EW Tutorial

This brief tutorial of the Elliot Wave Theory is still under construction. For a complete overview, please refer to the free resources of Elliott Wave International (the official EW institute that offers subscription services) at

http://www.elliottwave.net/educational/basictenets/basics1.htm

Contents

• Basic Patterns
• Rules
• Impulsive Waves
• Corrective Waves
• Waves Relationships and Projections
• Guidelines

BASIC PATTERNS

For EW theory, markets move following a basic structure of a 5 wave advance and 3 wave retrace. Five waves moves are in direction of the main trend, and are called “impulsive waves”. Three wave moves are countertrend moves, and are called “corrective waves”.

This is complete cycle of 5 waves advance and 3 waves retrace

A cycle could be seen in every time frame. Inside the complete cycle, looking at the “macro” impulsive wave, wave 1, 3 and 5 are impulsive too, while wave 2 and 4 are corrective; looking at the “macro” corrective wave, wave A and C are impulsive while wave B is corrective. Every subwave in turn subdivide following the nature, impulsive or corrective, of the macro wave. This is gives us a more detailed structure like this:

Cycles are different in degrees. While they are identified by structure and not by time, analysts usually consider nine cycles, from Grand Supercycle (that lasts centuries) to Subminuette (that lasts minutes).

Here is an example of a complete cycle in Gold on a small (hourly) time frame. Subdividing the labeled waves, you can see how impulsive waves subdivide in smaller impulsive waves, while corrective subidivide in corrective manner.

RULES

There are only 3 “rules” in Elliott Wave’s patterns, although there are a lot of “guidelines”. Rules are:

1. Wave 2 cannot exceed the start of wave 1

2. Wave 4 cannot enter wave 1 territory (no “overlapping”)

3. Wave 3 cannot be the shortest wave of a 5 waves move

IMPULSIVE WAVES

As said, an impulsive wave is a movement in direction of the main trend. It is subdivided into 5 sub-waves, each one with his own “personality”.

Wave 1

Wave 1 is the first reaction to the previous trend just ended. Usually is deceptive and at a first look intepretated as a correction in uptrend or a bounce in downtrends. Sentiment is still related to the previous trend.

Wave 1 should develop as a 5 wave move, but for experience sometimes shows a not completely clear structure. It could develop as a leading diagonal t00.

Wave 2

Wave 2s usually retrace great part of wave 1, in a shallow and sharp manner. During wave 2′s investors believe that the previous trend is resuming, even if volumes are usually smaller than in wave 1. Wave 2s creates pattern like double top/bottom, or H&S.

A typical wave 2 retracement is 61,8% of wave 1, although the only rule is that it cannot exceed the start of wave 1. if 61,8% is the typical retracement, 78,6% is not unusual.

Sometimes wave 2s are so sharp and deep that could be really difficult to subdivide them with a reasonable count.

Wave 3

Wave 3 is the strongest, powerful and usually longest wave of an impulse. Wave 3 is often the “point of recognition” that a new trend has started. There are a lot of breakaway gaps, volumes are huge, and there are many breaks of resistances (in a bullish wave 3) or supports (in a bearish wave 3).

Wave 3 always develop in 5 waves, and is the wave that has the strongest probability of extension with his subwaves in turn subdividing in smallest impulsive waves. For this reason, wave iii of 3 is usually the strongest part (and the most violent move) of an impulsive wave.

Wave 4

Wave 4 is a corrective wave and usually shows the more complex structure. After a strong wave 3, wave 4 could go sideways for a protracted period of time. It is surely the more “frustrating” wave, as every rangebound market is. A typical retracement level is  23,6/38,2% of the previous wave 3, although the only rule is that it cannot enter in wave 1 territory (although in futures market i can allow for a brief overlap, as i have experience of it. The important is not to have “closing” prices that overlap)

For the guideline of alternance, wave 2s and 4s cannot develop in the same corrective pattern. While usually wave 2 shows a zigzag correction, wave 4 can develop in a flat or often in a triangle.

Wave 5

Wave 5 is the last move of an impulsive wave, and usually develop as an impulse. Sentiment shows extremes that are not supported by market internals, with volume and other indicators that shows a lower high in respect of wave 3, preluding for a reverse. Wave 5 could develop in form of an “ending diagonal” (or wedge shape, see the Guidelines).

Wave 5 could even be “truncated”, without surpassing the wave 3 extreme. But is it difficult to predict a truncation and it’s a rare pattern too.

CORRECTIVE WAVES

Corrective patterns

Corrective Waves could be reduced to 4 macro-categories, although they could assume complex forms. The image shows the most common:

Zig Zags

are 3-wave moves where wave A is impulsive, wave B is corrective and retraces a small part of wave A, and wave C is impulsive. So the sub-waves sequence should be 5-3-5. A zigzag usually retraces a great part of the previous impulsive wave, and could morph into Double (A-B-C-X-Y) or Triple (A-B-C-X-Y-X-Z) Zigzags.

