Elliott Wave Principle Mastery and How to Nail the Market

The Ultimate Guide to Mastering the Elliott Wave Principle

Every new trader is looking hard to find the best strategy to beat the market. The Elliott Wave Principle (sometimes abbreviated to just “EWP“) is considered one of the most accurate tools to predict the future of any asset based on technical analysis.

In this article, we will explain how to use advanced trading techniques in order to master the use of the Elliott Wave Theory.

What is the Elliott Wave Theory?

Ralph Nelson Elliott was an accountant responsible for developing the Elliott Wave Principle in the 1930s.

Prior to Elliott’s theorem, most analysts believed that the market moved in a random, unpredictable way. Elliott, however, was able to discern that the market often moved in specific, repetitive and – most importantly – identifiable patterns.

In this article, you will learn about Elliott’s theory in depth.

Fundamental Rules to Master

1. Essentials

It’s important that we start with the basics first and move on to more advanced techniques once you have a grasp of the fundamentals. The idea is that after studying this guide your trading skills will be enhanced even if you decide the Elliott Wave is not the perfect theory for you.

At its most basic level, Elliott’s theory is that the market always moves in a series of waves. An overarching impulsive wave moves the price in the direction of the main trend-line, while a corrective wave moves against it.

In the case of an uptrend, the impulsive wave is made up of five waves that pushes the price higher.

In a period of downtrend the opposite occurs; the impulsive wave is made up of five waves that push the price lower.

After every impulsive wave the Elliott theory posits that there should also be a rebound that corrects the impulsive phase, which is known as a corrective wave. The corrective wave is made up of three individual waves.

Essentially, Elliott’s hypothesis is that every price move in any given market can be labelled with an impulse phase, formed by five impulsive waves and a corrective phase, characterised by three corrective waves.

Elliott Wave Principle Graph (figure 1)
Figure 1: Elliott Wave Principle Graph

The major trend of a Bullish Cycle is upwards. The impulse wave thus consists of five individual waves, three of which (1, 3 and 5) move with the direction of the main trend and two of which (2 and 4) move against it.

After the impulse phase, a corrective wave consisting of three individual waves then emerges. Two of the corrective waves move against the main trend (a and c), whilst one moves with the direction of the main trend (b).

Generally, the second impulse wave (2) will resemble a zigzag, whilst the fourth (4) resembles a triangle. However, any correction against the main trend (2, 4 or b) can be a triangle, flat, zigzag or a combination of the three.

In a Bearish Cycle, the opposite occurs. The impulse wave moves downward while the corrective wave pushes the trend back up.

2. Golden Rules

Elliott created three “golden rules” to help an analyst validate whether the Wave Principle is present:

Elliott created three “golden rules” to help an analyst validate whether the Wave Principle is present:

  • Wave 2 cannot retrace more than 100% of Wave 1;
  • Wave 3 should not be the shortest, but does not necessarily need to be the longest; and
  • Wave 4 cannot enter the zone of Wave 1.

If one of those three golden rules is not satisfied, then stop trying to apply the Elliott Wave Principle to a trend and search for another one.

If you intend to utilise the Elliott Wave Principle in your trading then it is essential to memorise those rules and apply them ad nauseum. Once you do, you’ll soon find yourself noticing that all (or at least most) charts come in waves of five and three.

Additionally, the Elliott Wave principle is something that can be applied to a wide variety of charts you will see in your life.

3. Fibonacci Sequences

If you are an active trader, there’s no doubt you should already be aware of at least the basics of Fibonacci ratios. However, what you may not know is how to use them in Elliott Wave Principle.

Fibonacci ratios help traders to set targets and stop losses, but with regard to the Elliott Wave principle, they also help us identify at which level each wave will retrace and extend.

The most commonly used of Fibonacci’s ratios is 1.618. So, why is that?

