Introduction to the Elliott Wave 5-3 Market Pattern

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Elliott Wave

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Elliott Wave

Elliott Wave theory is one of the most accepted and widely used forms of technical analysis. It describes the natural rhythm of crowd psychology in the market, which manifests itself in waves. The essence of Elliott waves is that prices alternate between impulsive phases that establish the trend and corrective phases that retrace the trend. In their most basic and straightforward form, impulses contain 5 lower degree waves and corrections contain 3 lower degree waves.

Elliott Wave is fractal and the underlying pattern remains constant. The 5 + 3 waves define a complete cycle. They can form different patterns such as ending diagonals, expanded flats, zigzag corrections and triangles. Fifteen different degrees of waves can be identified with each of the 5 smart drawing tools, allowing users to visually identify different degrees of waves on a chart. The key to trading Elliott waves successfully is counting them correctly for which there are rules and guidelines.

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Introduction to the Elliott Wave 5-3 Market Pattern

The principles behind modern Elliott Wave theory had their origins in the 1930s, when they were discovered by Ralph Elliott. He, in turn, had been inspired by a trader by the name of Charles Dow and several others. The most referred to textbook about Elliott Wave analysis for the modern trader is undoubtedly ‘The Elliott Wave Principle: Key to Market Behavior’ by Robert Prechter and A.J. Frost.
Prechter rose to fame when he used Elliott waves to correctly predict the stock market crash of 1987. 19th October 1987 is known in the annals of history as ‘Black Monday’, since on that day the stock markets saw an unprecedented drop of 23% in a single day.
Unfortunately, Prechter had much less success, towards the end of the 20th century, in correctly predicting market movements using his understanding of Elliott Wave theory.
Elliott Waves Defined
Elliott was, in the first place, an astute observer of crowd behaviour. He noticed that a period of mass optimism was nearly always followed by a period of darkness or pessimism. By studying this behaviour he was able to determine certain patterns, which he was later able to apply to stock market prices.

The basic Elliott wave structure can be seen in Fig. 1.19(a). It consists of five waves, three of which are fairly large and follow the main trend (Waves 1, 3 and 5) and two of which are smaller, countertrend movements, (Waves 2 and 4).
The two countertrend waves are vital for the overall directional movement to take place. Although there are a number of different variations of Elliott waves, they all fit into the basic structure you see in Fig. 1.19(a). The stock market is, at any given moment, somewhere on this five-wave Elliott chart.
How it Works
The basic Elliott waves repeat themselves over time. Elliott noticed that after the initial five-wave pattern, three of which follow the same direction as the main trend, there is normally a three-wave movement going against the main trend, which is upwards in this case.

This can clearly be seen in Fig. 1.19(b). Waves one, three and five follow the main, upward, trend, while waves two and four are merely corrections. After wave five, we see a three-wave corrective pattern, with waves a and c heading down and b being a smaller corrective upward wave.
The Moment of Truth
The moment of truth arrives after wave c. If this abc wave pattern is merely a correction during a longer term bull run, we will see a new five-wave pattern heading upwards again.

This is what happens in Fig. 1.19(c). After the red line, at the end of the abc corrective pattern, we see that the market resumes the previous up-trend with a new series of five Elliot waves, three of which head north (waves one, three and five) and three of which are smaller, corrective waves, (two and four). Eventually we get a three-wave abc corrective pattern again, after which we hope the market will resume its upward trend.
If, on the other hand, the abc pattern was no mere correction, but the start of a major downtrend, the market will not recover after wave c, but we will rather see something like the following:

The thick red line in Fig. 1.10(d) corresponds to the end of the abc wave pattern in Fig. 1.19(b), which we initially hoped to be a corrective wave. What happens after this shows that this was indeed no mere corrective wave, but the beginning of a major downtrend.
Problems in Paradise
The problems the world’s foremost Elliott Wave expert, Robert Prechter, had with correctly applying Elliott Wave analysis during the latter part of the 20th century serve to remind us that it is not as easy as it looks.
Theoretically, smaller wave patterns like the ones above, form part of bigger, long-term wave patterns. Whether the scenario in Fig. 1.19(c) or the one in Fig. 1.19(d) will unfold would therefore depend on how many smaller five-wave patterns we have already had, which were in the direction of the main up-trend.
The longer-term wave patterns should follow the same pattern we see in Fig. 1.19(a). Any major up-trend should therefore consist of three upward wave patterns, after which we will see a reversal. This can be seen below in Fig. 1.19(e).

