You should not be afraid of this apparently advanced trading topic, Elliott Waves. It is very easy to learn and understand. In this article, I am not going to talk about the history of Elliott Wave and things like that. This information can be easily found over the Internet.
What is hard to find over the Internet, is a clear and easy to understand explanation about the ways you can use Elliott Wave in your trading (1) not to enter against the trends and strong markets participants, and (2) enter at the right time to catch the strong movements and follow the trends. That is why this article was written.
Do You Have To Learn The Elliott Wave Analysis?
Elliott Wave Theory helps you to understand the market movements and trends much better. Although your trading system may not talk about Elliott Wave, it still helps you a lot not to go against the trend even when a too strong trade setup is formed.
There are good tools like Bollinger Bands and moving averages like Bollinger Middle Band for those who like to follow the trends, but it is still necessary to know at what stage the trend is and when it is more probable to reverse.
So, professional traders have to know what Elliott Wave theory is and what it talks about. At least, they have to know the waves and the strongest part of the price movement, either when the price is trending, or when it is ranging.
Is It Possible To Trade Profitably Without Caring About Elliott Wave?
Yes, it is possible, but only when you wait for the too strong trade setups if you want to go against the trend. Also, if you want to follow the trends, you have to wait for the too strong continuation trade setups that form on the continuation chart patterns like Triangles, or you have to know how to take the continuation trade setups that form above/below the moving averages like Bollinger Middle Band which is a 20 Simple Moving Average, in case of up/down trends. You can also distinguish and follow the support/resistance levels and their breakouts to follow the trends.
In spite of this, Elliott Wave can be a big help. Unlike the bugging information that interfere with your trading system and cause you to make mistakes, Elliott Wave helps you to use your trading system better.
You don’t have to be scared of Elliott Wave. It is not as complicated as you can see on many websites. Some people are used to make the things too complicated, but simplicity is the first thing in everything we want to do.
What Is Elliott Wave?
However, in the current article I am going to explain it in a simpler and more practical way.
As you can see on all the price charts, the price never goes up or down directly and without any noise or ups and downs at the middle of the way. For example, when it starts going up, a few or few bullish candlesticks form, but then it stops going up, forms a few bearish candlesticks, or moves sideways for a while, and then starts going up again.
Ralph Nelson Elliott who is the founder of Elliott Wave Theory, found out that the “ups” and “downs” usually follow a special pattern that repeats itself on all charts and markets, be it one minute or monthly charts, or stock, CFDs, currencies and… markets.
He analyzed more and extracted the main and most visible ups and downs within a movement. These ups and downs are called waves.
Before I show you the waves, first I have to explain what I mean by “movement”.
By “movement” I mean a fresh price movement. For example, imagine that the price has been going sideways for a while, but it suddenly starts going up. That upward movement is because of a special event like an important economic news, otherwise it would never form and the price would keep on moving sideways.
When markets start trending, the movements and the waves that form in trends, can be seen clearly in most cases. But when markets are moving sideways, the waves become too small and cannot be recognized easily. In spite of this, they still exist, but in a much smaller scale.
What Are Those Waves That Form In A Movement?
Let’s start with an upward movement first.
The movement starts when the price starts going up after a downtrend or a sideways movements. Usually the movements start with a buy signal which can be strong sometimes. Having Bollinger Bands on your charts is a big help to identify the beginning of a fresh movement, because in many cases a fresh and strong upward movement starts after a strong Bollinger Lower Band breakout and maybe a strong candlestick pattern.
The initial part of the fresh upward or bullish movement is called Wave 1. As you see on the below chart, it is started at the bottoms of a strong downtrend and after a strong Bollinger Lower Band breakout and a relatively strong candlestick buy signal:
Usually after the first upward movement which can be strong, there is a short down movement which is called Wave 2. I say “usually” because sometimes a wave becomes too small to be seen as a wave on the price chart. So, don’t expect to see the Elliott Waves on all movements under any condition. Sometimes it becomes impossible to distinguish the waves and differentiate them from each other. In spite of this, you can still under such a condition. I will tell you how.
After Wave #2, another upward movement will be started which is usually the biggest wave in an uptrend. That is where most professional traders enter to take the maximum advantage of the uptrend. This important movement is called Wave 3.
After Wave 3, there are two more waves: Wave 4 and 5.
