Introduction to Elliot Wave

The Elliot Wave Theory was proposed in the early 1930s by R.N. Elliot, a stock market speculator,
Elliot focused on classifying market activity according to a set of cycles and ratios of movements.
As with the waves on the ocean, market activity ebbs and flows in cycles that repeat and can be
subdivided into smaller cycles.
The theory states that markets move in repetitive patterns; a five-wave advance (impulse waves)
and a three-wave decline (corrective waves, labelled with letters). This cycle of eight waves can be
seen in all time frames from intraday to what Elliot called the "Grand Supercycle" of over 200
years. Each wave in a cycle can be subdivided into smaller cycles.
The diagram below shows how an eight-wave cycle advances in five waves and declines in three.
One of the rising impulse waves has been broken down into five smaller waves
According to physical law: “Every action creates an equal and opposite reaction”. The same goes for the financial markets. A contrary movement must follow a price movement up or down, as the
saying goes: “ What goes up must come down” (and vice versa)
Price actions can be divided into trends on the one hand and corrections or sideways movements
on the other hand. Trends show the main direction of prices, while corrections move against the
trend. In Elliott terminology these are called impulsive waves and Corrective waves.
HOW CAN YOU USE ELLIOTT WAVE TO PREDICT TRENDS?
Everything you have read so far is the background in brief to the Elliot Wave principles. Many
traders do use these studies, and are indeed profitable. However, when these principles are
combined with the Elliot Wave indicators, you have a powerful and unique trading technique,
which can be extremely profitable. Most charting software will have these Elliot Indicators as part
of their advanced packages.
The three Elliot Wave indicators that I often use are;
Elliot Wave Trend (ET) TREND
Elliot Wave Number (EN) WAVE COUNT
Elliot Wave Oscillator (EWO) MOMENTUM
Your most profitable trade
This would simply be the strongest trade indicated by this method; this trade is where there is-
1. A New EN of 3, i.e. moving from 2 to 3. Since wave 3 would be the longest of all cycle this
will produce you the most gain.
2. An ET of 1, since this being a positive
3. A positive EWO – the more positive the better.
LONG POSITION – i.e. when you will be buying the stock, to exit you have to SELL to close your
original position. So you buy when you expect the price to go up, and sell it to close your
position. For Long positions you are expecting EN of 3 or 5 (remember UP waves), ET must be 0
or 1, and EWO must be positive. These 3 things must happen simultaneously. Once these 3
indicators line up you should look for a good opportunity to go long. The price to close your
position is the open price of the first period where EWO first became negative. An EWO decline
to below 0 is enough to tell us that the price may retrace, so you should book your profits!
SHORT POSITION Refer to the Manual


IMPORTANT NOTE
Always have strong money management rules. Always have a stop loss and monitor your trades.
As your position goes into profit, consider to raise your stops to lock in profits. You should also
look to see the chart patterns, for example if you are long than look at the last three candlesticks
on your charts, and see if they are forming consecutive higher lows.

By Jay Lakhani, Forex Trader.