The first two times, the market headed back north after the abc wave corrective pattern, in other words we had the scenario in Fig. 1.19(c). The third time, we had a major turn in the market and we saw the same scenario we had in Fig. 1.19(d); the market started heading south.
Elliott Wave analysis will deliver the best results when used in combination with one or more other technical indicators, such as Fibonacci analysis. It takes years of practice to become an experienced Elliott Wave analyst.

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3 Elliott Wave Flat Patterns to Know and Understand

  • Three types of Elliott Wave Flat patterns: Regular, Expanded, Running
  • Where you will find flat patterns in the Elliott Wave sequence
  • Learn more on Elliott Wave Theory by downloading this beginner and advanced Elliott Wave guides

In Elliott Wave theory, a flat is a pattern consisting of three waves labeled A-B-C. It is a corrective pattern that runs counter trend. The pattern tends to be a shallow retracement of the previous trend and may be the ‘flag’ of the common flag pattern at times. At other times, it may look like a simple range that spends more time going sideways than making any real progress in price.

In an impulse, flats are typically found in the 4 th wave position. Flats can make up the ‘A’ or the ‘B’ wave of another corrective pattern, but you won’t find them in the ‘C’ wave of a correction.

There are essentially 3 types of flat corrections. The regular flat, the expanded flat, and the running flat. The name of the pattern you are identifying isn’t as important as what the pattern implies. In each of the flats above, the implication is a sideways consolidation that eventually would resolve as a complete retracement of the pattern and continuation of the trend prior to entering the flat pattern.

In the expanded flat, the ‘B’ wave breaks beyond the origination of the ‘A’ wave and the ‘C’ wave breaks beyond the origination of the ‘B’ wave. In the running flat, the ‘C’ wave does not travel back to the origination of the ‘B’ wave.

When seeking to identify an Elliott Wave flat, there are a couple of characteristics we look for.

  1. The sub waves of an A-B-C flat (regardless of the 3 types above) subdivide as 3-3-5
  2. In the flat, look for a second wave, or “B” wave that retraces 78-138% of the “A” wave

The 3 waves of the flat (A-B-C) subdivide as a 3-3-5 meaning the ‘A’ leg has 3 sub waves in it, the ‘B’ leg has 3 sub waves in it, and the ‘C’ leg has 5 sub waves in it. Because of the ‘A’ and ‘B’ legs both containing three sub waves each, it illustrates the struggle of the instrument to create a new trend against the previous trend. Therefore, prices end up slopping around sideways eating up more time than price. One thing to keep in mind when identifying corrective patterns, ‘C’ legs will always have five sub waves in it (triangles are the only exception as they contain just three sub waves). Therefore, if you see a 5-wave move, preceded by several 3-wave moves, count backwards and see if a flat pattern is at play.

Another characteristic we look for in identifying flats are a secondary or “B” wave that retraces most or all of the preceding wave, but in a clear 3-wave fashion. The trick here is to find that move that is a clear 3 wave move. As we learned in our impulse section, when the proposed wave 4 overlaps the price territory of a proposed wave 1, that overlap eliminates the impulse pattern and solidifies a 3 wave move. Therefore, when the proposed wave 3 terminates near the beginning or just beyond the beginning of the previous trend wave, closely monitor the end of wave 1 for overlap.

Intoduction to Elliott Wave analysis

What is Elliott Wave analysis all about?

You probably heard something about Elliott waves or even seen wave counts. That’s because nowadays Elliott wave analysis becomes one of the most popular approaches of the Forex market forecasting. Why? Elliott Wave Principle is the only tool in our experience, which can sort out the price movement on every timeframe from the Monthly or even Yearly chars to just one-minute intraday intervals. For example, you can trade on intraday charts, but at the same time, you also have a bigger picture. Simply put, Elliott waves are the DNA of the market. In the following articles, we will guide you through the Elliott Wave Principle. Let’s go.

