The mere mention of the Elliott Wave Analysis can give cold feet to even the most experienced and adept investors. Most traders try to use the principle but do it incorrectly. When they fail repeatedly, they criticize this approach.
Like everything else in life, you must invest time and dedication when learning a craft. Therefore, this article will help you learn and use the Elliott Wave Analysis with ease.
An Introduction to the Elliott Wave Theory?
To put it simply, prices keep fluctuating in the market. However, the price never moves without creating disturbances. The founder of the Elliott Wave Theory is Ralph Nelson Elliott. He discovered that the fluctuations in the market usually followed an established pattern. Such a model sustains itself on every market and chart. He scrutinized the most significant and visible volatility in the market and termed these ‘ups’ and ‘downs’ as waves.
He also gave the term ‘movement,’ to any latest change in the price. For example, consider the price showing a sideways trend for some time. However, if the price suddenly shoots up, then that upward motion is known as ‘movement.’ Such a change takes place due to significant economic news. Otherwise, the price will continue moving sideways, and the upward movement will never take place. When the markets begin to trend, the movements and waves that occur become evident. However, these waves become challenging to trace when the market moves sideways.
The Elliott Wave Theory says that any movement that is in the direction of the trend unfolds in five waves. Elliott called these motive waves. On the contrary, any correction that goes against the trend, unfold in three wave. and are known as corrective waves. The numbers 1, 2, 3, 4, and 5 signify the movement in the direction of the trend. The letters A, B, and C signify the corrective waves. These patterns are applicable in both the long-term as well as the short-term charts.
How to read the Waves that occur in a Movement?
Let us begin with the upward movement. This process commences when there is a hike in the price after a downward trend or sideways movement. Usually, a strong buy signal triggers a movement. In most cases, a new upward movement follows a dominant candlestick pattern.
The early part of the upward movement is known as Wave 1. It generally begins after a long downward trend. Following the initial strong upward swing, a small downward movement occurs called Wave 2. However, this second motion is so small that it becomes difficult to trace on the price chart. Sometimes it can be impossible to differentiate one movement from another.
Following this, another upward movement occurs. This is wave 3 and is generally the largest in the upward trajectory. In fact, it indicates the entry of most professional investors and traders. Therefore, their intentions are to take maximum advantage of the upward trend.
Both waves 4 and 5 refer to small movements. While wave 5 isn’t as strong as the first and the third, it is still significant. It tends to gain strength when a particular trend persists for and extended period of time.
What happens after the motive wave?
Following the formation of the fourth and fifth waves, the market becomes exhausted. At this point, the corrective wave takes control, and a reversal of the uptrend occurs. What is known as wave A, generally follows the fifth wave and is usually not strong. It displays a small downward movement that marks the commencement of corrective wave B. It is generally the shortest, followed by wave C, signalling the most significant downward movement.
This offers an excellent opportunity to those who want to move against an upward trend. However, wave C will only last if the upward movement doesn’t become too strong. Otherwise, a new buying signal will reverse the small downward movement that it generates.
What follows this process?
Now another cycle of starts with Wave 1. The length of the waves can vary according to different market conditions. Each time a party exercises a firm control, it becomes challenging to discern the waves from one another.
When considerable fear is present in the market, a sharp decline in prices occur. Therefore, the small upward movements succumb to the steady downward movements.
How can the Elliott Wave Analysis help you achieve positive results?
A strong Wave 1 usually marks the commencement of a fresh cycle. It is challenging to correctly distinguish the waves at times. This is due to the strong setups on the exhausted and sideways markets that lower the risk of moving against the powerful waves. It can be extremely productive to enter the market at the beginning or the middle of Wave 3. But how do you do it? Here is how you can go about the task.
- Wait for the formation of Waves 1 and 2. This will allow you to understand that the market is under the control of a certain entity. You can buy when the price is high, hold the asset, and sell at a higher price.
- What follows is a strong signal indicating its direction marks the beginning of Wave 3. An abrupt start of Wave 3 can help investors to enter the market when it has already begun to form.
- An upward trend causes a long and robust Wave 5. You can penetrate the market during the commencement or middle of this motion if a strong signal for continuation is present. Additionally, a support/resistance level breakout can also cause the formation of this continuation level.
The Elliot approach can help you increase your profit and success rate. Sometimes it is impossible to discern one wave from another. However, you can still enter the market using the support/resistance level breakouts as explained above.
Try avoiding the reversal level trade setup if you are not experienced in using this principle. You can, however, go for the strong reversal trade setups when they indicate the initiation of Wave C.
Following the tips mentioned above can help you trade and make consistent profits by controlling your risks.
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