Golden Ratio USD/CHF (figure 2)
Figure 2: Golden Ratio

The Italian mathematician Leonardo Fibonacci was the first to discover that the relationship of 1.618 is found in a startling number of situations in nature. For example, if you take the length from the top of your head to the end of your finger, this represents 61.8% of the whole length of your body. Or, if you divide the female bees by the male bees in any given hive, you’ll find that the answer 1.618

Fibonacci’s discovery also applies to the financial market. If an asset’s price was in an uptrend and a rebound occurs, it is reasonable to expect that the rebound will form 61.8% of the main trend.

The most common retracement trends for a wave (as per Elliott Wave Principle) are as follows:

  • The most common retracement for Wave 2 is 50% of the level of Wave 1. However, you’ll often see Wave 2 retrace 61.8% of Wave 1.
  • Wave 4 typically retraces about 38.2% of Wave 3. The next most likely retracement of Wave 4 is 50% of Wave 3.
  • Wave B usually retraces either 61.8% or 50% of Wave A.

The most common extension trends for a wave (as per Elliott Wave Principle) are as follows:

  • Wave 3 will generally extend 161.8% of Wave 1.
  • Wave 5 should ideally represent either 38.2% or 61.8% of the length from Wave 0 to Wave 3.
  • Wave B retraces between 50 to 61.8% of Wave A in the form of a zigzag. In case of a flat, there’s a chance it retrace to the beginning of Wave A.
 EUR/USD Elliott Wave example (figure 3)
Figure 3: tradingview.com

4. Personality of the Waves

This last section is more important than all of the above, because forming the ability to identify each wave’s personality will allow you to apply Elliott’s Principle like a master trader.

How do I differentiate between Wave 3 and Wave 5?

Very simply, Wave 5 is nowhere near as sharp as Wave 3. You’ll also notice that there is a significant amount of volume in Wave 3, whilst in Wave 5 the momentum starts to decrease and divergences are noticed.

Another indication pointing towards Wave 5 is that the volume is still increasing but the price is moving at a slower pace.

What is the difference between Wave 2 and Wave 4?

The simplest way to differentiate between Wave 2 and Wave 4 is that they tend to alternate; if Wave 2 is a simple correction then you would expect to see a complex rebound in Wave 4.

Usually, Wave 2 resembles a zig-zag shape, whilst Wave 4 is a combination of a zig-zag, a flat or even a triangle.

The structure of the corrective wave (A-B-C)

If Wave B did not retrace deeply towards the beginning of Wave A, it’s reasonable to expect a sharp movement in Wave C. However, if Wave B retraces to the top of Wave A then it is reasonable to expect Wave C to reach 138.2% of Wave A.

If Wave B surpasses the top of Wave A then there will be sharp movement in Wave C.

Market Psychology

Elliott believed that the market moves according to the collective psychology of the investors. He recognised that the market does not move in a chaotic, disordered way and was able to identify many repetitive patterns that showed up during many periods.

Many analysts argue that the price behaves or reacts according to
news and events. Elliott did not believe in this theory. To the contrary, he noted that the news and events follow the patterns that he discovered. Many people criticised this aspect of his theory, but it is evident once you begin using the Elliott Principle that he certainly has a valid argument.

With the fundamentals established, it is now appropriate to delve deeper in to Elliot Waves Principle by providing you with some common mistakes to avoid.

Mistakes to Avoid

The Elliott Waves Principle is a tough strategy to wrap your head around and there are many mistakes you can fall in to while using it to trade.

Firstly, there are some waves that is preferable to avoid entirely. The behaviour (a.k.a. at what point they will end) of Waves 2, 4, A and B is extremely hard to predict. It is usually advisable to stay out of the market until these waves have already formed.

Secondly, if you are planning to “long” an asset is generally advisable to avoid Wave C, as it is generally characterised by a steep decline in the asset’s price.

Examples of EWP in Practice

Here’s how the Elliott Wave Principle might be applied to a real-life scenario.

AUD/NZD Elliott Wave Example (figure 4)
Figure 4: Real Life EWP Example

We can use the Elliott Wave Principle to make a brief analysis of this chart.

You can see that Wave 2 retraces 61.8% of the upward movement made by Wave 1. Wave 3 then travels 161.8% of Wave 1 – take note of how steep Wave 3’s upward movement is.

