Elliot Wave Strategy - Advanced Forex Strategies

Elliot Wave Strategy

Elliott Wave Strategy, developed by Ralph Nelson Elliott is one of the earliest technical analysis tools that was developed around the 1930’s. More than a trading strategy, Elliott Wave aims to capture the market sentiment as waves as hypothesized by Mr. Elliott himself. According to the Elliott Wave theory, price tends to unfold in specific patterns which are termed as Elliott Waves.

The Elliott Wave theory is in fact a very comprehensive and a complex theory and involves counting price waves. Accordingly to R. N. Elliott, price moves in a series of waves, termed as impulsive (motive) waves and corrective waves in a series of 5-wave patterns. Waves 1, 3 and 5 are termed as impulsive waves, which move in the direction of the trend and waves 2 and 4 are termed as corrective waves which run counter to the trend.

The first chart below shows a simple 5-phase Elliott Wave in an uptrend and a downtrend.

Elliot Wave Basic Pattern
Elliott Wave Basic Pattern

Besides the 5 waves, Elliott further hypothesized that prices tend to then enter a correction which is formed by corrective waves A, B and C which run counter to the rally or the decline which made up the previous 5 waves. The waves A, B and C are known as the corrective trend, while the 5 wave pattern is termed as the dominant trend.

Combined, the Elliott Waves look as follows.

Complete Elliot Wave CycleComplete Elliott Wave Cycle

The above wave represents the Elliott Wave at its basic form. R. N. Elliott further noted that prices tend to move in cycles terming them as follows:

  • Grand Super cycle
  • Super cycle
  • Cycle
  • Primary
  • Intermediary
  • Minor
  • Minute
  • Minuette
  • Subminuette

Each of the above wave cycles range from multi century (Grand super cycle) to minutes time frame (Subminuette). The Elliott Wave methodology is definitely not one for beginners or even intermediary traders. It requires a lot of experience and a complete understanding of how the waves work in order to trade with Elliott Waves and is therefore not advised for everyone.

How to trade with Elliott Waves Strategy?

While Elliott Waves may seem complex, it is the wave rules that make it easy to count the waves and thus trade based off these wave counts. The following rules need to be met for any of the waves to be valid.

  • Wave 2: Wave two makes for the starting point of the analysis. It is determined that wave 2 should never extend beyond the starting point of Wave 1
  • Wave 3: Wave three is the largest, strongest wave in the 5 wave pattern. Wave three is typically expected to extend wave 1 by a ratio of 1:1.618
  • Wave 4: Wave four is a correction to wave 3 but it should typically extends no more than 38.2% of wave three. Wave 4 is most preferred as it allows traders to enter the pullback on the previous strong trend
  • Wave 5: This is the final wave in the dominant wave trend but it usually hard to trade

From the above rules, it is now obvious that the focus of the Elliott wave strategy is to either trade wave three (which is more risky but offers tremendous rewards) and/or wave four, which is the safest.

The Elliott Wave strategy can be applied to any time frame and any markets. However, it is important that traders learn how to correctly count the trades, which is very subjective.

Elliott Wave Strategy – Sell Setup

In the first chart below we have a classic Elliott Wave strategy set up. The notes on chart illustrate the wave rules outlined above in this article. The sell deal is recommended at wave 4 which pulls back to 38.2% of Wave 3 and the sell trade can be exited at the trough of wave 3. Stops can be placed either at wave 2 or at the trough of wave 1.

Elliot Wave Strategy - Sell Setup
Elliott Wave Strategy – Sell Setup

 

Elliott Wave Strategy – Buy Setup

The next chart below shows a buy set up example using Elliott Waves. Here we notice that after wave 3 starts to pull back the wave 4 ends near 38.2% retracement level of wave 3, which marks the entry point into the long set up. Trades are then exited at the peak of wave 3.

Elliot Wave Strategy - Buy SetupElliott Wave Strategy – Buy Setup

Elliott Wave Trading Strategy – Conclusion

The Elliott Wave trading strategy as outlined above is one of the simplest ways to trade the EW pattern which works across any time frame. However, there are more complex rules that can be applied as well in order to trade more effectively. More importantly, the Elliott Waves can be applied to any trading strategy or chart patterns in orders to derive the maximum benefits. As mentioned earlier, the Elliott Waves require a lot of practice in terms of wave


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