Flats

are sort of sideways correction, and  often shows a subwaves sequence of 3-3-5. In a “regular” flat, wave B usually retraces almost the entire wave A (forming dobule tops/bottoms) , while wave C exceeds slightly the wave A extreme. Sometimes it happens to see “Irregular” (as in the picture) or “Expanded” flats, where the 3-waves move in wave B carries prices beyond wave A start, and wave C could fall short to exceed wave A extreme.

Triangles

are usually in wave 4 or wave B position, never as wave 2. They usually develop in a succession of five 3-wave moves (3-3-3-3-3, labeled A-B-C-D-E), where it’s not unusual to see wave E to “overshoot” the trendline before reversing sharply.  Given the position (4s or B’s), break of triangles are terminal moves (wave 5s or C’s) that lead to a change of trend. There are other forms of triangles not reported in the picture, like Ascending, Descending, contracting, Expanding

Complex Structures or “Combinations”

like Double threes or Triple Threes above, includes multiple combinations of the cited corrective structures.

Wave A

Wave A is the first countertend move of a correction. As wave 1s, it could be clearly impulsive or assume a deceptive form; given the macro categories of corrections, if it shows five waves is preparing the ground for a zigzag, while if it’s in three waves, it indicates a flat. The latter case is usually misleading as it often happens (to me) to confuse a three waves wave A with a complete ABC correction.

Personality of wave A’s is much the same of wave 1s

Wave B

Wave B is always a three waves move in common corrective patterns. It is a “difficult” wave, because in irregular flats it could even surpass wave A starting point, giving the idea that trend is resuming. Even triangles can be found in wave B position.

Wave C

Wave C is assimilable to a wave 3, as it has many of wave 3 properties. It is impulsive, with 5 subwaves, and could be strong to lead market to deep retracements. Being impulsive, wave C’s shows every feature of that kind of move.

WAVES RELATIONSHIPS AND PROJECTIONS

There are many “common” relationship between waves, useful to project target and reversal levels. Relations are often based on Fibonacci work (i won’t talk of it here) and retracement levels. Consider that when a level has multiple confluence of target of different degrees of waves (for example: projecting wave C of a w2 leads to 61,8% of w1), that level usually proves formidable resistance. See also Channels in Guidelines section.

Wave 1 doesn’t have a “rule”, and for trading it i only rely on seeing a five wave move after a supposed completion of trend.

Wave 2 usually retrace a percentage of wave 1 between 50%-61,8% (typical)-78,6% (extreme but not unusual). If wave 2 has a recognizable pattern, look for relations between subwaves.

Remember however that the only limit for wave 2 is the start of wave 1.

Wave 3 could be projected in relation to wave 1. It cannot be the strongest wave, so it should be at least equal (100%) to wave 1, but the most common relation is 161,8% the lenght of wave 1. In w3 you should look for a five wave structure, but they oftend extends so basing only on the structure could lead to early exits. 261,8% of wave 1 is not unusual too.

Wave 4 has the only limit of not overlap wave 1, but there are many common relations. Remember that w4 is the most difficult wave to trade, but a common retracement is 38,2% of wave 3 (especially if wave 3 is extended) or 50% of wave 3. Sometimes, but i have to say it is rare, it could reach even 61,8% of wave 3.

Wave 4 has relations with the lenght of wave 1-3 too, and it usually between 23,6 and 50%.

Wave 5 has many possible projections, aside truncation or ending diagonal shapes. It is usually in realtion with wave 1 (commonly is equal – 100% of w1 – but 61,8% or 161,8% are not unusual). It could be derived as projection of wave 4, targeting the 127,2% or the 161,8% of wave 4 (also called external retracement). If a level combines two of these relations, it has strong probability of being the final target.

Wave A same as wave 1.

Wave B has combinations of target depending on his structure. You can rely on wave 2 targets if wabe B develops as a zigzag or a flat, or w4 targets if develops in more complex structure.

Wave C shows relations with wave A, as it usually is 100% or 161,8% of wave A. You should consider that wave C is impulsive and has to show 5 waves, and that there are relations between the corrective pattern in which wave C is in (the C of a wave 2 could want to rech wave 2 targets in relation with w1).

GUIDELINES

Ending diagonals

One of the strongest pattern i have seen is an ending diagonal. It shows in w5 position (rarely in wave C), and it’s a terminal pattern that leads to sharp change of trends. In classic technical analysis is also called wedge.

Ending diagonals are the only impulsive structure (it is composed of 5 subwaves) where overlapping is allowed. Two converging trendlines could be drawn, one between wave 1, 3 and 5 and one between wave 2 and 4. Wave 5 usually overshoot the trendline (also called a “throw-over”).

Once the trendline between w2 and w4 is broken (and sometimes backtested), prices go very fast to at least the start of the diagonal.

You could see a good example on recent ES daily chart

Alternation

Someone talks of “rule of alternation”, but in Elliott work as seen there are only three rules. But this is a good guideline that says that wave 2 and wave 4 must show different corrective patterns.

Channels

Some analist find useful to draw an “Elliott channel” to project the end of an impulse. A channel could be drawn combining wave 2 and 4 extremes, and projecting a parallel line that starts from wave 3 top. Wave 5 should end touching the upper line, or – in my experience – after a brief fake breakout, called a “throw-over”.