Wave 4 is a small bearish movement like Wave 2. Wave 5 is another upward movement which is not that strong and is usually smaller than Wave 1. However, sometimes Wave 5 becomes too long and strong when the trend is too strong. We will talk about Waves 3 and 5 more, later in this article.
After forming the last two waves (4 and 5), bulls get exhausted. That is the time that bears may take the control and the uptrend may reverse. However, a consolidation forms and the price goes sideways when bulls are serious not to give the full control to bears but are exhausted at the same time.
The wave that forms after wave 5, is called Wave A. This wave is a bearish wave which is not usually strong, specially when bulls are really strong. When the uptrend is too strong, then Wave A is a small bearish movement that can be the beginning of the formation of a consolidation like Flag or Triangle, or the beginning of a sideways movement.
After Wave A, another upward movement appears which is known as Wave B. This wave is usually the shortest wave.
Wave C which is the last bearish movement, is usually the biggest downward movement. It is the good chance for those who like to go against the uptrend. However, this wave is long enough only when bulls are not too strong and serious, otherwise it can be a short bearish movement that will reverse after a new buy signal formed by candlesticks.
That last three waves (A, B and C) can be formed when the market is noisy and choppy, in the way that it sometimes becomes hard to distinguish Wave A and the next two waves. Having Bollinger Bands can be a big help in this case too.
What Happens After Wave C?
After Wave C, another set or cycle of Elliott Waves will be started from the beginning (wave 1). The waves length can be different under the different markets conditions. When bulls are stronger, the bullish waves are longer, and when bears are stronger, the bearish waves will be longer:
When bears take the control, the bearish waves (A, B and C) become longer. On the above chart, the first cycle (the yellow zone) was more bullish, and so the bullish waves were longer. The second cycle (the green zone) was bullish too, but bears were stronger and bulls were getting more exhausted compared to the first cycle. Therefore, the bearish waves are longer on the second cycle.
The below chart shows a too strong bear market. As you see, the bearish waves are too long:
When a party takes the control very strongly, it becomes too hard and sometimes impossible to distinguish the waves. It is possible that the waves I am showing you on the above chart are marked by me incorrectly, but there is no other way to mark them when the trend is too strong. For example, nobody can say whether the small upward movement that I have marked as Wave 4, is really Wave 4. When fear takes the control, the price collapses very strongly and the small bullish waves get lost under the bears feet!
For example, while it seems EUR/USD has completed a cycle on the daily chart, it is not clear where the bullish waves are on the weekly chart:
It is almost the same when bulls take the control strongly.
The Long Time Frames Movements On Shorter Time Frames
When one of the strong waves is forming on a longer time frame, a cycle is in progress on a smaller scale on a shorter time frame. For example, when Wave 4 is forming on the above chart which is weekly, several different cycles are forming on a shorter time frames. Each of these cycles can be in different stages.
Even on the same time frame, there are smaller cycles forming on the bigger cycles.
How To Have Better Trading Results Using Elliott Waves Analysis
Wave #1 is usually started when a strong trade setup forms by candlesticks. A too strong trade setup which is usually the start point of Wave 1, can be the beginning of a strong trend. Therefore, when a too strong trade setup forms on a sideways or exhausted market, it can be known as the beginning of a new cycle.
That is what we always emphasized on. Although we have not talked about Elliott Wave analysis in our regular trading system, we completely follow and comply with it. When you take a too strong candlestick signal on an exhausted and sideways market, there is a higher chance to enter the market at the beginning of Wave 1. Although it is sometimes impossible to identify the waves properly and correctly, you lower the risk of going against the strong waves, when you take the too strong setups on the exhausted and sideways markets.
Most professional traders try to enter the markets at the beginning or even middle of Wave #3, because it is usually the strongest wave among all the other Elliott Waves. The question is how do they do it?
First, they wait for Wave #1 and #2 to form. This assures them that a party has completely taken the market control. That is why they say trading is about buying high and selling higher, because first you have to wait for the price to go up. Then, you enter when bulls already have the control. So, you buy high, hold, and sell higher. It is the same with going short. Just the direction is opposite.
After Wave #2, if a too strong signal which is against Wave #2 direction forms, be it a strong candlestick pattern or a support/resistance breakout, professional traders take it as the beginning of Wave #3. If Wave#3 starts without a strong signal, then a support/resistance level breakout can help them to enter the market when Wave #3 has already started to form a while ago.
