Elliot Wave Basics
This article covers the Elliot Wave Basics so that you can understand more advanced Elliot Wave Strategy easily. The Elliott Wave got its name from its developer Ralph Nelson Elliott although it was Robert Prechter who actually popularized it. The basic premise behind this principle is the fact that there are distinct perceivable trends visible in crowd behavior and market movements can be tracked in line with this behavior.
The objective was to bring about a sense of rationality when predicting market movements, a move made all the more plausible since Elliott’s primary research tool for this was in fact the Dow Jones Industrial Average. He supplemented this basis along with various observations made in nature and again found that there were patterns at play that could be predicted preemptively.
Among such patterns, we have the five wave pattern which really serves as a basic pattern for the whole principle. This pattern is showcased in the image below.
5 Wave Pattern
In this pattern, you can note that points 1, 3 and 5 are indicative of a directional movement while points 2 and 4 point towards interruptions which are counterintuitive to the directional movement seen in case of points 1, 3 and 5.
This pattern is fundamental to Elliott Wave Basics since it is seen across all market movements.
In Elliott’s own references, Waves 1, 3, and 5 would be referred to as Impulse Waves where there is a trend while Waves 2 and 4 would be referred to as Corrective Waves since there is a clear correction taking place.
These wave patterns can be noted in the image below.
In the above image, you can note that there is a primary 5-wave impulse pattern along with a 3-wave corrective pattern.
This tenet would be central to your understanding of the Elliott Wave principle including in case of trade cycles over a prolonged period of time; they too can be broken down into 5-wave impulse patterns and 3-wave corrective patterns. In other words, there is a very clear fractal nature to the Elliott wave principle.
On the following page, you can see this aspect clearly showcased over a prolonged period of time as mentioned above.
Primary rules of the Elliott Wave principle
There are three cardinal unwavering rules to the Elliott Wave principle which you need to keep in mind at all times as a savvy trader.
First, always remember that Wave 2 cannot retrace itself back beyond the entire span of Wave 1. Refer to the above image – Wave 2 clearly falls short of Wave 1 when it comes to the extent of its retracement; this will always be the case without exception.
Then it is also true that there will always be waves longer than Wave 3 among the three impulse waves; it simply cannot be the one that is the shortest under any circumstances.
Finally, there is a clear ruling that Wave 1 can never be overlapped by Wave 4.
As you trade, these rules will become all the more apparent to you so remember to apply the tenets of Elliott Wave principle, especially the cardinal rules listed above, and you will see for yourself the extent to which they continue to apply in every conceivable trading scenario.
One important aspect to always bear in mind in the context of the Elliott Wave principle is that its waves showcase numerous degrees to which they are prevalent, starting from Subminuette at the primary level all the way to Grand Supercycle. Yet, you will see the fundamental wave patterns as mentioned in the beginning of this article prevalent there as well.
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