Elliott Wave Analysis on Forex

The market is volatile. However, its variability can be predicted. And if you can predict, then you can (and should) earn. Ask how? There are many technical analysis tools that allow you to determine the patterns of market changes. One of the most effective is the Elliott Wave Theory.

It's simple: there are eight market waves that are constantly repeating, which allows us to profit from changes in the value of the instrument. Do you want to learn more about the Elliott theory in just a few steps and make profit in the Forex market with its help?

Prerequisites for the emergence of the theory

The Elliott Wave Theory is the first major work in the field of price chart analysis after Dow Theory . As a basis, the statement is taken that the whole history in one form or another repeats itself and the so-called Elliott waves are formed. Just as any social or economic events have the same development scenario, in the same way you can distinguish structures like two drops of water similar to each other. “History repeats itself” is one of the foundations of Dow's work, which Elliott developed into a complete analytical system . The developer himself was never able to make a fortune on his brainchild, but there is undeniable evidence that Ralph Elliott predicted events with amazing accuracy, and he did this not only with regard to the price, but also the possible start and end times of the movement in the market.

Elliott waves are an ordered system of rules that describe the behavior of the main research object - wave movement . It means some directional shift of the chart up or down. The relationship between individual movements leads to a complication of the structure of the model, and then the same rules begin to apply, but only in relation to a larger wave. Thus, a thing that is not entirely obvious at first glance becomes clear - the entire chart is highly fractal, self-similar, it can be decomposed into similar components from weekly movements to every second tick fluctuations.

The nature of the vibrations

At first glance, the trading process is absolutely chaotic, especially if you watch it on a 1 minute time frame. However, even on it, Elliott waves can be distinguished. They consist of a constantly shifting balance of supply and demand., and this happens cyclically, not necessarily because of a change in market conditions, but at least because someone fixes a profit, having no idea what will happen next and thus creates a movement in the opposite direction. This whole process of framing new Elliott waves can take from minutes to months, depending on the scale of the money involved in the formation of the movement. The author introduced a special system for marking, which provides for a variety of designations to separate fluctuations in terms of their magnitude and length - from the global supercycle in two Elliott waves to hourly ones. It doesn't make much sense to markup on smaller periods, since the effect of market noise is too strong, which some people attribute to automated algorithmic systems.

So, Elliott waves consist of two types - impulse waves and corrections . They differ as follows: there are five components in the impulse wave , and only three in the correctional one . The logical question of why exactly 5 and 3 can be answered if you try to choose the simplest combination of the same components so as to distinguish one from the other and none of them was an integral part of the other. So it turns out that this number pair is the simplest solution. The next picture shows the decomposition of such a cycle 5-3 into its constituent parts with a sequential reduction in scale.

Fractality of wave structures

Basic structures

Impulses

This is a type of Elliott wave, consisting of 5 oscillations, three of which are directed in the same direction. In essence, momentum is the main driving force behind the trend in the market. According to statistics, it turns out that impulse movements account for less than a third of the total market time. But on the other hand, at this time, the main price shifts occur, while events develop quite dynamically, the traffic intensity is many times higher than that in a calm time for the market. The classic impulsive Elliott wave is characterized by the following features:

• The first, third and fifth movements are directed in the same direction ;
• The second and fourth are corrective (pullbacks) and directed in the opposite direction ;
• The fourth movement does not enter the price territory of the second;
• The third move in the Elliott wave cannot be the shortest among the trend (1, 3 and 5).

These simple rules make it possible to identify such movements on the chart almost without problems. However, there is a variation called a diagonal that is slightly different from the normal impulse. In this case, the Elliott waves break the third rule , and the fourth wave crosses with the second, but the third wave still cannot be the shortest. In this case, you can draw generatrix lines that will converge and form a triangle, as shown in the following graph example.

Diagonal. The intersection of the second and fourth waves.