When trend is too strong, Wave #5 can also be as long and strong as Wave #3. You can enter the market at the beginning or middle of Wave #5 if a too strong continuation signal forms. Like the beginning of Wave #3, this continuation signal can also be formed by a support/resistance level breakout or a too strong candlestick pattern to start Wave #5.
Some professional traders use other tools or indicators to track the formation of Wave #3. For example, a 50 Simple Moving Average sometimes can be a big help, specially when the trend, and so Wave #3, are supposed to be too strong.
For example, on the below chart which is the same EUR/USD daily chart you saw above, when the price crosses the 50SMA and Bollinger Upper Band at the same time, and then the price goes against Wave #2, it indicates that most probably Wave #3 is started. Similarly, when it does the same when Wave #4 is forming, and then the price goes against this wave, it means Wave #5 is started which can be too strong also on the too strong trends.
When you are in doubt even when tools like 50SMA or Bollinger Bands have formed the signal, methods like support/resistance levels breakouts can be help a lot:
Elliott Waves Prevent You From Going Against The Trends
Those who miss the trends and all the continuation signals to join the trend, have to wait for the reversal signals. Also, those who are already in while a trend is forming, have to be careful to get out on time, not to lose the profit they have made. On the other hand, they have to know how to maximize their profit and not to get out too early.
Elliott Waves help you to do all of these. How?
When a strong trend is formed on the chart, the first strong reversal signal is the beginning of Wave A which is usually short. So, if you take this reversal signal, chances are it goes against you very fast and hits your stop loss. That is why we don’t take the reversal trade setups that form on a bull market and when bulls are still too strong and the uptrend is sharp, or on a bear market and when bears are still too strong and the downtrend is too steep.
We ignore these setups even when they look too strong, because they are usually the beginning of Wave A that will reverse very soon. Sometimes when the trend is too strong, Wave A is too small to be seen. Its movement can be seen on the shorter time frames, but not on the same time frame that the trend is ongoing.
After Wave A, Wave B starts forming which is agreeable to the trend direction, but usually it is not strong enough also and closes around the same level that Wave A was opened. These movements (Wave A + B) usually form a consolidation on trends. They can be ended to a complete reversal which is Wave C. So, if you want to take the reversal setups and go against the trend, first you have to wait for Wave A and B to form. Then you enter the market when Wave C starts forming:
Sometimes you think you are at the beginning of Wave A, B or C, whereas the trend is too strong, and so, Waves 1, and 3 have been too long and even Wave 5 is not completely yet. Going against the trend under such a condition can be too risky. The below chart shows that most probably the market has not started the Wave 5 yet. Still we have to wait to make sure that whether the uptrend will be continued or will be reversed. If it moves sideways and forms a consolidation, then starts going up again, it mean a new cycle is started and the uptrend will be continued. If it forms a too strong reversal signal by candlesticks while it has already moved sideways for a while or formed a consolidation, then it can be known as the beginning of Wave C, and so we can go short:
Does it look too hard and confusing?
Then let me give you a simple formula: Don’t go against the trends and don’t take the reversal trade setups when the markets have not moved sideways yet:
A real example of a strong reversal signal that was taken safely:
Taking the too strong candlestick signals while considering the Elliott Waves and the trends situation, helps you to have a higher success rate and take the big movements. If you learn how to do that, you can even follow the too strong and unexpected movements, because these movements follow the Elliott Waves and strong setups on the long time frames. The below chart is one of the examples. I think you remember that trade setup. Look how a too strong trade setup started the Wave 5 on a bearish market, and then how a too strong and sudden movement happened while Wave 5 was forming:
Knowing the Elliott Waves is a big help to (1) increase your success rate and (2) have bigger gains. But, to be a consistently profitable trader, it is not a must to know the waves in details. Keep in mind that sometimes it impossible to differentiate the waves from each other, and knowing the waves doesn’t help you under such a condition. However, you can easily enter the markets if you take the too strong candlestick trade setups, or the support/resistance line and levels breakouts, under the conditions that was explained above.
You can avoid taking the reversal trade setups and signals, even when they are too strong, when the trend is still strong and probably is forming the strong waves like #3 and #5. You can go for the too strong reversal trade setups when they are placed in a position that they are probably at the initiation of Wave C.
If you follow the above tips, you can trade, make profit consistently, and control your risks properly.
Hope Elliott Wave analysis doesn’t look mysterious and complicated anymore.