Part [A] Basic of Wave Principle
Updated
Elliott Wave background
In the 1930s, R.N Elliott identified the price of the stock trends and reversed a specific pattern. This pattern is repetitive in form and, the patterns have predictive value. He decided to use this pattern (Elliott wave theory) to predict the market. The Elliott wave is not primarily a trading system. It is a detailed description of how the market acts. The Elliott wave is part of technical analysis. Also, the Wave principle is the reassembled form of dow theory.
[“Elliott wave theory is governed by men’s social nature and since he has such a nature,
its expression generates forms. As the forms are repetitive, they have predictive value”]
-Elliott Wave Principle The key To Market Behavior]
Waves in the market?
We all know that price never moves in a straight line. It will neither fall in a straight line nor rise in a straight line.
Price will create highs and lows. And this high and low creates waves. Elliott wave theory is all about counting waves and, we are going to use the Elliott wave to trade the market.
Now, the concept of waves is acceptable for you.
Elliott wave theory is made of 5+3= 8 waves.
Let me show you that structure in both trends.
In bull market ( UP Trend ) :
Figure 1.1 This is the Elliott wave structure in an uptrend. As we discussed, Elliott's wave theory is made up of 5+3=8 waves. Where five waves move with the trend and three waves move against the trend.
In Bear market (downTrend) :
Figure 1.2 This is an example of Elliott wave theory in the Bear market. We can see that five waves move with the trend and, three waves move against the trend.
Take a deep breath, I know you have lots of doubts in your mind. Let me solve some.
1. Elliott wave theory works in any time frame.
2. These 5+3=8 waves will give us a market edge. It will provide strong trends & trend reversals.
3. The accuracy of Elliott wave theory is 84% of you are using the wave principle correctly.
Practical Example of Elliott wave theory :
In the Bull market :
Figure 1.3 This is the TATA MOTORS 4 hour timeframe chart. I used bar charts because It is easy to recognize Elliott's waves in bar Patterns. Well, it works for me to recognize if you feel that you can recognize patterns in another chart, go ahead with bar charts!
In Bear Market:
Figure 1.4: This is the ITC daily time frame chart. It shows the beautiful Elliott wave structure in the Bear market.
Elliott wave structure :
Now, we all know that Elliott is made of a 5+3= 8 wave structure. So, Let's start getting into it!
To understand the wave principle, we have divided the wave structure (5+3=8) into two Phases which are an Impulse phase/structure & a corrective phase/structure.
Figure 1.5 This picture illustrates Two phases of the Elliott wave principle.
The impulse phase is made up of 5 waves and, the corrective phase is made up of 3 waves.
Figure 1.6: This picture divides the wave principle into two phases.
1. Impulse phase/structure ( which includes five waves and, which moves with the trend you can see in bull market impulse phase is going upward and in a bear market, impulse phase is going down which is directional move.)
&
2. Corrective Phase/structure ( which includes three waves and which moves against the trend, you can see that in bull market corrective phase is going downward and
In bear markets, the corrective phase is going upward, which is a counter-trend move.
Figure 1.7, Elliott wave has 2 phases. motive/Impulse phase ( directional move ) and corrective phase(counter trend move). We can divide these 2 phases into two types of waves. Impulsive waves and corrective waves.
Let’s zoom in on the impulse phase to understand the underlying structure and wave behavior.
Motive/Impulse Phase :
Important things about the impulse phase
1). Motive/Impulse phase is a Five wave structure that includes wave1,2,3,4 & 5.
2). motive/Impulse phase is a directional move ( moves with the trend.)
3). The Ending point of the impulse phase is the starting point of the corrective phase.
4). motive/Impulse structure is powerful than corrective structure.
5) Impulse phase can divide into two types of waves
i) Impulse waves: 1, 3,5 ( move with Trend of impulse Phase )
ii) Corrective waves: 2,4 ( Moves against the trend of Impulsive Phase)
Let me give you a quick understanding because we are going to cover these waves in-depth,
Impulsive waves are trend-following moves. We can find this type of wave structure in both phases. Impulsive waves create trends.Impulsive waves are (1,3,5,A,C)
Corrective waves are counter-Trend moves. We can find this type of wave structure in both phases. Corrective waves provide pause to continue the trend,
Corrective waves : (2,4,B)
Motive/Impulse Phase in Bull market
Figure 1.8(A), wave 1,3,5 is an impulsive wave of impulse phase because The trend of impulse phase up and, Impulsive wave are following the trend and heaving upward move.
And
wave 2,4 is the corrective wave of an impulse phase because the trend of the impulse phase is up but, the corrective wave is moving down, which is against the trend.
Motive/Impulse Phase in Bear Market :
Figure 1.8(B), wave 1,3,5 is an impulsive wave of impulse phase because the trend of Motive/impulse phase down and Impulsive wave are following trend and heaving downward move.
And
Wave 2,4 is the corrective wave of an impulse phase because the trend of the Impulse phase is down but, the corrective wave is moving upward, which is against the trend.
Corrective Phase/structure :
Important things about the impulse phase
1). The Corrective Phase is a three-wave structure that includes waves A, B, C.
2). The corrective phase is a counter-trend move ( moves against the trend.)
3). The Ending point of the corrective phase is the starting point of the Impulse phase.
4) correction phase can divide into two types of waves
i) Impulse waves: A, C ( move with Trend of correction Phase )
ii) corrective waves: B ( moves against Trend of correction Phase )
Corrective Phase in a bull market:
Figure 1.9(A): wave A, C is the impulsive wave of the Correction phase because the trend of the correction phase is down and Impulsive waves are following the trend and heaving downward move.
And
Wave B is the corrective wave of a Correction phase because the trend of the Corrective Phase is down but, the corrective wave is moving upward which is against the trend.
[Note: here, the correction phase moves against the trend. That's why the market has an uptrend but, the correction phase is in a downtrend.]
Correction phase in Bear Market :
Figure 1.9(B): wave A, C is the impulsive wave of the Correction phase because the trend of correction phase Up and Impulsive waves are following the trend and heaving Upward move.
And
Wave B is the corrective wave of a Correction phase because the trend of the Corrective Phase is Up but, the corrective wave is moving down, which is against the trend.
[Note: here, the correction phase moves against the trend. That's why the market has a Downtrend but, the correction phase is in an uptrend.]
Impulsive wave structure :
1. Impulsive waves are directional moves that are bigger than corrective waves.
2. Impulsive waves create trends.
3. Impulsive waves are subdivided into five waves.
( that means wave 1,3,5, A, C which moves with the trend will have five sub-waves.)
4. Impulsive waves are easy to recognize.
(Impulsive waves can also be called motive waves)
5. Ride of impulsive wave can give us a high probability trade setup with high Rewards
We are going to cover impulsive wave formations in the next part.
(diagonals,extensions,Impulse,Truncation)
Figure 1.10: As we discussed, Impulsive waves subdivide into five waves.
Here wave 1,3,5, A, C has five subwaves which you can see in the chart.
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Check this chart: it illustrates how accurate the wave principle is!Note
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