| Technical Forex Strategies: Elliot Wave Principle |
 Elliot Wave Principle analysis, introduced by Ralph Nelson Elliot in 1938, identifies market phases in the form of waves. Although Elliot Wave analysis does have some gray areas and can be quite complicated, it is an invaluable technical tool when developing a Forex strategy.The basic premise of Elliot Wave Principle is that market moves take two forms: impulsive and corrective. Impulsive waves (waves of the larger trend) can be subdivided into five, or a multiple of five, waves. “Corrective” waves retrace by subdivisions of three (or a multiple of three). Impulsive waves are annotated by numbers (1-2-3-4-5) and corrective waves by letters (A-B-C). Impulsive waves consist of five waves, but each of these waves have their own special characteristics. The first wave follows a market bottom or top, and it naturally can be broken down into five subwaves. Wave two is one of two corrective waves in an impulsive trend. It can take any of three patterns (more on this later), but it is always subdivided into three waves. Wave three is most often the largest and most powerful wave. While this is not a necessity, wave three can never be the shortest wave of a trend. Wave four is the second corrective phase. It is typically longer and more complicated than wave two, but this is not always the case. Finally, wave five concludes the impulsive move before a larger ABC correction or a reversal takes place. Elliot identified three specific corrective patterns: zig-zag, flats and triangles. Each of these patterns form three waves (annotated on the chart by letters), but their subdivisions vary. Zig-zags are composed of a 5-3-5 structure. For example, if the larger trend is up, a corrective zig-zag will have five waves against the larger trend(Wave A), three waves up (Wave B), then another five waves against the trend (Wave C). If a chart shows an immediate five waves going against an impulsive five wave move, the market is forming a zig-zag correction. An appropriate Forex strategy would be to hold short until the completion of Wave C. Flats also forms a three wave pattern, but are subdivided into a 3-3-5 pattern. A flat will show three subwaves down against the previous trend (Wave A), three subwaves up matching or exceeding the previous high (Wave B), and finally five subwaves against the larger trend (Wave C). In “irregular flats” (which is a misnomer because they are the most common), wave B will form a new high, and will be followed by an exaggerated wave C. Irregular flats can be confusing since the fresh high in price is actually corrective, but a count of only three subwaves is a tip that a top or bottom is forming. Irregular flats form the famous “head and shoulders” chart pattern. Triangles present the toughest environment for traders. Triangles have three concrete properties: they trade within a tight range that can slant in any direction (this range can narrow or expand); they are subdivided into three waves, and they must have a minimum of five reversals within this range before the price can breakout. This is a basic introduction into Elliot Wave Principle and how to implement it into a Forex strategy. RN Elliot identified even more complicated corrections that combine any and all of the three basic correction patterns. Although wave labeling can initially seem daunting, it is fascinating to see the consistency of the patterns in the Forex market. Elliot Wave Principle is worthwhile study for Forex traders, and is an asset is obtaining and securing profit. |
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