Cheat Sheet for Applying Elliott Wave Theory in Financial Analysis
In the world of financial trading, the Elliott Wave Theory stands as a significant tool for analysts and traders alike. This theory, developed by Ralph Nelson Elliott in the 1930s, offers a systematic approach to understanding and predicting market trends based on specific rules and Fibonacci level correlations.
The Elliott Wave Theory is governed by a set of rules that help traders identify and confirm wave patterns and price targets. The basic structure of an impulse wave consists of five waves: 1, 2, 3, 4, and 5. Corrective waves, on the other hand, typically form a 3-wave (A-B-C) pattern against the trend.
One of the core rules of the Elliott Wave Theory is the wave 2 rule, which states that wave 2 cannot retrace more than 100% of wave 1. Wave 3, the longest and most powerful wave, cannot be the shortest among waves 1, 3, and 5. Wave 4 cannot overlap the price range of wave 1, except in rare cases.
Another crucial aspect of the Elliott Wave Theory is the Fibonacci level correlations. Wave 2 typically retraces between 50% to 61.8% of wave 1, while wave 4 often retraces between 23.6% to 38.2% of wave 3. Wave 3 commonly extends between 138.2% to 161.8% of wave 1.
Fibonacci extensions are used to project the end of waves, especially for wave 3 and wave 5 targets. Wave 5 often has a Fibonacci relation to wave 1 or 3, commonly extending to 61.8%, 100%, or 161.8% of wave 1 or wave 3's length.
It's worth noting that wave 5 can be truncated, meaning it may fail to exceed the end of wave 3, especially in weak or ending markets. This deviation from typical impulse patterns must be recognized carefully.
In corrective waves, waves 2 and 4 alternate in form: if wave 2 is sharp, expect wave 4 to be a flat, and vice versa. Wave A and wave C of corrections tend to be equal in length. Trendlines drawn between waves 1 and 3, and through wave 2, help identify the termination zone of wave 5.
While exact percentages of time price remains inside specific Fibonacci retracement levels in Elliott waves are not universally fixed, practical trading experience shows price commonly respects retracement zones of 38.2%, 50%, and 61.8%. Wave 2 typically spends substantial time between 50% and 61.8% retracement levels of wave 1, while wave 4 usually respects the narrower 23.6% to 38.2% retracement zone of wave 3.
In conclusion, the Elliott Wave Theory mandates strict rules for wave formation and overlaps, combined with Fibonacci retracement and extension ratios to identify precise price targets and validate wave counts. Wave 2 and wave 4 retracements and wave 3 and 5 extensions align closely with key Fibonacci levels. Price typically spends a notable portion of the corrective phase time within 50-61.8% and 23.6-38.2% Fibonacci retracement zones, while wave 5 truncation is allowed but indicates a weakening impulse wave.
[1] https://www.investopedia.com/terms/e/elliottwave.asp [2] https://www.investopedia.com/terms/f/fibonacciretracement.asp [3] https://www.investopedia.com/terms/f/fibonacciextension.asp
- In the realm of technological advancements, there are numerous software and applications that utilize the Elliott Wave Theory to automate and aid investors in their trading strategies.
- As technology continues to progress, investing in financial markets can now incorporate AI-powered financial tools, which can analyze and predict market trends using the Elliott Wave Theory, thus assisting traders in making informed decisions.