Who is the author?

We should say many thanks to Ralph Nelson Elliott (1871 – 1948), who was an accountant and economist. In 1938 he published ‘The Wave Principle’, and his second book ‘Nature’s Law – The Secret of the Universe’ was printed in 1946. Elliott described patterns that repeatedly form on the market according to very well-defined rules.

We must also thank Robert R. Prechter Jr. and A.J. Frost for the book ‘Elliott Wave Principle: Key to Market Behavior’, which nowadays is the primary source of rules and guidelines. And furthermore, in 2006 another great book was published – ‘Elliott’s Code’ by D.V. Vozny. Unfortunately for many readers around the world, this book is in Russian.

The begging of the journey

So, this series of articles based on the two books. Any rule or guideline in any article fits the rules in these publications. And rest assured, I’m not going to just retell you the books. The thing, I’m really going to do, is to teach you the Elliott Wave Principle and share my experience. The most examples will be from the real market. Also, we’ll go through some cases, which aren’t described in the books, but you can find them on the charts.

Market’s LEGO

There’re two main things in the Elliott Wave Principle: impulses (five-waves price movements) and corrections (three-waves price movements). We’ll come back to this in the next articles, so you’ll see that there’s just one main LEGO block, which is an impulse. But for now, let’s focus on these two ones.

Let’s have a look at the chart below. You can see there a 5-wave decline – that’s an impulse wave (there’re some cases where we could have a 5-wave correction, but I’m going to describe it later). Also, there’s a 3-wave advance, which we could consider a correction. Fine, we’ve just found an impulse and a correction, so it’s time to see a little bit bigger picture.

The next chart is just the real wave count, which I posted in my analytics. The decline is likely in the third wave of a bearish impulse, while an upward bounce is the fourth wave of it.

So, we can come to the following conclusion: there’s no wave, which could stay apart from the others. The Elliot Wave Principle is like a Russian nesting doll (Matryoshka). Each wave is a part of another wave, but also each wave consists of smaller waves. This story happens from higher to lower timeframes.

And this makes the Elliott Wave Principle different from other techniques of market analysis. The majority of the technical analysis approaches focus on patterns and signals, which stand aside from each other. The power of EWP is an ability to see the bigger picture, not just an individual setup.

Thinking opportunities

You probably heard that if you use the EWP in trading, you will come across more than one possible wave counts. Usually you have a few possible scenarios, which sometimes are contradictory. This is the most exciting about the EWP because it’s like playing chess.

If some holy-grail indicator tells you to buy or sell, you wouldn’t think what you’re going to do if something goes wrong. With the EWP, you are trying to figure out trading actions depending on which wave count is in place. That’s a core skill of a successful trader.

Real examples

Let’s get to some real stories. The first example is the DJI index. In September 2020, the index reached the historical high, and I posted a quite bullish wave count. I expected the market much higher because the fifth wave was far from over.

A few months later, the market climbed even higher, but I was still bullish. This expectation was based on some things in the EWP we’re going to learn soon, but for now, you can see how it worked.

So, the trend is still bullish, and you can see the current wave count below.

The second story is USD/TRY. In October 2020, the fourth wave looked finished as a triangle, so I expected another bullish impulse, which developed in the next few months.

Then there was a long story with a bearish correction, which finally ended up, so the bullish trend has been continued as expected.

Finally, in April 2020 there was another bullish moment because of the possible ending of wave 4. So, the market went even higher.

Bottom line

There’re bad examples as well. However, speaking of trading, the most important thing is what you’re doing when the market is moving along the trend according to your wave count. So, we can use the EWP as a great tool to find opportunities in the markets.

In addition, there’s no obligation for you to trade any wave count you labeled or just seen on the web. You should trade only the best counts when you have a great moment to open a trade. In other words, you should wait for a good call like a hunter in the woods. And when you see the opportunity, then you do the best to trade it most successfully.

It’s just the beginning. In the next articles, we’re going through the more specific rules and guidelines of the EWP.

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