Elliott Waves

What Is an Elliott Wave?

The Elliott Wave pattern is a type of technical analysis that traders use to analyze market cycles and forecast market trends by identifying extremes in investor psychology, highs and lows in prices, and other collective factors. It was developed by Ralph Nelson Elliott in the 1930s.

In its most basic form, the Elliott Wave pattern consists of five waves in the direction of the main trend (known as impulse waves) followed by three corrective waves (a 5-3 move). This forms a complete Elliott wave cycle.

1. Impulse Waves: These are the five waves that move in the direction of the main trend. They are labeled as 1, 2, 3, 4, and 5. Wave 1, 3, and 5 are motive, meaning they go along with the overall trend, while Wave 2 and 4 are corrective, moving against the trend.

2. Corrective Waves: After the five-wave sequence, a three-wave corrective phase follows, labeled as A, B, and C. Here, Wave A and C are motive (moving against the main trend), while Wave B is corrective.

So, in a bull market, the pattern would look like a strong rise (Wave 1), a modest fallback (Wave 2), another long upward move (Wave 3), a slight pullback (Wave 4), and a final upward move (Wave 5). This would then be followed by a three-wave downward correction (A, B, C).

The pattern in a bear market would be the reverse of this, with the five-wave impulse move going downward and the three-wave correction moving upward.

It's worth noting that these cycles are fractal in nature; that is, they occur on all time scales, from minutes to years, and the smaller cycles nest within the larger ones. This means that a complete cycle at one level can be just one wave at a higher level.

TradingView's Elliott Wave Indicator

The Chart Pattern Elliott Wave indicator is configured to recognize the most common wave patterns, which are built according to the following rules:

Impulse (Motive wave):

1. Wave structure: 5-3-5-3-5

2. Wave 2 does not retrace more than 100% of the length of wave 1

3. Wave 3 moves beyond the end of wave 1

4. Wave 3 cannot be the shortest among waves 1, 3, and 5

5. Wave 4 does not go beyond the level of wave 1

ZigZag (Corrective wave):

1. Wave structure: 5-3-5

2. Wave b is shorter than a

3. Wave c goes beyond the level of wave a

The indicator analyzes the last 600 bars in search of patterns, conditionally dividing them into two levels by nesting (main and sub-waves). The start and end points of the waves in the patterns found are tied to the most suitable pivot points. Then the indicator checks the rules for impulse and zigzag and draws patterns that capture the most amplitude price movements.

The following marking is used to indicate the level that the wave belongs to:

Main Waves: (1), (2), (3), (4), (5), (a), (b), (c)

Sub-waves: 1, 2, 3, 4, 5, a, b, c

This marking does not correspond to the historical levels of the Elliott wave theory; it is conditional. It displays the nesting level of the pattern.

When the pattern is in the In Progress mode, the indicator builds as many waves as possible based on the pivots, and uses a local extremum (highest high or lowest low) to build the last wave. If that last wave does not complete the pattern, the indicator draws possible projections of the next wave using Fibonacci proportions. Depending on the length of wave 3, wave 5 will be projected either from wave 1 or from the height of the movement of the first three waves. The projections of wave C are constructed from the length of wave A. All other projections are calculated based on the wave preceding them. The minimum number of waves in the in-progress pattern is 3.

Understanding and applying the Elliott Wave theory can be complex as it requires the interpretation of wave counts, which can be subjective and vary among analysts. Also, like any other trading strategy, it's not 100% accurate and should be used in conjunction with other technical analysis tools to confirm signals.