The diagonal can be formed either at the beginning of the movement , that is, in the first wave, or at the end - in the fifth. Also, formation at the end of wave C is quite common, we will consider this in the section of corrections. Due to the fact that many people decided to interpret the theory of constructing a counting by Elliott waves in their own way, and at the same time they were published, and some even translated the original book from English, in some sources you can find the name “ terminal impulse”. This is the name of the same diagonal variation of the Elliott Wave at the end of the trend, in which the first wave is greater than the third, and the third is greater than the fifth and there is an intersection of the second and fourth. Such impulses are followed by a fairly deep retracement, from 50% to 60% of the entire impulse range. The main property of such impulses is that they consist of triplets , that is, the structure looks like 3-3-3-3-3 , and not 5-3-5-3-5 , as in the usual type of Elliott impulse waves. The final diagonal almost always signals a reversal in the medium term, and if formed after a long dynamic movement, then the reversal can be quite fast and then a deep pullback will follow.

Corrections

The corrective movement consists of three waves , which, in a different combination, give the corrective Elliott waves. After the trend movement in the market, there is a lull, which is accompanied by profit taking, entries into the market by those who assume the end of the trend reversal , as well as those who are simply engaged in short-term trading and trade any relatively large movement in any direction. Corrections are much longer than impulses, and the second wave in this combination is usually the longest. If in the impulse the composite Elliott waves are usually denoted by numbers from 1 to 5, then in corrections they will be waves A, B and C. The first and third waves have signs of lower-order impulse, that is, they consist of 5 components, wave B has a structure of three waves. This is the most difficult wave for counting , as it is itself a corrective wave in a corrective model. It is not recommended to trade during a rollback, the model can be very complex and difficult to analyze, which can lead to a sequence of losses.

Flat correction

A common type of retracement and the most common type of Elliott wave retracement. A distinctive feature is a structure consisting of three waves , the first of which consists not of five, but of three, that is, the general view is 3-3-5 . It is by the first wave in the retracement that one can judge what form the entire structure will take. It got its name flat because the waves are of comparable size. So, for example, wave B in the plane usually makes up at least eighty percent of the Elliott wave A, and sometimes even crosses the level of its beginning (in this case, an irregular correction is obtained). Wave C reaches or almost reaches the level of wave A, in rare cases it can significantly exceed. I.e. you need to be guided by the fact that two of the three Elliott waves - A and B or B and C will be of a comparable size. Ideally, they are all roughly equal and form a graphic “flag” pattern, implying a continuation of the trend.

A flat correction with equal waves B and C forms a “flag” pattern.

This is the simplest version of a retracement movement of the corrective Elliott wave, it is easy to identify and build trading plans in accordance with the accepted form. If the first two waves are equal, then the market can be entered after the extremum formed after wave B is broken. In this case, a pending order is placed and there is no need to look out for the end of wave C. For those who are good at understanding and understand how to build a smaller Elliott wave, you can try to catch a reversal after C is formed in the form of a five-wave. A separate type of flat corrections is a traveling plane - waves consistently exceed the range of the beginning of the previous one, but in wave C, truncation (failure) is possible.

Zigzag

The second common type of corrective Elliott wave, which has a structure of two five-wave movements and one three-wave (5-3-5). Such retracements are quite deep and reach over 50 percent of the previous impulse. In the model itself, the retracements are not as large as in the plane and rarely the size of wave B exceeds 60% of the size of wave A. The last wave C can be approximately equal to wave A, but there are also variants with a range from 60% to 160% of the Elliott wave length A.

Zigzag with a deep recoil in wave B and extended C.

It is possible to identify a zigzag at an early stage by the good visual impulsive nature of the first component of its wave, as well as the mark of the beginning of wave A that does not reach wave B. The deeper the retracement in B, the higher the probability that wave C will be extended, while it can values and 260%. At the end of the movement and the beginning of the correction, such Elliott waves can form the well-known "Head and Shoulders" pattern , in which impulse waves 3,4 and 5 form the left half, and corrective A, B and C add the right half. The same applies to the bearish variant - the inverted GUI.

Triangles

A rather rare type of Elliott waves related to correction, consisting of five movements, each of which is corrective , that is, it consists of three waves of a smaller order. The final structure of the triangle is represented as 3-3-3-3-3 . Elliott Wave trading implies strict adherence to the rules , therefore, it is not necessary to consider every narrowing structure exactly as a triangle, since all waves should have a zigzag shape, only in this case it is possible to uniquely identify it. This type of correction can be assumed after the third wave denotes its structure of a three - neither in a flat correction, nor in a zigzag wave C can be a three, respectively, it will be a triangle or a more complex correction with a large wave B. This option will be canceled when continuing formation of Elliott wave from triplets and narrowing of the wave range.

