The Elliott Wave Theory was created by Ralph Nelson Elliott in the 1930s and has since been one of the most reliable methods for forex trading amongst pro traders in Australia. This system only uses price and not volume like some other technical analysis methodologies. It can provide a trader with valuable information on when to enter or exit trades based on crowd psychology.
Although this guide is short, it will teach you the basics of using the Elliott Wave Theory (EWT) and how to utilize it during your forex online trading activities.
What do we need to use the EWT? Before anything else, we’ll need a charting program. One of the most popular charting programs is MetaTrader 4 (MT4). We’ll also need an account with a forex broker that provides the MT4 platform.
How to read the EWT?
The Elliott Wave principle is based on the idea that stock market prices unfold in specific patterns or shapes which are predictable after certain degrees of development. For example, when the first five waves unfold (1-2-3-4-5), they will inevitably develop into one final ABC corrective pattern (a flat) before resuming its bullish trend again. This ABC formation consists of three motive waves (A-B-C) and two corrective ones (a triangle). It is represented in the chart below:
Notice that in this lineup, all waves are labelled. To read a price movement, we only need to look at the wave (1-2-3) and whether it is a motive (bullish) or corrective (bearish) one, and then check for how many degrees of development has been made. The numbers on the left side indicate how much each degree has been formed; for example, wave three has developed two out of three degrees (60 percent). This means that once wave C completes and reverses in the opposite direction, we can expect a decline back down to 50% before resuming its bullish trend again.
It’s important to know what every numbered degree represents:
The Ascending Triangle
Every degree counts in the Elliott Wave Principle, and one of the essential degrees is the fifth one. The motive wave five always unfolds in three distinct lines, forming an ascending triangle. When line b touches or goes beyond line a, it’s time for traders to take profits before the next bullish leg is triggered. It’s also worth mentioning that when line c penetrates line a in its way down inside of which lies wedge support, this means that prices are ready to drop into at least 50% of their initial impulse waves before continuing their rally. Of course, there are exceptions, but generally speaking, this rule works most of the time.
The Double Three Structure
When five waves unfold in succession (1-2-3-4-5), the following three waves (consisting of 5, 3, and A) will eventually develop into another motive wave (consisting of five; 1-2-3-4-5). This is known as a double three structure. For example, once impulse wave three finishes unfolding on top of the line, then this means that we should expect more bullish momentum before the larger degree unfolds.
The Double Zigzag
The second most important pattern inside an Elliot Wave sequence is called the double zigzag. It consists of two corrective structures A-B-C, and C’-D’-E’. These patterns are especially relevant for managing trades because they usually indicate where reversals are likely to occur -mainly if you can spot them unfolding throughout multiple waves. For example, once line D’ goes beyond or touches line C’, this means that an upside reversal is likely to occur.
For instance, in the chart above, wave 5 unfolds as a double zigzag [lines b and c], so we need to know how it develops over time. As you can see, not only do we get the expected retracement back down to at least 50% on wave 3 (1-2-3), but there’s also another downside correction before another bullish leg resumes [line d]. If we want to be confident about recognizing these patterns while trading, we should become familiar with them while doing practise trades first.
