That’s where the Elliott Wave pattern comes in. It’s one of many patterns used to try to identify current trends and predict future ones. In this article, we’ll take a look at how this pattern works.
We’ll also give you some Elliott Wave examples so that you fully understand how it works. All this information should empower you when you’re putting together your next trading strategy.
What Is the Elliott Wave Theory?
Developed by Ralph Nelson Elliott in the 1930s, the Elliot Wave Theory helps to analyze and identify trade marketing trends. The patterns from this theory form part of the technical analysis used by traders.
At its core, the Elliott Wave principle is based on the idea that market trends follow a repeating cycle. And each of these circles is made up of bigger and smaller waves. Analysts identify these waves in order to develop predictions for future price movements.
In the Elliott Wave theory, there are five market waves in the direction of the trend known as the “impulse wave.” This is followed by three in the opposite direction, known as the “corrective wave.” Elliott Wave trading patterns range in size from small intraday moves to long-term trends over many years.
As a starting point, a trader will try to identify the current wave based on the Elliot Wave. From there, they’ll try to predict the following price up trends or downtrends. The trader will check for the end of the corrective ways and the start of a new impulse wave. This point provides opportunities to buy or sell assets.
As with all trading analysis tools, you shouldn’t only rely on the Elliott Wave theory to make predictions. There are a variety of other analytical methods you could use. But, also take the time to use your own skills as a trader to make your decisions.
How Do You Trade Using Elliott Wave Theory?
The above gave you a good indication of what the Elliott Wave theory is. Now, let’s discuss how can the Elliott Wave trader analysis be used for buying and selling stocks at the right time.
These are the steps a skilled trader will take when using the Elliott Wave principle:
- Is the trend there?: Check for this by using indicators such as Elliott Wave Fibonacci, for example. Or, if you’re experienced enough, you can just look at the prices on the chart.
- Count the number of waves: As mentioned earlier, there should be 5 waves of positive movements (impulse waves) and 3 negative movements in prices (corrective waves). When you know the number of waves, you should be able to see what’s the market’s current cycle.
- Are there patterns?: While the number of waves might be in line with the Elliot Wave principle, you need to make sure the pattern matches too. You’ll see that the impulse wave will have a strong and steady advance. It’s then followed by a sharp correction and then another strong advance.
- Determine when to buy and sell: After concluding that the waves and patterns are in line with the Elliott Wave principle, plot at which points you’ll be trading. Feel free to use other tools to support your decision at this point.
- Set your stop losses: This is a method of minimising losses on the trade if your predictions were incorrect. You simply need to decide what your target is and pull out when you reach this target.
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Examples of Elliott Wave Theory
To get a better understanding of this theory, we’ll take a look at some Elliott Wave examples. These are based on previous cycles most of us have lived through.
End of a Bear Market & Start of New Bull Market 2008
From late 2007 into 2008, the U.S. stock market experienced a bear market after the S&P 500 index declined by 50%. Based on the Elliott Wave principle, this drop showed a three-wave structure. It was made up of:
- Wave 1: The initial impulse wave.
- Wave 2: A corrective wave.
- Wave 3: The last impulsive wave.
Then, from March 2009, the S&P 500 index rose by 50% within a few months, marking the start of a bull market.
- Wave 1: The start of the bull market in March 2009.
- Wave 2: A corrective wave from April 2010 to July 2010.
- Wave 3: This was a powerful wave representing strong market growth from July 2010 until May 2011.
- Wave 4: Another corrective wave from May to October 2011.
- Wave 5: A strong reversal and the end of the bull market from May 2012 to November 2012.
Elliott Wave Grand Supercycle Example
The largest degree of wave structure in the Elliott Wave Theory is the Elliott Wave Grand Supercycle. It can run many hundreds of years. As an example, we’ll take a look at the oldest stock market index in the world, the Dow Jones Industrial Average (DJIA).
- 1700s to the mid-1800: The DJIA has its first Grand Supercycle, which was an uptrend.
- Mid-1800s to early-1900s: This wave was a long downtrend that lasted until the early 1900s.
- 1900s to late 1920s: Another Grand Supercycle where prices were on the up.
- 1920s to mid-1940s: A severe bear market ensued.
- Post-WWII boom: This uptrend lasted until the early 1970s.
- 1970s to early 1980s: A long bear market showcasing the sixth Grand Supercycle.
- 1980s to early 2000s: One of the longest bull market runs.
- Early 2000s to mid-2000s: Another bear market.
- Mid-2000s to now: This Grand Supercycle uptrend includes a bull market until 2018, the 2020 decline due to the COVID-19 pandemic, and the following strong recovery.
Elliott Waves Corona Crash Example
When the Covid-19 pandemic started in 2020, markets took a hit. The 2020 Corona crash followed the typical Elliott Wave Theory waves:
- Wave 1: The S&P 500 index dropped by 35%. This marked the first impulse wave lasting from February 2020 to mid-March 2020.
- Wave 2: A sharp rebound followed and lasted until early April 2020.
- Wave 3: Another downtrend started n early April 2020 when the S&P 500 index fell by 35%. It lasted until late May 2020.
- Wave 4: A corrective wave lasted from late May to mid-June 2020
- Wave 5: When the S&P 500 index fell by about 10%, the last wave kicked in and lasted until the end of June 2020.