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Elliott Wave has a comprehensive collection of complex techniques yet around 60% of those techniques are easily understood. The remaining 40% can take more time to understand. For the purpose of this paper we shall focus on the basics which is sufficient to provide a fundamental understanding of The Elliott Wave Principle.
The theory of Elliott Wave can be broken down into two key aspects: Impulse Patterns and Corrective Patterns
• BASIC ELLIOTT WAVE PATTERNS
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Elliott theorised that in every timeframe and within a major trend, a pattern will exist that consists of 5 Waves.
The Initial Impulse move Wave (1) is usually a weak rally with only few participants. Once Wave (1) completes, a period of selling ensues which is a corrective Wave (2) - the selling however is not sufficient to create a new low.
The Second Impulse Wave (3) having broken Wave (1) really begins to rally as quite often Market Stops are placed just above the peak of Wave (1) and the breakout of Wave (1) sees the price accelerate to the upside.
As the Buying begins to dissipate towards the end of Wave (3) profit taking ensues and we see selling entering the market to create the Correction Wave (4). The final advance to Wave (5) can be created by traders late to the price advance and see the corrective wave as an opportunity to join the trend. This final wave (5) usually lacks the strength of Wave (3) as less traders enter the trend and finally the diminishing buying will create a market top before entering a new phase.
• ELLIOTT WAVE CHARACTERISTICS & PROJECTIONS
Within Elliott Wave we can identify certain rules and constraints that define the type of Wave that is forming. Also we can project where waves may terminate using Fibonacci techniques and begin to build a roadmap of price action. The following information is provided as a guide to how the waves interact with each other and the accepted characteristics and criteria for each wave pattern.
To be able to successfully apply Fibonacci price projections we first need to understand the fundamental measuring techniques applied to specific waves. The price distance of any given wave is measured as the vertical distance from the beginning to the end of the wave:
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 Click on image to enlarge!
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Secondly, we need to have an understanding that Wave 1 is the start of the sequence and that Wave 2 has a direct relationship with Wave 1. In order for us to project any price extensions we need to confirm that Wave 2 has indeed formed and retraced a percentage of the initial Wave 1.
Most commonly it is found that Wave 2 pullback retracements are either 50% or 61.8% of Wave 1. As we do not rely on commonalities we shall provide some statistical data to reinforce the concept of the Wave 2 Pullback as can be seen in the following diagram:
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It is necessary to have a Pivot reversal to provide confirmation that Wave 2 has indeed formed. Once we have seen evidence that Wave 2 has indeed formed it is then possible to apply Fibonacci Tools to calculate Wave 3 Targets.
There is a relationship between Wave 3 and Wave 1 and typically we monitor for the following:
Wave 3 = either
1.62 x length of Wave 1, 2.62 x length of Wave 1, 4.25 x length of Wave 1
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The most common multiples of Wave 1 to Wave 3 are 1.62% and 2.62%
Whilst Wave 3 is generally considered the largest pattern of a 5 wave move, there are exceptions and in the most rarest of circumstances (2%) it can be the shortest wave. To further understand our expectations of the Wave 3 projection typically we see the following:
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Wave 4 of the Elliott Wave count is considered a pullback or a correction wave after the momentum has dissipated from Wave 3. It is considered a retracement of Wave 3 for a period of potential profit taking before the original Primary trend resumes.
Wave 4 is related to Wave 3 by the following standard ratios:
Wave 4 = either
24% Retracement Wave 3, 38% Retracement Wave 3, 50% Retracement Wave 3, 62% Retracement Wave 3
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Wave 5 of the Elliott Wave count is the final move of the Primary Trend. It is a little more complex in as much that it has two primary relationships which correlate with Wave 3. In essence the relationships are directly correlated with the length of Wave 1 or Wave 3 depending on the 1.62 extension. If we find that Wave 3 is greater than a 1.62 extension then we look to project targets based on the length of Wave 1. However, if we find that Wave 3 is less than a 1.62 extension then the ratio of Wave 5 will be based on a measurement taken from the start of Wave 1 to the top of Wave 3. Let us look at both individually:
1. If Wave 3 is Greater than 1.62% or extended then the Wave 5 ratios are:
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Wave 5 = either
1.00 x length of Wave 1, 1.62 x length of Wave 1, 2.62 x length of Wave 1
2. If Wave 3 is Less than 1.62% then Wave 5 will be based on a measurement from the beginning of Wave 1 to the top of Wave 3 and the ratios used are as follows:
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Wave 5 = either
0.62 x length of 0 to 3, 1.00 x length of 0 to 3, 1.62 x length of 0 to 3
We have looked at some of the characteristics of Elliott Wave patterns and also identified how we are able to project forward to find future price targets. To further our understanding let us finish with identifying some fundamental rules:
Rule #1. Wave 2 can never retrace more than 100% of Wave 1
Rule #2 Wave 4 may never end in the price territory of Wave 1
Rule #3 Out of the three impulse waves (1,3 and 5), wave 3 can never be the shortest however, it does not have to be the longest providing that Wave 1 or Wave 5 are shorter than Wave 3.
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