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Forex Basic Strategies

Trading The Forex Market Using ‘Price Action With Context’ Strategy

Introduction

Price action with context is a process to predict a currency pair’s movement by reading the chart. The key price driver of a currency pair is fundamental events, but we can predict the future movement based on the present and past activity of the chart.

Central banks and financial institutes drive the forex market. Therefore, when they make the price move, they left some signs of their activity. As a price action trader, we will read their activity and anticipate what they might do in the future.

What is Price Action?

Price action is a process to inquiry about a currency pair’s price development. The main aim of the price action trading is to understand buyers’ and sellers’ sentiment in the price and predict future movement based on these. The price action trading is based on the combination of several trading indicators and price behaviors. Therefore, you might have to use multiple trading tools as a price action weapon.

The price of a currency pair moves based on the sentiment of buyers’ and sellers’. Therefore, using price action is logical that can provide accurate trading signals. In the price action with context trading strategy, we will identify a market direction by reading the chart and then enter a trade from the correction to get the maximum return with a minimum risk.

What are Price Action Weapons?

There are many parts in the price action trading that a trader should know, like- candlestick, support and resistance, trend, market flow, event level, key Level, and market context.

Candlestick

Candlestick represents the price movement of a currency pair for a specific timeframe. The four major parts of candlestick trading are- opening price, closing price, high price, and low price. Candlestick represents both continuation and reversal price direction based on the opening, closing, high and low. There are many candlestick patterns in the market, but in this trading strategy, we will focus on reversal candlesticks only.

Example of reversal candlestick – Pinbar, Engulfing Bar, and Two Bar, etc.

Support & Resistance

Support and resistance are a price zone from where the price is likely to change the direction. When the price is moving up, it will reverse as soon as it finds resistance. On the other hand, the price will stop moving down as soon as it finds a support level. There is more to know about the support and resistance in this trading strategy-

Event Level – Event level is a price zone that works as both support and resistance. It is the most important Level as both buyers and sellers put attention to it.

Key Level – key levels are a significant level in the daily or weekly timeframe to understand the price’s top and bottom.

Dynamic Level – Dynamic levels move with the price rather than a specific horizontal zone. In this trading strategy, we will use 20 Exponential Moving Average as the dynamic Level.

Market Context

Market context is a process to identify the nature of a trend. It has four elements:

Impulsive – When the price aggressively creates new highs and lows, it is considered as an impulsive trend. It indicates that the price will continue the current trend.

Corrective – In a corrective market structure, price barely creates new higher highs or lower lows. It is an indication of market reversal.

Volatile Trend – In volatile trends, the market follows the corrective structure and indicates a market reversal.

Non Volatile Trend – Non-volatile trend appears with the impulsive market momentum when the price tries to continue the current movement.

Bullish Price Action Trade Setups

Find the market in an impulsive bullish pressure in H4 or daily timeframe. Identify the Key support level and consider buy trades only as soon as the price is trading above it.

Entry

To enter the trade, you have to wait until the price comes down towards an event level with a corrective structure in 1 Hour timeframe. Enter the trade as soon as the price rejects and closes above the event level with a reversal candlestick.

Stop Loss

Put the stop loss below the recent swing low with 10-15 pips buffer. Here the buffer means you should put the stop loss 15 pips below the swing low.

Take Profit

The primary target of the take profit would be the next event level. However, if the bullish trend remains impulsive, you can extend the take profit. On the other hand, you can close earlier if the price barely creates new higher highs.

In the example below, we can see a visual representation of how to take the entry with stop loss and take profit level.

Bearish Price Action Trade Setups

Find the market in an impulsive bearish pressure in H4 or daily timeframe. Identify the key resistance level and consider sell trades only as soon as the price is trading below it.

Entry

To enter the trade, you have to wait until the price comes down towards an event level with a corrective structure in 1 Hour timeframe. Enter the trade as soon as the price rejects and closes below the event level with a bullish reversal candlestick.

Stop Loss & Take Profit

Put the stop loss above the recent swing high with 10-15 pips buffer. Here the buffer means you should put the stop loss 15 pips above the swing high.

The primary target of the take profit would be the next event level. However, if the bearish trend remains impulsive, you extend the take profit. On the other hand, you can close earlier if the price barely creates new Lower lows.

In the example below, we can see a visual representation of how to take the sell entry with stop loss and take profit level.

Final Thoughts – Trade Management Idea

In the above section, we have seen how to trade using the price action with context. In this trading strategy, buy and sell trades come after filtering out unusual market movements from the volatile market conditions.

However, no forex trading strategy in the world can guarantee a 100% profit, so your trades might go wrong even if you strictly followed all rules. If you want to grow your account with a consistent profit, you should follow strong trade management tools, as mentioned below:

  • Ensure that you are not taking over a 2% risk per trade of your trading balance.
  • Move your stop loss at breakeven as soon as the price creates a new higher high or lower low.
  • If you face a 3 or 4 consecutive losses, take a break and observe the market until it follows the trend accurately.
  • Make sure to keep your mind free from any bias while you are analyzing the market.

