The Key to Elliott Wave Success

The core challenge in applying Elliott Wave Theory successfully lies in correctly counting the waves and identifying the current market phase. Understanding the distinct characteristics of each wave within the overall structure simplifies this process significantly. Combining this with solid Price Action Analysis provides powerful trading insights, crucial for navigating potential Market Manipulation Strategies often seen at wave termination points.

Video: Simplified Elliott Wave Guide

This video breaks down the characteristics of each Elliott wave and provides practical clues to help identify the market's current position within the wave structure.

Elliott Wave Fundamentals

Elliott Wave theory is based on the fractal nature of markets, meaning price patterns repeat across all time frames. Two main types of price progressions exist:

• Motive Waves: Move in the direction of the larger trend (includes Impulse and Diagonal waves).
• Corrective Waves: Move against the larger trend (includes Flat, Zigzag, Triangle, and Combination structures).

The basic sequence consists of a five-wave motive phase (Waves 1-5) followed by a three-wave corrective phase (Waves A, B, C).

The Three Unbreakable Rules

Regardless of the complexity, three rules must always hold true for a valid Elliott wave count:

1. Rule 1: Wave 2 cannot retrace more than 100% of Wave 1.
2. Rule 2: Wave 4 cannot enter the price territory of Wave 1.
3. Rule 3: Wave 3 cannot be the shortest of the three impulse waves (Waves 1, 3, and 5).

Characteristics of Each Wave (Bull Market Context)

Wave 1: The Beginning

Wave 1 marks the start of a new impulse sequence, often emerging from a prior downtrend. Market sentiment is typically very bearish. Many view it as a minor rally within the downtrend and may initiate shorts. It often subdivides into five smaller waves and can sometimes form a leading diagonal.

Wave 2: The Deep Retracement

Wave 2 corrects Wave 1, retracing a significant portion (often 50%, 61.8%, or 78.6%) but never exceeding the start of Wave 1. Sentiment remains bearish, but the failure to make a new low alerts informed traders. It typically forms as a Zigzag or Flat correction (ABC pattern).

Wave 3: The Power Wave

Often the longest and strongest wave, offering the largest profit potential. Optimism grows as it becomes clear the trend has shifted. Breaking the Wave 1 high accelerates the move as stops are triggered. Pullbacks are shallow or non-existent. Wave 3 frequently extends 1.618 or 2.618 times the length of Wave 1.

Wave 4: The Complex Correction

Wave 4 corrects Wave 3, typically shallower than Wave 2 (often 38.2% or 50% retracement). Crucially, it must not overlap with Wave 1's price territory. This wave often reflects profit-taking, leading to sideways, choppy, and prolonged price action, frequently forming Triangle patterns, but Flats or Zigzags are also possible. Trading during Wave 4 can be difficult due to false breakouts.

Wave 5: The Final Push

The last leg of the impulse sequence, moving with the trend but often with less momentum than Wave 3. Bullish sentiment is widespread, often driven by retail participation. Technical divergences (e.g., RSI, MACD) and lower volume compared to Wave 3 are common, signaling waning momentum and an impending reversal. Wave 5 often equals Wave 1 in length or travels 61.8% of Wave 1's length.

Wave A: The Initial Correction

Starts the corrective phase after Wave 5 completes. Most participants are still bullish, viewing it as a minor pullback. Similar structure to Wave 1, often sharp. Can subdivide into five or three waves.

Wave B: The Bull Trap

Corrects Wave A, moving counter to the new corrective trend. Often lures traders into believing the prior uptrend is resuming but typically fails to exceed the Wave 5 high (sometimes forming a double top). It's usually a deep retracement of Wave A (50%, 61.8%, 78.6%) and often forms a Zigzag or Triangle. Fading Wave B near its termination can be a high-probability trade.

Wave C: The Strong Corrective Leg

The final leg of the correction, often powerful and convincing traders the trend has reversed. Usually moves strongly below the Wave A low. Wave C is frequently equal in length to Wave A (1.0) or extends to 1.272 or 1.618 times the length of Wave A.

Quick Checklist & Guidelines

• Waves 1, 3, 5 are trending; Waves 2, 4 are corrective.
• Wave 3 is never shortest (but not always longest).
• Wave 2 retraces < 100% of Wave 1.
• Wave 4 doesn't overlap Wave 1.
• Wave 2 and Wave 4 should exhibit alternation (different in price, time, or pattern complexity - e.g., sharp vs. flat, simple vs. complex).

Mastering these characteristics and rules within your Price Action Analysis framework is key to effectively applying Elliott Wave theory in Smart Money Trading.