If you’ve unfamiliar with Elliott Waves, start here before jumping into the charts. It will give you just enough info to start following along. I recommend reading Elliott Wave Principle: Key to Market Behavior by Frost and Prechter for more detailed instruction.
Elliott Wave Theory (EWT) is a method of technical analysis which focuses on the wave-like patterns that tend to form on price charts. Zoom out on a chart, and look at the larger moves. They often move in trends, forming “waves”.
Impulse Patterns
Let’s start with the epic Tesla run of 2020. Notice a clear 5-wave pattern as tesla works its way higher, with smaller short term pullbacks. A 5-wave movement in the direction of the larger trend is called an impulse. There are 3 waves going up (with the trend), and 2 waves going down (against the trend). Theoretically, each of those advancing waves (labeled 1, 3, and 5) should also consist of 5-waves, forming a fractal.
Impulse patterns carry a trend along its advance, whether it is up or down. They divide into 5 waves, labeled 1, 2, 3, 4, 5.
A suspected impulsive wave may be near its end when 5 waves can be counted from the start of the advance. Keep in mind – Just because you can count 5 waves, does not mean that a 5 wave pattern has actually completed.
Corrective Patterns
Corrective waves move against the trend or sideways as a consolidation type pattern. Corrections against the trend are commonly divided into 3-wave structures, labeled A, B, C. Wave A moves against the trend (ie. down when in a bull market or up when in a bear market). Wave B moves with the larger trend. Wave B is sort of a correction within a correction, in that it moves against the larger corrective pattern. Wave C moves against the larger trend, similar to wave A.
Wave A divides into 5 waves, in the direction of the corrective move.
Wave B divides into 3 waves, in against the corrective move.
Wave C divides into 5 waves, in the direction of the corrective move.
The steep A-B-C decline shown above is a Zig-Zag, suitably named for its appearance. It is possible to get a similar move, where wave B makes a new high within the correction, resulting in closer to a net sideways move. This is called a Flat.
Wave 4 in the above chart forms a Triangle pattern, which is labeled as A-B-C-D-E. It can be clearly counted starting from the top of wave 3. There are a few variations of triangles.
Complex corrections: Corrections can string together multiple patterns, or even several of the same in an alternating fashion. For example, a zig-zag could repeat itself to form a double, or even triple zig-zag before ending. See Elliott Wave Principle: Key to Market Behavior if you want to learn how to label complex corrections.
Time Horizons
There are no fixed time horizons for Elliott waves. However, there are some general guidelines for each wave degree. This is important, since waves form fractals. Larger waves can be broken down into smaller waves, and those into even smaller ones. Starting from largest to smallest, wave degrees are referenced as follows:
Supercyle: decades
Cycle: years
Primary: months to years
Intermediate: weeks to months
Minor: weeks
Minute: days
This list leaves out higher and lower degree waves that I normally do not reference or label in my charts. I aim to follow the primary and intermediate degrees of trend, which are patterns that play out over weeks to years. Minor degrees are labeled, since they are the building blocks of intermediate trends.
Advantages
The main advantage of Elliott wave analysis is that allows for estimation of price targets with each move. Wave patterns tend to advance in fibonacci relationships toward one another, and there are a few hard rules which can rule in or rule out various wave patterns.
Rules for Impulse Patterns (with the trend, according to Frost and Prechter)
- Always divides into a 5-wave pattern
- Wave 2 never corrects more than 100% of wave 1
- Wave 3 is never the shortest wave in an impulse pattern
- Wave 3 always moves past the end of wave 1
- Wave 3 is always an impulse pattern
- Wave 2 always divides into a zig-zag, flat, triangle, or combination pattern
- Wave 4 never enters the price territory of wave 1
- Wave 4 always divides into a zig-zag, flat, triangle, or combination pattern
- Waves 1, 3, and 5 cannot all be extended
- Waves 1 and 5 may be either an impulse or a diagonal (a diagonal is a 5-wave pattern slightly different from an impulse).
Rules for corrections are more nuanced, so they will be left out of this article. These rules can be used to set targets for stops, buy/sell points, and expectations for the extent of price appreciation or decline.
For in-depth instruction on Elliott Wave theory, check out www.elliottwave.com. This is not sponsored, and I have no relationship with Elliott Wave International.