Overall, price action is the core element of trading that every trader should know. There are many trading strategies combining price action and other trading tools. The strategy we have seen above has a good history of providing profitable trades. Therefore, if you can implement it properly, you can consistently grow your trading account.

Categories
Forex Elliott Wave

Advanced Applications in Wave Analysis – Part 2 of 4

Introduction

As we commented in previous articles that cover the corrective structures, R.N. Elliott considers its study as a key to understand the current market situation and what to expect for the next path.

In this educational article, we expand the observations of the flat and the zigzag pattern.

Corrective Patterns in Action

In the first part of this four-part series, we commented that impulsive waves create trends. Corrective waves correct or retrace the progression of the trending movement developed by the motive waves. A corrective structure will never appear in a wave 1, 3, 5, in a wave A and C of a zigzag, and wave C of a flat pattern.

The Flat Pattern

The flat pattern develops different variations depending on the strength of the trend or the level of complexity of the correction in progress. In its fundamental nature, the flat follows an internal sequence as 3-3-5.

On the other hand, variations in the flat pattern surge in the extensions of its waves B and C. In brief words, as wave B extends more than the 100% of wave A, wave C will tend to be short. And the lesser the retrace of wave A by wave B, the larger wave C will be.

  1. Failure in B. This case represents the scenario when wave B retrace between 61.8% and 81% the progress of wave A. If wave B extends beyond 81%, it means that the market is temporarily weak. Wave B will fail when the wave A be a double zigzag or a double combination. Wave C will tend to retrace the advance of wave B entirely. This variation could appear in waves 2, 4, A, B, or inside a horizontal triangle in its legs C, D, or E.
  2. Failure in C. This type of failure tends to occur when wave A experiences a complete or almost complete retracement made by wave B. When the price movement fails in wave C, the market shows a signal against the dominant trend. In this context, this pattern will appear in a terminal sequence. Wave C duration will be shorter than wave B and will show a similar duration than wave A. This variation could arise in waves 2, 4, A, B, or the wave 5 of a terminal impulsive wave.
  3. Regular. This formation is the typical flat pattern. Wave B retraces at least 81% of wave A, and wave C will advance wave B entirely. Also, this wave could extend between 10% and 20% beyond the end of wave A. In this variation, wave B will tend to be a complex structure, and its extension in time will be longer than waves A and C. The regular flat could rise in waves 2, 4, A, B, or in waves C, D, or E in a terminal impulsive wave.
  4. Double Failure. This scenario is infrequent; however, the double failure occurs when wave B to retrace beyond 81% of wave A, and wave C doesn’t extend beyond 100% of wave A. The double failure variation will look like a contracting triangle. Finally, this scenario will tend to appear in waves 2, 4, in wave A inside of a triangle or an irregular flat. When it happens in a wave B, it could belong to a zigzag, a regular on in an extended flat.
  5. Extended. This configuration occurs when wave C advance reaches between 138.2% or beyond 161.8% of wave B. Waves A and B must be similar in terms of price and time. This variation should tend to appear in waves 1, 3, or 5 as an impulsive terminal wave. In waves A, B, C, or D in a horizontal triangle, or wave E of an expanding triangle.
  6. Irregular. This is the most straightforward variation of the flat pattern. At the same time, it isn’t easy to find it in the real market. This pattern is indicative of the strength of the previous move. Wave B must be higher than wave A in price. Generally, wave C will be equal to wave A in price and time relation. This variation tends to appear in waves 2, 4, in wave B before the extended wave C of a flat, or as the wave B in a zigzag when wave C moves beyond 161.8% of wave A.
  7. Continuous. This correction is the most powerful variation of the flat pattern. This type of formation tends to imply volatile movements of the same degree. The continuous flat pattern tends to emerge in the second wave after an extended third wave. When it appears in the fourth wave, this variation could occur before a fifth extended wave. In a wave B, it surges before an extended wave C; in a triangle pattern, it could happen in the a-b-c series, or in a wave B of a zigzag that forms a triangle structure.

The following figure represents the seven flat pattern variations.

The Zigzag Pattern

The main difference between zigzag and flat pattern is that zigzag does not have a wide variety. The central aspect to take in consideration with the zigzag pattern is the extension of wave C compared with wave A, and the subdivisions number of wave C compared with wave A.

  1. Wave A. This wave must have an impulsive structure; this means that its internal structure must contain five segments. The A wave of a zigzag formation shouldn’t experience a retrace beyond 61.8% by wave B. If the wave B retraces beyond 61.8%, this could be indicative that the market is developing a complex correction as a double zigzag or a double combination.
  2. Wave B. This wave must show a corrective structure with three segments in its construction. As stated earlier, its progression should not go beyond 61.8% of wave A. This wave never will present a continuous correction. If this situation occurs, then the zigzag moves inside a triangle pattern. In this case, the zigzag will be the second wave of an impulsive sequence. Consequently, if this scenario occurs, then the wave B could not be a complex corrective structure as a double or triple zigzag, nor any other type of combination of corrective structures.
  3. Wave C. This part of the zigzag pattern contains five internal segments. Its extension could be from 61.8% to 161.8% of wave A.

Conclusions

In this educational article, we presented the variations of the flat pattern and the zigzag. These variations can provide a significative clue to the wave analyst respecting to the market situation and what to expect for the following sessions.

In the next educational article, corresponding to the third part of the advanced applications in wave analysis, we will present the variations in the triangle pattern.

Suggested Readings

      • Neely, G.; Mastering Elliott Wave: Presenting the Neely Method; Windsor Books; 2nd Edition (1990).
Categories
Forex Elliott Wave

Additional Observations in Wave Analysis – Advanced Level

Introduction

R.N. Elliott, in his treatise “The Wave Principle,” emphasizes the importance of the corrective patterns knowledge. Elliott adds that its comprehension can provide to wave analyst an advantage in the forecasting process.

Glenn Neely, in his work “Mastering Elliott Wave,” not only expands this information defining a set of observations about the different corrective patterns and its potential implication for the next path. He also extends these observations to impulsive structures.

Corrective Patterns

The significative movements occur after a correction; in this sense, the knowledge of the potential extension of the next move provides a valuable edge to wave analyst.

The following list shows the corrective formations according to their strength level.

  1. Triple zigzag. This complex corrective pattern is the strongest of the corrections group. The triple zigzag rarely appears in the real market; however, its appearance is indicative of its strength (or weakness) level. When it surges, it will raise on a terminal structure, or in a triangle pattern. Once the triple zigzag ends, the next move will not experience a complete retracement.
  2. Triple Combination. This type of complex correction can be formed by a combination of flat, zigzag, and triangle. Usually, it will end with a triangle pattern. Once the triple three formation ends, the next path would tend to retrace the entire movement even in an upper degree. If this pattern surges as a terminal structure, the next move should entirely retrace the formation triple three.
  3. Triple Flat. This complex formation corresponds to the combination of three flat patterns. In this case, the next path should not retrace its advance completely, except when the Elliott wave structure surges as a terminal structural series in the fifth wave.
  4. Double Zigzag. This complex corrective pattern should not experience a complete retracement by the next movement.
  5. Double Combination. The double combination is a complex corrective pattern that generally could contain a zigzag or a flat formation with a triangle. In the same way, this structure tends to end with a failure in wave c. This pattern tends to be entirely retraced by the next path.
  6. Double Flat. This complex combination surges in rare cases. However, when it rises, generally, the next move will not retrace the complex structure fully.
  7. Extended Zigzag. This variation of the zigzag pattern generally appears in triangle formations or at the end of a terminal structure. The next path of an extended zigzag generally will never be entirely retraced.
  8. Extended Flat. This variation tends to emerge in triangle patterns. In the same way that the extended zigzag, the next move should not retrace it completely.
  9. Zigzag. This standard corrective pattern can be found in the real market. In general, the next path could retrace wholly and partially the extension of the zigzag pattern.
  10. Flat. Although this pattern and its variations are typical, the retracement of the next movement tends to be unclear.
  11. Double Three. In general, the extension of this complex corrective pattern tends to warn about the potential next movement. In short, while most extended being the double three pattern, the next move will be stronger.

Triangles

Glenn Neely, in his work, considers that triangle patterns require a different treatment. 

  1. Contracting Triangle. The thrust developed in a contracting triangle is a movement with a higher level of momentum. This move will be bigger or smaller, in terms of time, depending on its nature. If the contracting triangle is horizontal, the next path will be equal to the largest segment of the triangle. In the irregular contracting triangle case, the next movement will reach the 161.8% respecting to the largest leg of the triangle. Finally, in the continuous contracting triangle, the thrust can reach the 261.8% of the broadest segment of the triangle. 
  2. Expanding Triangle. In this kind of triangle, the thrust differs from the case of the contracting triangles. The thrust of an expanding triangle tends to be minor than the most extended segment of the triangle.

Impulses

The advantage of the next movement of an impulsive wave is the knowledge of the potential correction. In this context, it is tough to determine what kind of correction will occur before the corrective sequence begins. 

  1. Trend. After the motive wave completion, the impulsive movement should not experience a retracement beyond the origin of its first segment, except if the impulsive wave corresponds to a fifth wave. In general, waves A, 1, or 3, should not experience a retrace greater than 61.8% by the next move.
  2. First Extended Wave. When the extended wave is the first move, the motive wave should experience a retracement until the end of wave 4. 
  3. Third Extended Wave. In this case, once the impulsive wave is completed, the motive structure should experience a retrace between the high and low of the fourth wave.
  4. Fifth Extended Wave. The next corrective structure of a fifth extended wave should retrace more than 61.8% to the impulsive move.
  5. Terminal Structure. The movement after a terminal structure should retrace the progression of the terminal structure completely. The time elapsed in the evolution of the corrective move should be shorter than 50% of the time elapsed in the making of the terminal structure.

Conclusions

In this educational article, we discussed the observations described by Glenn Neely in his work “Mastering Elliott Wave” concerning the potential next movement, depending on the pattern in progress.

In this context, Neely, following the steps of R.N. Elliott, provides an ample proportion of time to describe what to expect after a corrective structure. This knowledge could provide the wave analyst an advantage in its comprehension about the market situation and what should be the potential next move.

In our following article, we will present the advanced applications in the wave analysis in a four-part series.

Suggested Readings

– Neely, G.; Mastering Elliott Wave: Presenting the Neely Method; Windsor Books; 2nd Edition (1990).

Categories
Forex Course

111. Trading Forex Market Using Elliot Wave Theory

Introduction

In all the previous lessons, we understood the terminology and interpretation of the popular Elliot Wave theory. Now we are well-versed with the subject to apply it to the forex market.

The Elliot Wave Theory is a wide concept and can be traded in several different ways. In this lesson, we shall analyze the forex currency pairs using Elliot wave concepts by combining it with some price action.

The best way to trade the Elliot waves

We know that according to the Elliot wave theory, there are two types of waves. There is an impulsive wave pattern made of 5 waves, and a corrective wave made of 3 waves. The impulsive wave is towards the trend, while the corrective wave is basically a pullback for the overall trend.

As a trader, we need to look for trades that payout well along with less risk. So, it is not ideal to trade all the impulsive waves and corrective waves.

Trade setup 1

The setup is to trade the impulsive waves. In the 5-wave impulsive pattern, three waves are along with the trend and two against it. Out of those three impulse waves, the ideal wave to catch is Wave 2. This is because, the Wave 2 is usually the strongest out of the three impulse waves, which significantly reduces the risk on the trade.

Trade Example

After the market makes the first wave, the price starts to pullback. But while the market is retracing, we won’t know where the market will hold and complete its second wave. So, we make use of other tools to determine where the market will resume its trend.

Consider the below price chart. As represented, the market made its first wave. Then, wave 2 began, where the market started to retrace. But, note that, at this point in point, we cannot confirm the end of wave 2. So, to determine the completion of wave 2, we shall be applying the Fibonacci retracement.

In the below chart, the fib retracement has been applied. We can see that the market began to hold at the 50% level. This hence confirms that wave-2 leg has come to an end. Thus, we can prepare to go long in anticipation of wave 3.

In the following chart, we can clearly see that the market held at the 50% fib level and ended up making a higher high, i.e., wave 3.

Trade setup 2

This is the type of setup where we consider the complete 5-3 wave pattern. In the below chart, the 5-wave impulsive pattern is represented with the black trend lines, while the 3-wave corrective pattern is represented by the red trend lines. Since in an Elliot wave pattern, the high of the third corrective wave must be below low of the first wave in the impulsive wave pattern, we can trigger the sell at the area shown in the chart.

This hence concludes our discussion on the Elliot Wave theory. In the next lesson, we’ll summarize this topic for your better understanding and then pick another interesting course.

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Categories
Forex Course

108. What Are Corrective Waves & How To Comprehend Them?

Introduction

In the last lesson, we discussed the impulsive waves and 5-wave pattern corresponding to it. A trend is made up of the combination of the 5-wave pattern and the 3-wave pattern. The 5-wave impulsive pattern moves along the original trend, while the 3-wave corrective pattern moves against the trend. In this lesson, we shall discuss the corrective wave and then interpret the 5-3 waves.

Corrective waves

In case of an uptrend, the impulsive waves are towards the upside, and the corrective waves are towards the downside. Continuing with the example mentioned in the previous lesson, the corrective waves are represented in the below figure.

In the above figure, waves a, b, and c represent the corrective waves. The overall trend of the market is up, but corrective waves are against it. In other terms, the 3-wave corrective wave can be considered as pullback for the uptrend.

Note: The 3-wave corrective wave is also referred to as the ABC corrective wave pattern.

Reverse Corrective Wave Pattern

The Elliot wave theory is applicable to both uptrend and downtrend. So, for a downtrend, the impulsive wave faces downwards following the overall trend, while the corrective wave faces upwards. Below is a figure representing the 5-3 wave pattern for a downtrend.

Types of Corrective Wave Patterns

The above illustrated corrective wave is not the only type of corrective wave that occurs. According to Elliot, there are twenty-one 3-wave corrective wave patterns, where some are simple and some complex. However, a trader need not memorize all of them at once. The following are three simple corrective waves that are most occurring in the market.

The Zig-Zag Formation

The zig-zag formations are very steep compared to the regular one and are against the predominant trend. In the three waves, typically, wave B is the shortest compared to wave A and wave C. Note that, the Zig-Zag pattern can happen twice or thrice. Also, the zig-zag patterns, like all other waves, can be broken into 5-wave patterns.

The Flat Formation

As the name suggests, in flat corrective wave patterns, the 3-wave pattern is in the sideways direction. That is, the wave C does not go below wave B, and wave B makes a high as much as wave A. Sometimes, the wave B goes higher than wave A which is acceptable as well.

The Triangle Formation

The Triangle formation is a little different from the other corrective patterns. The difference is that these patterns are made up of 5-waves that move against the overall trend. These corrective waves can be symmetrical, ascending, descending, or expanding.

These were some of the most used corrective patterns used by traders. These must be known to technical traders by default. In the next lesson, we shall discuss another important concept related to the Elliot Wave theory.

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Categories
Forex Elliott Wave

Validation Rules of Corrective Waves – Intermediate Level

Introduction

Contrary to the case of impulsive waves, corrections do not require a sequence of retracements. The confirmation of the corrective patterns depends on the lengths of waves A and B within the correction. 

The validation of a corrective structure is defined in two stages. If both stages are verified, then the wave analyst will be sure that the corrective formation is correct. It should be noted that there is the possibility that only one of the two stages is validated; this does not limit that the pattern being valid.

Flats and Zigzag Patterns

Case 1 – Wave A is Larger than Wave B

In this case, the wave analyst must draw a trendline linking the origin of waves A and the end of B.

The first stage will verify the authenticity of the corrective formation if the price action violates the trendline O-B within a period equal to or less than the interval of wave C formation.

In case the time-lapse is longer, then the price action could be developing a terminal structure, or wave 4 of wave C could be incomplete, or the corrective pattern analyzed is not correct.

If the analyzed pattern is correct, then the second stage must be revised. In this stage, the wave analyst must study time lapsed in the complete retracement of wave C, which must be in a time equal to or less than the time spent in the formation of the wave C.

Case 2 – Wave B is Larger than Wave A

In this case, the first stage would fulfill if the wave C undergoes a complete reversal in the same or shorter time when the time lapsed in the wave C construction. 

The second stage will fulfill if the price action exceeds the trendline O-B in a period less than or equal to the time that took the wave C formation.

Triangles

As we have seen in previous articles, there are two types of triangles, contracting and expanding. Unlike flat and zigzag patterns, where the first stage of validation consists of the violation of the trendline O-B, in the case of triangles, the trendline B-D violation is the one considered.

Contracting triangles are the easiest to validate after the violation of the trendline B-D. However, this does not happen in the same way in expanding triangles. 

In expanding triangles, validation comes determined through the “no confirmation.” That is, once the wave E finishes, the price action should not reverse the advance of wave E completely. 

Therefore, this retracement would discard out any possible violation of the guideline B-D, or it would take longer to reverse the advance of the wave E than the duration of the wave E.

Validation of a Contracting Triangle

As mentioned above, in the case of triangles, the guideline B-D is used instead of the line O-B. The first stage of validation of the contracting triangle pattern will occur if the price exceeds the line B-D for a period less than or equal to the time it took to construct the wave E.

The second stage is defined by the thrust that occurs after the wave E in a triangle, which should exceed the highest (or lowest) price achieved by the triangle. In turn, the thrust should finish within a time range that not exceeding 50% of the duration of the triangle.

Conclusions

In this educational article, we have seen that the criteria for validation of corrective waves differ from impulsive waves in terms of the conditions to consider for a valid pattern. 

Also, we reviewed the importance of validating each structure under analysis. That will help the wave analyst to verify if the pattern identified is correct or not. 

This knowledge will allow the analyst to facilitate the realization of forecasts on the potential next movement of the market.

In the next educational article, we will review some key concepts for the process of analyzing waves such as wave compaction, degrees, and introduce the concept of complexity in the wave analysis.

Suggested Readings

  • Neely, G.; Mastering Elliott Wave: Presenting the Neely Method; Windsor Books; 2nd Edition (1990).
Categories
Forex Elliott Wave

How to Analyze the Zigzag Pattern – Intermediate Level

The zigzag pattern is a three-wave structure that has a limited number of variations. In this educational post, we’ll present how to analyze the zigzag pattern under an intermediate level perspective,

The Elliott’s Zigzag Pattern

R.N. Elliott, in his work The Wave Principle, described the zigzag as a corrective formation that follows an internal sequence defined by 5-3-5.

The wave analysis analyst should consider that corrective patterns are not easy to recognize while the structure is not complete; however, it results revealing and useful to make forecasts once the formation is complete.

Zigzag Construction

Glenn Neely, in his work Mastering Elliott Wave, describes the zigzag construction as follows:

  1. Wave A shouldn’t retrace beyond 61.8% of the impulsive wave.
  2. Wave B should retrace at least 1% of wave A, but shouldn’t exceed 61.8% of wave A.
  3. Wave C must finish at least slightly beyond the end of wave A.
  4. If wave B retraces more than 61.8% of wave A, thus the movement developed doesn’t correspond to the end of wave B. In this case, the move realized correspond to a segment of a complex wave B.

The following figure illustrates the steps of the zigzag pattern construction previously described.

Types of Zigzag

According to the extension of wave C, the zigzag pattern would be classified as normal, extended, or truncated.

Normal zigzag: In this case, wave C can reach between 61.8% to 161.8% extension of wave A. Concerning wave B, this segment doesn’t retrace more than 61.8% of wave A, and wave C shouldn’t extend beyond 161.8% of wave A.

Truncated zigzag: This formation is less frequent than the other two zigzag pattern variations. Further, wave C shouldn’t be lower than 38.2% of wave A, but not greater than 61.8% of wave A. 

Once wave C ends, the next path should retrace at least 81% of the entire zigzag formation. According to Neely, this pattern it is likely that appears in a triangle structure.

Extended zigzag: This variation is characterized by having a more prolonged wave C than the other two models, which surpasses the 161.8% of wave A, being similar to an impulsive sequence. 

Once completed the wave C, the next path tends to retrace at least 61.8% of wave C.

Canalization Process

To canalize a zigzag formation, the wave analyst should pay attention to wave A and the end of wave B. 

The canalization process begins with the trace of a base-line linking the origin of wave A with the end of wave B, then using this line, a parallel line is projected at the end of wave A.

If the wave analyst encounters a zigzag pattern, then the corrective formation could move inside the channel, violate it, but never move in a tangent way to the channel. If it occurs, then the corrective sequence may correspond to a complex correction.

Finally, once the price violates the base-line O-B, we can conclude that the zigzag pattern ended.

NASDAQ e-mini and its Zigzag Pattern

The following figure represents to NASDAQ in its 12-hour timeframe. The chart reveals the upward process that the technologic index developed in the Christmas rally of 2018 at 5,820.50 pts.

The impulsive bullish sequence completed its internal five-wave moves at 7,879.50 pts on April 24th, 2019, from where the price began to develop a corrective zigzag pattern.

As illustrated in the last figure, the wave (a) in blue looks as a five-wave structure that ended at 7,290 pts on May 13th, 2019. The second leg of the zigzag pattern advanced close to 61.8% of the wave (a), which accomplishes the requirement of zigzag construction.

The next bearish path, corresponding to wave (c) produced a second decline in five waves and dropped beyond the 61.8% and below 161.8% of (a) which lead us to conclude that the type of zigzag pattern is normal.

At the same time, we observe that the price didn’t violate the lower line of the descending channel. However, once NASDAQ soared above the upper line of the descending channel, the corrective structure ended, giving way to the next upward motive wave.

Conclusion

In this educational article, we reviewed the characteristics of the zigzag pattern and how the wave analysts can differentiate from another kind of corrective formation. 

At the same time, the Fibonacci tools represent a useful way to validate what structure develops the market. In this context, this knowledge will allow the wave analyst to identify potential zones of reaction, which would enable us to incorporate into the trend.

In the next article, we will review the triangle pattern and how to recognize its variations.

Suggested Readings

  • Neely, G.; Mastering Elliott Wave: Presenting the Neely Method; Windsor Books; 2nd Edition (1990).
  • Prechter, R.; The Major Works of R. N. Elliott; New Classics Library; 2nd Edition (1990).
Categories
Forex Elliott Wave

Trading the Elliott Wave Principle – Part 3

The zig-zag pattern is a corrective Elliott Wave structure developed by a 5-3-5 internal sequence. In this educational article, we will unfold two guidelines to trade this pattern.

Looking at the wave B

The first guideline is looking at wave B with the eyes placed in wave C progress. The following chart shows an idealization of this trading setup.


There are two different ways to set up the entry into the market. The first one is to wait for the retrace of wave (B) into the area between 38.2% and 61.5% of Fibonacci retracement. The second one settles once the price breaks and closes below wave B of wave (B). In the chart, wave B has a blue label, and wave (B) has a black degree.

The invalidation level is above wave 5, or the last swing. To set the profit target, we use the Fibonacci projection. The first target (conservative scenario) is at the 61.8% of waves (A) and (B). The second target is at 100%, and the last one is at 127.2%.

Following the trend

The second guideline is at the end of wave C. In this context; we seek to join the primary trend. The next chart explains the model for this setup.


The setup is as commented in the article “Trading the Elliott Wave Principle – Part 1.” In this case, from the previous chart, we enter the market after the breakout and close of wave 4 of wave (C).

The first profit target is at 100% of the Fibonacci projection of waves ((1)) and ((2)) labeled in red degree. Note that a conservative profit target could be at the 61.8% of the Fibonacci projection.

An alternative to placing the invalidation level is below the end of wave (C). A second option is under the origin of wave ((1)) labeled in red degree.

Trading the zig-zag pattern

The Bank of America Corp. (NYSE:BAC) 3-hour chart shows a zig-zag structure. The Elliott Wave formation started on December 31, 2014, when the price found sellers at $18.21 per share.


Sometimes, the line-chart can be helpful to unveil the internal structure. From the BAC line chart (left), we observe the 5-3-5 sequence started at the end of December 2014.

On the right side, we see the OHLC chart. In this figure, we observe the trading setup looking for trade the wave C.

From the example; the short position is active once BAC dropped and closed below $17.10.

The first profit target at $16.50 (61.8% Fib projection) is conservative. This level could allow us to move to breakeven and left the trade without risk. Finally, the BAC sell-off drove to the price to find the second target at $15.95 and the third target at $15.57.

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Forex Elliott Wave

Corrective Waves Construction – Part 5

Elliott defined a complex corrective wave as the combination of two or three simple corrective structures. In this educational article, we will review the main characteristics of this group of EW formations.

The basics

Elliott named the combination of corrective waves combination as “double three” and “triple three.” These formations could present zig-zag, flat, or triangle patterns.

The price action can be characterized by a sideways movement. Each end of a simple corrective wave, as labeled by Elliott as W, Y, and Z, and each reactionary wave as X.

The following chart exposes the basic model of a double three and a triple three.


Consider that the difference between a double three and a triangle pattern is its internal structure. A triangle follows a 3-3-3-3-3 sequence. Meanwhile, in a double three, its internal wave C follows a five-wave movement.


Alternation and complexity

R.N. Elliott identified the alternation in corrective waves. If the first correction is simple, the next corrective move will be complex and vice-versa.

In the same way, a corrective wave alternates its formation. For example, consider an A-B-C sequence; if wave A starts as a zig-zag, wave B will likely be a flat pattern. Remember that wave C always runs as five waves.

The next figure shows the alternation in a corrective wave construction. This alternation is analogous if wave A is a flat pattern.


Alternation in the real market

The below chart corresponds to the NASDAQ Biotechnology Index ETF (IBB) in the 3-hour timeframe. The Elliott wave movement shows a decline started on October 01, 2018, when the price action found sellers at $122.97.


The wave A of Minor degree is composed of a corrective move developed as a zig-zag pattern ending at 100.67 on October 29, 2018. Once completed this path, IBB formed a regular flat pattern ending in early December at $111.58.

Finally, wave C of Minor degree was realized as a five waves sequence on the Christmas low at $89.64.

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Forex Elliott Wave

Corrective Waves Construction – Part 4

The third basic corrective formation is the triangle. This pattern follows a 3-3-3-3-3 sequence. In this educational article, we will unfold the main characteristics of this Elliott Wave pattern.

The basics

A triangle structure emerges when the two markets’ forces, buyers, and sellers, are in balance. When the triangle pattern is in progress, the volume and volatility tend to decrease over time.

The triangle pattern is the most common Elliott Wave structure. The main rule of construction is the composition of five segments, or internal waves, which are built by three waves each segment. The following chart shows the basic structure of a triangle pattern.


Triangle variations

There are four triangle variations; these are contracting, barrier, expanding, and running. The next chart exposes the different triangle variations.


A triangle pattern tends to appear before the end of a trend. For this reason, it is useful the study in recognition of this Elliott Wave structure.

The triangle pattern in action

The example corresponds to the weekly chart of Nikkei 225 futures (CME:NKD) in log scale. The Japanese index shows a motive wave of Cycle degree in progress. The bullish sequence started in March 2009, when the market found buyers at 6,950 pts.

Pay attention to the extension of the third wave of Cycle degree, which climbed over 16,000 pts. At the same time, the third wave of Primary degree soared 12,740 pts (154.42%).


From the chart, we observe two triangles formations. The first one is a barrier triangle and was developed on wave 3 of Primary degree. The Elliott Wave structure started in the second half of May 2013 and ended in the first half of October 2014.

The second one is an expanding triangle in progress. The EW structure belongs to the fourth wave of Cycle degree. Currently develops the segment C-D. Consider the possibility that the price action could not reach the previous high of 2018 at 24,515 pts.

For the current sequence, the most likely path is a marginal upside, giving way to a bearish move probably to the 18,000 pts. Once completed this corrective move, Nikkei should start a rally with the eyes placed at the 26,000 pts.

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Forex Elliott Wave

Corrective Waves Construction – Part 3

The second basic corrective formation is the Flat Pattern. Although this structure has three waves, it is different from the zig-zag. In this article, we will describe the structure of the Flats.

The basics

A Flat structure is an irregular corrective formation that contains three segments and built by a 3-3-5 sequence. If the price action breaks a motive wave rule, and the structure does not correspond to a zig-zag pattern, we are likely facing a 3-3-5 formation.

In a flat pattern tends to retrace less of the last impulsive move. Also, this corrective formation tends to occur after a strong trend; it means when the major trend is strong. In the following figure, we observe the basic structure of the flat formation.


Flat pattern variations

There are three types of Flat patterns: regular, expanded, and running flat. In a regular flat correction, wave B moves between the 2/3 and 100% of wave A, and wave C could travel from the 100% to 1/3 beyond of wave A.

In an Expanded Flat, wave B moves over the origin of wave A, and wave C extends ahead of wave A.

The Running flat structure, unlike the Extended Flat, characterizes by the extension of wave C, which ends before the end of wave A.

In the next diagram, we can appreciate the different flat formations.


Channeling in flat formations

A useful tool to identify a flat pattern is the channel. The channeling process allows us to visualize the potential next movement of the market.

The channeling process starts by tracing a horizontal line from the origin of wave A. Once completed; it must project the base-line at the end of wave A.

The next figure shows the different variations of the flat pattern.


The flat pattern in action

The e-mini SP 500 future (CME:ES) on its daily chart shows a sell-off started on October 03, 2018, when the price reached at 2,944.75 pts. The first decline was developed in three waves. As says the canalization process for this structure, we trace a horizontal channel from the origin to the end of wave A.

After this movement, ES made a sideways move in another three waves. Finally, the e-mini began a second bearish leg developed in five internal waves until 2,316.75.


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Forex Elliott Wave

Corrective Waves Construction – Part 2

R.N. Elliott, in his work “The Wave Principle” described the zig-zag structure as a corrective pattern. In this educational article, we will unfold the zig-zag formation.

The basics

The zig-zag pattern contains three waves in a higher degree, and follow a 5-3-5 sequence in its lower degree. This order means that the first leg (A) has five internal waves; the wave (B) has three segments. Finally, wave (C) is formed by five waves. The following picture shows the formation of a zig-zag pattern.




Zig-zag variations

A zig-zag pattern could develop some variations as a normal, truncated, and extended. The following chart represents the different variations of the zig-zag structure.

Consider as a key to classify what kind of zig-zag structure is running, each segment of the corrective wave must follow the 5-3-5- sequence, and the extension of wave C.




Zig-zag patterns: Channeling

Another tool to identify the type of zig-zag pattern is the use of channels. Channeling allows us to identify the potential movement of a zig-zag formation.

Channeling is developed in the same way as motive waves. In this case, we must connect the end of the last motive wave with the end of wave B and project the parallel line at the end of wave A.

In the next figure, we observe the difference between a normal and a truncated zig-zag not necessarily surpass the base-line of the channel. The main difference is that in a normal zig-zag, the wave C projection could be at least 2/3 of wave A.

In the truncated zig-zag, the wave C projection is between 1/3 and less than 2/3 of wave A.

On the extended zig-zag pattern case; the sequence could be indicative of a complex corrective sequence formation.




The S&P 500 weekly chart shows a zig-zag pattern. The bearish sequence started in October 2007 when the price reached at 1,576.1 pts. The corrective move ended on March 2009 at 666.8 pts. In some cases, the line chart could be helpful to visualize each segment of a wave. In this example, we observe in the line chart how the structure accomplishes the 5-3-5 sequence.




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Forex Elliott Wave

Corrective Waves Construction – Part 1

Corrections are formations that occur after each impulse. As we have seen before, corrective waves have three segments. In this article, we will see the main characteristics of the corrective waves.

Nature of the corrective waves

Generally, corrective waves are more challenging to identify than impulsive waves due to their variations. Elliott spent a large part of his time describing the different types of corrections. The author, in his Treatise, explains that “a corrective wave in progress is complicated to predict accurately between its pattern and extent.

Corrections are characterized by having three waves, except triangles that have five internal segments. Some factors that can influence the form of correction are time, speed, the extent of the previous movement, etc.

In the following figure, we observe the formation of the basic corrective structures.


Corrective waves formation

If the price action does not allow all the rules of formation of an impulsive wave to be verified, then the market is developing a corrective structure.

The most straightforward corrective structures are:
– Zig-zag, this formation has a 5-3-5 sequence.
– Flat, whose internal structure has a 3-3-5 configuration.
– Triangles, these formations develop in a sequence 3-3-3-3-3.

There are also corrective structures that are a combination of two or three simple corrective patterns. These formations are known as double three and triple three.

Alternation in the corrective waves

Just as impulsive waves alternate, corrective waves do too. In simple terms, Elliott points out that if wave two is a simple structure, wave four will be complex and vice versa. In the following figure, we observe how the corrective waves alternate in complexity.


Corrective waves can also alternate in the strength level. That is, a correction can be ordinary or strong. In the following chart, we observe the ideal model of the strength level in a corrective structure.