Wave 4 then makes a slight retracement of Wave 3, not a deep one like Wave 2. Also note that there is an alternation here between Wave 2 and 4; Wave 2 is a zig-zag correction while Wave 4 is flat.

Wave 5 then represents 100% from the beginning of Wave 1 to the end of Wave 3, however the slope of Wave 5 is nowhere near as steep as Wave 3.

At the end of an impulsive wave we should then expect a corrective wave with A-B-C structure. In this case there is a zigzag movement after Wave 5, beginning with Wave A and followed by an upward movement in Wave B which retraces 61.8% of Wave A.

To finish the corrective wave, Wave C unfolds with five waves downward that have an equal length to Wave A. Look out for the sharp decline in Wave C!

There are many different levels to which a wave can retrace and extend. If you are interested in more detail, feel free to visit this website:

https://www.elliottwave.com/free-reports/elliott-wave-principle

How to Trade EWP

There are many ways to trade using the Elliott Wave Principle, however, we will show what we believe are the most effective ways to use it in your favour.

Some analysts prefer to trade at the point of Wave 3, while others choose to trade Wave C. We will teach you what we have learned the hard way.

EUR/USD 15-min Chart (figure 5)
Figure 5: EUR/USD 15-mins chart

The best method we have found is to wait for the entirety of the cycle to be complete and then trade on the new cycle that inevitably emerges afterwards. The chart above shows how a whole cycle can be completed within a 15-minute period.

The idea is to find the main direction of the trend and trade along with it – never against it.

EUR/USD 30-min Chart (figure 6)
Figure 6: EUR/USD 30-mins chart

On the 30-minute chart above you can see what happens after the initial cycle completes; another cycle emerges which continues trending downward along the direction of the main trend.

Tricks to Master

To finish this article, it is appropriate that we should give you some tricks about how to excel when trading forex using the Elliott Wave Principle.

Firstly, our major point of advice is not to force the counting of waves. If you are finding it too difficult to count the waves then don’t persist and try to find a pattern that isn’t there; jump across to another currency and see if you have any better luck there.

The financial market will give you opportunities every day. Stay patient.

Secondly, don’t just rely on Fibonacci sequences when trying to identify an Elliott Wave cycle. Focus more on the personality of each wave; find the alteration between Wave 2 and Wave 4; look at the slope of each wave to work out which wave you are on.

Thirdly, and particularly if you are a beginner, don’t ever try to trade against the trend. Follow the famous quote and act always as if “the trend is your friend”. Moving averages, MACD, Price Volume and stochastic are all fantastic tools to combine with the Elliott Wave Principle, but if you remember the trend is your friend you’ll always be alright.

Finally, at first you might find you have difficulty understanding this principle and even applying it. What we recommend you do is to take your time to learn about it.

The effort and time invested in learning this theory is worth it, we can speak from experience.

Non-Farm Payrolls Explained

What are “Non-Farm Payrolls” and what is the meaning of the term?

What are “Non-Farm Payrolls”?

The Non-Farm Payroll is a monthly record of job creation, not including seasonal agricultural roles, in the USA.

The non-farm payroll report also contains details about the unemployment rate, participation among the available US labour pool as well as metrics about hours worked and the hourly earnings of workers.

Why do Non-Farm Payrolls matter?

The number of new jobs being created is an important measure in determining the health of an underlying economy since more job creation suggests a growing economy. As such, the rate of job creation is closely studied and grabs most of the attention. However, the outright unemployment rate and average hourly earnings are just as important. Especially when the US central bank (the Federal Reserve) is trying to gauge just how tight the underlying employment market is. 

What do I need to know about Non-Farm Payrolls?

Markets seem convinced that the Fed will now move to reduce its balance sheet and to raise interest rates once more, before the end of 2017. While it’s hard to see beyond that, the unemployment situation is one number that could cause the markets and the Fed to think again. The headline NFP or jobs number has been erratic of late. But we haven’t had a big print below forecasts since July. Might one be on the horizon now? That said wage growth is the last piece that’s missing from the Fed’s rate rise jigsaw. So any sign of upward pressure on wages will cement the case for a rate rise. 