Triangle on the daily time frame of the dollar-ruble pair.

In rare cases, the Elliott Triangular Wave may continue to develop such a structure, and the result will be not five movements, but nine. In such a situation, wave e takes the form of a triangle, that is, the range should continue to narrow. As a rule, this occurs on not very large time frames, one of the latest examples is the silver chart. Also, intermediate Elliott waves in the correction - B can consist of triangles. The most important thing to know is that the triangle is always the penultimate movement in the structure , whether it be an impulse and a triangle in the fourth wave, or a correction and a triangle in wave B. It is always followed by a movement directed along the local trend .

Complex corrections

They are a type of Elliott wave, consisting of several simple corrections of different types, but of approximately the same scale. It can be a union of a plane and a zigzag , a plane and a triangle , a zigzag with a plane and a triangle . Denoted such combination letters W, X and Y . When very complex and large-scale structures are formed, a combination of Elliott waves is obtained, consisting of W, X, Y, XX and Z. That is, another connecting wave XX appears. In such combinations, the main thing is to highlight the main areas that look like independent models in order to suggest further development of the situation and possible continuation of this form of movement. The sole purpose of this should be search for the ending point of this Elliott Wave pattern, since it is generally not recommended to trade corrections , let alone such large varieties.

Using Fibonacci ratios

Elliott waves are related to each other by certain ratios. This was noticed by the author on the example of not only pullbacks, but the relationships between the driving waves. Surprising is the fact that these proportions are based on the “golden ratio”. The same value can be obtained if we take the limit of the ratio between the next member of the sequence of Fibonacci numbers and the previous one with an infinite extension. This gives a value of 0.618 or 61.8%. All the rest from a number of basic ones are obtained by taking this ratio sequentially from oneself, dividing the resulting parts by themselves, and so on. The main possible dimensions of the Elliott wave are: 23.6; 38.2; 61.8; 76.4; 78.6; 161.8; 261.8. These are the basic values that can be guided by when calculating the possible size of the pullback, as well as the potential target of the current impulse movement. The second wave is characterized by rollbacks ranging from 23.6% to 76.4%, there are also deeper ones, but this happens rarely. The fourth wave is usually guided by a pullback to the third, therefore, it is necessary to look at the ratio between them, and not with the whole movement, starting with the first. In the fourth wave, the pullback usually does not exceed 38.2% of the third. The first and fifth Elliott waves are usually about equal, while the third is often lengthened and can range from 127% to 261% of the first wave, in rare cases 361% and even 423%. Since the structure of Elliott waves is fractal , these methods are applicable on absolutely any scale, up to a five-minute chart.

An example of a correction with working out at Fibonacci levels.

Supporting tools

Some indicators can be used as assistants in identifying and navigating the current Elliott waves. Moving averages on a four-hour time frame with a period of more than 30 show the end of corrections quite well, as they act as dynamic support for the price. The specific value must be selected depending on the analyzed instrument and the selected period. Movings with periods of 150, 200 and 250 are well-known for their popularity on the hourly frame . The same applies to daily charts, but they rarely intersect. However, this kind of support makes sense to take into account.

The second good tool for determining the end of a large Elliott wave is the oscillators . Typical signals are divergence and convergence , which are used to confirm impulse completion . They are formed between the third and fifth waves, while in the correction they can signal that wave C has come to an end. As a rule, the MACD indicator is used for this , it shows reversals very accurately and rarely gives false signals. Applicable for periods older than half an hour, but you need to understand that the smaller the time frame , the more likely the formation of triple divergences and non-working signals .

Conclusion

In general, the whole theory of constructing each of the Elliott waves is quite natural and has been used for quite a long time. Despite the fact that it was developed for the stock market, it is also successfully used in the currency market . Robert Prechter, one of the main current ideologues and followers of Elliott himself, argues that modern margin markets with automated trading systems do not affect the performance of models at all , but only slightly shift statistical data towards greater volatility of structures. Nevertheless, despite the rather strict rules by which the Elliott waves are built, there is always some variability in the counting, and whether it will be correct or not can be said only after the formation of the structure is over, experience and long-term observations of the price with attempts to analyze and predict further events are very important here .