Elliott Wave Theory is a theory of price movement. It has been introduced back in 1920 and traders use it ever since, meaning it has to be something right with it.
Elliott Wave theory suggest that market moves in repetitive circles, or waves. Elliot Wave has two direction of waves and all waves are either Impact Waves or Correctional Waves. Every impact wave is followed by correctional wave and vice versa.
Elliott Wave Theory Rules
- First leg is Impact wave (going on with main trend still powerful)
- Second is correctional wave and this wave almost never extends below starting point of the first wave. In most cases this retracement of the first wave won’t go more than 61.8% of Fibonacci Retracement line
- Third leg is in most cases the largest wave and that wave is showing us that original trend has lost its power
- Fourth wave is again correctional and it retraces usually less than 38.2 % of the wave three. This would be good entry point, putting the stop loss just above wave 3
- Fifth wave is the final leg of the wave and the last wave in direction of the newly formed and dominant trend. At the end of this trend you will be able to notice divergences on momentum indicators
After 5 legs of new trend a corrective trend will arise, wave a. This is not actually a new trend but a correction of this new dominant trend. It usually goes up to beginning of the wave 5. This is also a good entry point.
Next is wave b, correction of wave a. It usually retraces to 50% level of the wave a, starting to form Head and Shoulders formation. You can use Head and Shoulders market strategy and enter the market on broken neckline.
Wave c. This wave is almost always the size of wave A letting you put very precise Take Profit point in your trade. You just need to measure wave a.
Elliott waves are fractals in nature. That means that every leg of Elliott Wave is made of little Elliott Waves.
Also, in many cases wave c will be wave number 1 of the Elliott Wave going in the other direction.
Elliott Wave Trading Strategy
You should never trade wave 1 unless you have identified it as a wave c as well. If this is the case, wait for the 50% Fibonacci retracement for the entry point. Exit on wave 3. You can trade retracement of wave 3 and and set big take profit with wave 5 being the largest wave in formation. Next is wave A, you should wait for wave b to retraces and to enter on wave c with Take Profit set to length of wave a.
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