What to watch over Non-Farm Payroll releases?

Dollar Index and all of the FX majors. High levels of job creation are often interpreted as equating to expansion within the US economy. Whilst falling employment suggests a contraction. And because the US is a significant consumer of commodities, their prices can also be sensitive to this data and react accordingly. Don’t forget though that a stronger US Dollar has historically been negative for commodity prices.

Efficient Market Hypothesis

Efficient Market Hypothesis is, essentially, a theory that beating the market is impossible.

According to EMH stocks and currency always trade at their fair value on exchanges and reflect all available information, making it impossible to make a profit from the markets or any trading strategy.

Under Efficient Market Hypothesis the only way to earn higher returns than those of an index, is to buy higher risk investments.

The Efficient Market Hypothesis (EMH) is highly controversial and often disputed as different people view different areas.

Efficient Market Hypothesis in 2 Easy Steps

What is Efficient Market Hypothesis

So the topic for this article is the Efficient Markets Hypothesis also known as EMH.

And this is the basic video before we move onto a more advanced video on the Efficient Markets Hypothesis.

It’s best if you already know the meaning of Fundamental Analysis and Technical Analysis also known as Chart Analysis as tools for predicting share and stock price movements.

Share and stock is the same thing. Some people say share price,some people say stock price. So make sure you know these 2 forms of stock price analysis before watching this video.

We will discusses the basics of Efficient Markets Hypothesis as well as the basic differences between Strong Market Efficiency, Semi-strong Market Efficiency and Weak Market Efficiency.

Initially these words sound pretty intimidating right now but don’t worry you will see how easy and simple actually is when you view the examples.

My next more advance video will still actuallybe super easy and you can find it in MBABullshit. com. And it simply and easily explains how stockand share prices move up and down in efficient markets depending on people’s expectations. Alright so now let’s get down to it to this basic video. First of all, it’s best to recall basic stock investing. Basic stock investing orbasic stock playing, or trading or whatever you want to call it or whatever type, they’renot exactly the same. But anyway, in basic stock investing, it’s a game of Good Newsversus Bad News. Now what do I mean by that? Well, it depends on sales reports. For example,it could be sales reports, income reports, any or profit reports you may want to callit. Anyway, what is this mean? It means that the Good News or Bad News regarding sales reports or profit reports are directly related to stock price. Basically, if the sales reports are good or the profit reports are good then the price of shares are supposed to in theorythe price of shares or stocks go up. But if the sales reports of a company are bad thenthe share price or the stock price of that same company should go down. How might people earn money using the news? Well, let’s just look at this story about greedy Bob and greedy Bill. Let’s say that Bob here is the CEO of a company and he seesthat latest company sales reports and he sees that the company is doing great. And let us say that this company that Bob works for is listed in the stock market. So Bob the CEOsees the latest company sales reports and he sees that his company is doing great. Whathe might do he does not announce this report to the public yet and instead he tells hisbuddy Bill about this great sales report before telling the public. Now what does Bill do?Bill buys the stock or buys the share of stock before the news announcement about this company’sgreat sales report. And then what happens? Bob then decides to announce it to the publicand after the news announcement, the share price goes up. And what happens to Bill? Billgets rich quick. Why? Because he bought the stock before the news announcement and thenthere was news announcement and then Bill share price went up. So Bill gets rich quick. So that’s one way people can earn money by trading the news. Basically this is the story about greedy Bob and Bill. What actually happened here? (1)Number one is Bob the CEO learns about the good news. (2) At first, he tells only hisbuddy Bill about the good news. (3) Bill buys the stock in advance. (4) And then Bob announcesthe good news to the public to people like your grandma, or very often we have this grandmainvestors who don’t know much about the inside information of the company about thesecret information of the company. And then it’s only after people like grandma hearabout the news that the stock price goes up. And then people like Bill over here get richquick. And grandma here did not get rich quick because she heard about this good news alreadyafter Bill made money on it. So in other words, people like grandma hear about the news toolate together with everyone else. So she’s not so happy over there. And you might saywhy she doesn’t earn money the stock price still went up. Well, in theory, remember thatin stock trading for you to win someone else has to lose because you buy the stock cheapor Bill here buy the stock cheap and then he sells it expensive. Who does he sell expensivetoo? Well, he sells it expensive to people like grandma after the price has already goneup. So in theory anyway, stock trading for you to win someone else must lose. And inthis case, Bill won against grandma. So in theory, Bill bought the stock when it wasstill low priced before the announcement and then sold it to grandma at a high price afterthe announcement. However this is actually what happens. This does not happen in what we called an efficient market. Another way of saying itis; we saw this bad situation over here but actually in a perfectly Efficient Market thatwould not happen, this bad thing that happened over here, this bad situation between Bill,Bob and grandma. This would not happen in a perfectly Efficient Market. Why? Becausein a perfectly Efficient Market; (1) there’s number one example there’s good news. (2)Number 2 even if Bob is the CEO, Bob, Bill and grandma all learn about the good newsat the same time even if Bob is CEO in a perfectly Efficient Market. Why is that? Because ina perfectly Efficient Market, the keyword here is perfectly efficient, all relevant information about the company such as the sales report flows or moves or travels instantlyor super quickly between Bob, Bill and grandma. So Bill does not have an advantage even if he’s the buddy of Bob which is the CEO. Now, in MBAbullshit language, in businessschool bullshit language, instead of saying perfectly Efficient Market, we usually sayStrong Market Efficiency.

