Technical analysis in general is a method of market forecasting, based on pattern recognition. The Elliott Wave Principle is a more specific method, which uses its own patterns, called “waves”. They are as follows:
What is an impulse? Every impulse consists of 5 waves. Impulses show the direction of the larger trend. There are only three simple rules for an impulse:
- Wave 2 must not go beyond the start of wave 1.
- Wave 3 can not be the shortest among waves 1, 3 and 5.
- Waves 1 and 4 must not overlap.
In order to be categorized as an impulse, every five-wave looking pattern should have the following sub-wave structure: 5 sub-waves (labeled 1-2-3-4-5) for waves 1, 3 and 5, and 3 sub-waves (labeled a-b-c) for waves 2 and 4. Example:
Truncated fifth wave
Truncated fifth wave is maybe the rarest of all Elliott Wave patterns. It occurs, when wave 5 of a five-wave impulsive pattern does not go beyond the end of wave 3 of the same impulse. In order to recognize such a truncation, one should be able to count five sub-waves in the supposed truncated fifth. Example:
After every impulse, a correction follows. What is a correction? Corrections are 3-wave movements in the opposite direction of the larger trend. After every correction the larger trend resumes. Example:
Three types of corrections exist
- Zig-zag correction
This type of correction consists of 3 waves, labeled A-B-C, with a 5-3-5 structure (5 waves for A, 3 waves for B and 5 waves for C) Example:
Sometimes two or three zig-zag corrections occur, connected by an intervening X-wave. In the first case they are labeled W-X-Y, while in the second one there is one more X-wave, connecting Y with Z, thus completing the triple zig-zag W-X-Y-X-Z. Examples:
This type of correction consists of 3 waves, labeled A-B-C, with a 3-3-5 structure (3 waves for A, 3 waves for B and 5 waves for C). And while the wave structure remains always 3-3-5, the shape of flat corrections could be regular, expanding or running. Regular flat example:
Expanding flat example:
Running flat example:
Every triangle correction consists of 5 waves moving sideways, labeled A-B-C-D-E. Each one of these 5 waves has a 3-wave structure (3-3-3-3-3). Triangles indicate that there is only one final move left in the direction of the larger trend, after which, a reversal should be expected. This means that triangles occur as wave 4 of an impulse, wave B of a zig-zag correction, or the final wave X in double and triple zig-zag corrections. Sometimes triangles could be positioned as wave Y or wave Z of a corrective combination. Example:
The above-shown triangle is the most common type, where the two lines are contracting, thus making the whole pattern narrowing towards the end. However, there are some cases, when the lines are expanding. On the next chart you can see a good example of an expanding triangle.
Something called “diagonal” sometimes appears instead of an impulse wave. This could happen in wave 1 of an impulse and wave A of a correction for a leading diagonal, or in wave 5 of an impulse and wave C of a correction for an ending diagonal. Every diagonal consists of 5 waves just like a regular impulse wave, but here you should expect waves 1 and 4 to overlap and each wave to subdivide into 3s (rarely 5-3-5-3-5). Example: