 2, 4, b – corrective waves. So, sometimes the first three waves are marked with numbers but in other cases they are labelled with letters. Can you really see the difference? We suggest that we should always use the letters for the first three waves. As a result, 5-wave pattern should have waves a, b, c, 4, 5 and 3-wave structure should include a, b, c. That is easier. Besides, when you see the first reverse wave against the previous trend you never know whether it is going to be 5-waved or 3-waved – nobody will tell you. And you can trade in either impulsive wave c or 5. In our further posts 5-wave structure will be called abc45 and 3-wave structure will be called abc.

On the figure below the impulsive waves a, c, 5 in the up trend are marked green while the corrective waves b and 4 in the up trend are marked grey. In the down trend the impulsive waves a and c are red while the corrective b is grey.

waves-patterns

Waves’ Description

  • Wave a

Almost half of first waves emerging from the base of the market and is no more than a “rebound” from the lowest levels. Wave 1 is usually the shortest of 5 waves, sometimes very dynamic, if it is the foundation of the market.

  • Wave b

As a rule, takes place completely or almost completely the distance traveled by the wave 1, but held above the base 1 of the wave.

  • Wave c

As a rule, the longest and most dynamic of all the 5-wave impulse. Crossing the top of wave 3 level 1 wave registers all types of classic breakout and signal to open long positions.

  • Wave 4

This wave has a complex structure, it is the same as the wave b is a correction or consolidation phase.

  • Wave 5

It is much less dynamic than Wave 3. During this wave, many indicators (oscillators) behind the price movement, and there are negative divergence (divergence), warning of the approach of the top of the market ..

Then there is a rollback, often before the starting extremum – a wave b.

The basic movement typically occurs in the phase 3. Here wave object can be achieved.

Wave 4 may provide a strong pullback, often questioning the possibility of achieving the goal inertia.

Waves’ Fractality

Nesting and fractality – is the basis of the wave of market analysis. Fractality of forex market is also studied by a fractal market analysis. At the initial stage of learning it all seems very complicated. The first difficulty is related to the subjective method and abnormal structures of the Forex market. This creates a lot of options markings. The second problem is connected with the misconceptions. It is necessary to immediately get rid of illusions. Elliott Wave analysis is a not a trading system, but only a view of the market, empirical observation.

All waves are divided into action and reaction. The wave pattern is a combination of 5-3: the impulse is replaced by a correction.

The wave structure at all levels, from the minutes and to weeks, consists of basic combinations, basic models – the pulse, Zigzag and Flat Correction. Of these, as the bricks, add up all kinds of corrections and triangles higher level.

An important point – the impulse is both a wave and a model, pattern, trend.

Zigzag and Flat Correction is also the one and the other, namely, the direction of development and a set of pulses of different orders.

These three models we identify both structural elements, precisely because the market always offers us a more complex model. But all these FOREX pretzel can be decomposed into simple components.

The main consequence of waves’ fractality is that each wave of the older chart counts in abc or abc45 structure of the younger chart. For example, A wave of H1 chart is abc or abc45 of m15 chart. Or B wave of H4 chart is abc or abc45 of H1 chart. Converse is also right: abc or abc45 of the younger chart is some wave of the older chart. For example, abc of m15 chart is say C wave of H1 chart.

The next figure illustrates the principle of waves’ fractality.

waves-fractality

Resume of Waves Strategy for Trading

So, let us resume those basics of waves strategy that will be useful for forex trading:

  1. You could find and trade waves’ patterns on forex and stock markets on any charts including minutes (m1, m5, m15), hours (H1, H4), daily, weekly, monthly.
  2. You had better take a trade in c or 4 wave of abc or abc45.
  3. Always remember about fractality of waves of younger and older charts.
  4. When looking for a good trade, always realize in what wave of the older chart you are. Never trade against the older chart.

P.S.: You may find samples of forex and stock market analysis in our menu’s section Market Analysis.

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