So if you’re in business school, you’re wondering what does Strong Market Efficiency is that the textbook or your professor teach and talking about,they’re talking about a perfectly or almost perfectly Efficient Market like this situation over here where they all learn about the information at same time or almost the same time. What does this mean for investors? It means that in a perfectly Efficient Market withstrong market efficiency at any one time, anyone and everyone already knows all relevantinformation about a share or stock. So nobody can earn money by using any information suchas this sales report over here. Nobody can earn money using this information to analyseand predict the future share or stock price movements either up or down. So people likeBill cannot use the information to beat grandma. Why? Because grandma already knows the sameinformation too at the same time that Bill knows it. So it’s useless to use insideinformation. What is inside information? What’s the differencebetween information and inside information? Inside information just means the secret informationthat only Bill and Bob know. Grandma doesn’t know it yet. It’s secret, inside means likesecret information or advance information that Bob knows. But in a perfectly EfficientMarket with strong market efficiency, it is useless to use inside information, fundamentalanalysis or even technical analysis to give you or to give Bill an advantage in stockinvesting. Why? Because fundamental and technical analysis are based on information and sincethese two are based on information, how can these two give you an advantage if the information you’re using is already known by everyone. Remember in stock market investing, you havean advantage if you know about this information before other people know it. Therefore, Billalso does not have an advantage when he uses fundamental analysis which uses that informationand he also does not have an advantage when he uses technical analysis which also usesinformation or which is also based on information. debbierojonan Page 1

Why Trade at All?

Welcome to a three-part series on Trade The Day.

Forex trading can seem like a daunting challenge before starting on this journey, which begs the question.

“Why Trade at All?”

According to the Efficient Market Hypothesis (EMA), the prices of financial securities reflect all information regarding those securities.

Because of this, the theory goes, it is impossible to undertake any analysis – technical or fundamental – that will help you generate excess market returns.

That is because prices are efficient, no amount of technical or fundamental analysis will enable you to determine price movements such that you can make significant profits.

The theory seems to make a lot of sense and can help explain why trading is so hard.

Because trading is hard, no one is denying that. However, does this mean you should not bother; especially when making a profit is considering somewhat impossible by the EMA?

Efficient Market Hypothesis
The Efficient Market Hypothesis (EMH) graphically displayed

What does it mean then if we have heard stories, know of or have even seen people make a significant amount of money trading?

Why would all the big institutions have trading desks and invest so much in things like algorithmic trading if there was nothing to be gained from it?

Trading is indeed profitable for people, whether at the retail or institution level. That statement is a fact. As such, this may mean that the EMA is wrong. For how can there be people generating significant profits in trading if the markets are efficient?

In actuality, it is not so much that the EMA is wrong but rather that it is a bit understated.

The hypothesis should be stated as follows: given an infinite amount of time, resources and people then the prices of securities reflect their true value and generating excess returns is impossible.

That is, if you had an endless amount of people spending an endless amount of time analysing absolutely everything then, yes, you would find the absolute truth about the value of an asset. However, there are only so many hours in the day, there are only so many people studying a particular market and each of these people have their own lives to lead and their own needs to be met.

As such, there is only a limited amount of time, resources and people that can be put into studying financial markets. This, therefore, means that it is not possible for everyone to know everything about the markets. And so, there would necessarily be inefficiencies in prices that can be exploited for excess returns.

It is through these inefficiencies that people, retail and institutional, can and do indeed make money trading.

The question is whether you can too.

Read “Why Trade at All?” – Part 2 here

Welcome to Part 2 of the three-part series “why trade at all” on Trade The Day.

Actually, the question is first whether to trade FX or not and why to trade FX at all.

With many Forex brokers, you can leverage your account balance up to 500 times its value (500:1).

In other words, by signing up with xyz, you can enter into positions worth up to 500 times your deposit.

Let us say that you have a balance of $1,000 and enter into a trade worth $100,000 (in this case it would be an implied leverage of 100:1, as for every $100 in position you had $1 in deposit): a reasonable price movement of 1% with respect to your position value equates to $1,000.

You could effectively double (or wipe out) your entire deposit with just a 1% move in the value of the underlying instrument.

By trading leveraged instruments, it is possible to earn far more in a given amount of time than by trading the underlying instrument

So now that it has been established why trade at all and why trade FX, the next thing to determine is what to look for when trading so you can answer the question of ‘why bother’.

Regardless of whether you trade based on fundamental or technical analysis; every trading style is based on pattern recognition.

Technical analysis is based on the idea of analysing chart movements and predicting future price movements based on similar conditions seen in the past.

Fundamental analysis, in contrast, is where future price movements are predicted based on market information. However, fundamental analysis is still based on predicting future human (market) behaviour based on expectations built from past behaviours.

In either situation though, past performance cannot guarantee future results. Nevertheless, what other information do we have to predict the future than everything in the past?

The difference between successful traders and unsuccessful traders – at any level – is whether they have found exploitable patterns overlooked by everyone else.

As indicated previously, due to limited time, resources and people; it is not possible for market participants to be aware of every market pattern and inefficiency.

And so, for every trader, there is an opportunity to find some. These do not necessarily need to complex either. For example, think about all the times you could not see something that was right in front of you.

This is a very human phenomenon and at the end of the day it is either human’s trading or at least algorithms coded by humans, and it is surprising how often the obvious is overlooked.

Furthermore, there could be an indicator that was “all the rage” in the past, which fell out of fashion, now works again precisely and perfectly because everyone forgot about it.

Part 3

Trading is a personal skill and at the end of the day, you also need to find a strategy or system that works for you.

There’s no use trying to trade in a style that creates more confusion for you.

Trading is much like starting a new small business – as you are trying to generate a new income stream – and so it would be foolish to not treat your trading with a similar professional attitude.

It can take at least two solid years of full-time work for a small business to become profitable.

It would be reasonable to expect that to be successful at trading it will require a similar level of commitment and investment.

Considering the commitment you are making; it would be worth finding a strategy that works for you.

It is almost like starting a new job where you get to pick how you can do your job; why would you want to do a job in a way that you do not enjoy or understand?

Finally, there is a somewhat amusing analogy about trading in relation to brain surgery: imagine picking up a book on brain surgery one night, reading through it, and then deciding to walk into an operating theatre tomorrow.

FX trading is one of the few professional ventures that you can start as you learn.

Making mistakes is one of the best ways to learn and unlike brain surgery you have the opportunity to make and learn from your mistakes as you go.

You can pick up a book on FX trading, fire up a demo account and start today.