Elliott Wave Theory is used to study the mechanism of price action as well as market psychology. Elliott Wave trading strategies attempt to identify the recurring price fluctuations in the financial markets. The recurring price changes occur as a result of a natural cycle of the crowd’s psychology, which is present across every market.

Elliott Wave rules and guidelines can help you recognize price swings and the appropriate waves. They also help to categorize them into a series of patterns that are meaningful and can be used as a reliable method to predict future price movements. The basic idea behind price-action is that price action occurs through an inexplicably constant alternation of the trending (impulsive or motive energy) or the corrective (correction) cycle, creating this effect on any scale (Fractal).

Elite CurrenSea has produced an amazing piece of work in the form of an extensive guide on EW wave analysis and trading. The guide is broken down into thematic sections that explain various aspects of Elliott Wave theory and its correlation with Fibonacci. Most importantly, the resource masterfully covers the application and detection of impulsive and corrective waves, which we will summarize in the article below.

The idea behind EW corrective and impulsive waves

We will not dive into the depths of the theory to discover every aspect and idea the author came up with because it could require a lengthy journey. Instead, we will present an outline of the system to help our readers on how they are able to apply the concepts, as it will help to choose the right EW charting software. Elliott Wave trading strategies will guide you in understanding the fundamental elements in EW theory. However, should you want to be an expert in the field, you should learn the theory as well as the most recent revisions.

Motive Wave Patterns

The guide explains all EW patterns in great detail and provides a graphical representation of each stage of the waves. As we have already mentioned before, Elliott Waves patterns consist of two kinds of waves. The first is the Motive Wave that is composed of five waves. Three of these are impulse waves (waves 1, 3, and five) and two can be described as diagonal waves (waves two and four). Patterns of motive waves may be either downtrend or uptrend.

The initial wave of the pattern has a small rise with only a small number of traders taking part. The pattern is followed by wave two, which is characterized by a brutal sell-off; however, it allows the beginning of another rally, the third wave. The third wave is slow, but once it breaks through the high of wave one, the rally picks up momentum. This is the most active phase in which traders are actively adding positions as part of their Elliott Wave trading strategies.

Profit-taking and Market Pullbacks in Waves

The fourth wave is a time for profit-taking, which results in a pullback in price. However, it is more organized than wave two. In the previous wave, only a few traders who missed earlier movements enter the market to start a new rally. But the number of traders is not enough to propel the market, so it eventually tops out.

The downtrend of the motive wave follows a similar dynamic, though it occurs in the opposite direction. It begins with wave one, which has the weakest sell-off, involving only a few market participants. In wave two, the rally is stronger, but there’s still a chance for a reversal before another sell-off starts. Wave three is the most active, as it breaks the law of wave one, creating momentum for traders to open short positions or exit long ones. In wave four, profit-taking leads to a significant decline in asset value. In wave five, only a few short-sellers remain, attempting to start another decline. However, it won’t be enough to sustain the market rally, and it will eventually stop.

Corrective Wave Patterns

Corrective waves are more complicated than motive waves. Therefore, it is essential to use the best Elliott Wave charting platform not to become confused. The corrective wave pattern is based on these five main waves we have discussed above. It comprises three waves, also called the ABC Corrective Pattern (ZigZag correction). As with the motive-wave patterns we also have downtrend and uptrend corrective wave patterns, which have similar features in opposite directions.

In a wider uptrend-corrective wave pattern, the first wave (Wave A) sees a slight decrease in value. Investors save their gains and begin withdrawing money. Since the trend is still upward, some traders enter the market and start the second wave (Wave B). As Wave A’s decline becomes clear, most buyers will exit their positions, starting Wave C. At this point, many short-sellers join in to push the market down.

In a larger downtrend-corrective wave pattern, the first wave sees participants taking their gains and ending short-term trades. The downtrend attracts a few sellers as the second wave (Wave B) starts, initiating a weak rise. Elliott Wave trading strategies suggest that when Wave C begins, those noticing movement in Wave A will quickly leave the market. This will cause more buyers to join and push prices up.

How do you utilize Elliott Wave in trading?

We’ve explained the behavior of waves using Elliott Wave theory. Market participants go through various phases of waves. But how do you interpret these waves? How do you determine the best time to trade or leave the market?

The Elliott Wave trading strategy focuses on understanding market psychology. Recognizing shifts from pessimism to optimism is key. It’s important to know when the market is bullish and when it turns bearish. In a bullish market, investors are eager to trade and buy. However, the bullish mood fades as sellers’ remorse takes hold, and investors start selling their investments. This leads to the correction phase in the market.

Before applying the EW theory in the real market, you need to decide where to start counting the waves. Recognizing the type of wave at any given time can be tricky. Therefore, look at the market’s extremes—the highest and the lowest points. This will help you identify the shift in market direction. For example, if you start counting at the highest point, you’re observing the trend moving downward, and vice versa if you start at the lowest point. While this can be useful for some, it may not be very beneficial for experienced traders.

To better understand market wave patterns, start counting the waves on monthly or weekly charts. According to EW principles, traders should begin counting at the end of the previous impulse wave.