This article in The Trader’s Indicator Series discusses Corrective Wave Characteristics, one of the Elliott Wave market cycle categories. The previous article discussed Trend Wave Characteristics, which is the market cycle that traders should be involved in. Since market cycles are also an integral component of the trader’s toolbox and crucial for manual trading, it will be useful to gain an understanding of how price action fits into these cycles as well.
In the last series, called The Trader’s Pendulum, we took you through the 10 Habits, all aimed to support a successful trader. Your mission in developing these habits is to get out of the Technical Trader’s Trap and transform into an Entrepreneurial Trader so that you can start being accountable to your trading. We invited you to take action and begin your journey by completing the Trader’s Scorecard (www.fxtradersedge.com/scorecard) and to get down to business by arranging a free coaching session. In this Indicator Series, we talk about the mechanics of trading.
Corrective Wave Characteristics
Corrective waves have their own personalities as illustrated in the figure above.
Wave A kicks off the corrective move. Whether it’s wave 2, wave 4, or simply the A-B-C following the larger 5-wave sequence, the characteristics are the same. This is the wave where traders are convinced that there is just a simple pullback before the next leg of the move up in the case of an uptrend. Wave A sets the tone for wave B. If A travels in 5 waves, the correction is likely to go deep as a zig zag move. If A travels in 3 waves, then the correction is likely to be a sideways correction like a flat correction or a triangle.
B waves are usually bull traps. After wave A, the market looks to re-buy the uptrend, not recognizing that the correction isn’t over yet. The market gets very euphoric about the continuation of the trend and the move up after wave A can be quite weak and corrective—a big disappointment! However, a 5-wave move in wave A followed by a 3-wave correction in wave B, provides a great setup for positioning for the wave C move down.
Wave C is often called the killer wave, for it can be just as strong and long as a wave 3. It knocks all the long positions out of the way in the case of a prior uptrend. But once wave C is done, the trend will continue. Targeting the end of wave C is a good time to go long again. However, a highly profitable trade is to sell the corrective wave B pullback to be able to ride wave C.
Riding wave C is one of my favorite trade setups. This is also called the equality trade, because the conservative measuring objective for wave C is the distance that wave A travels.
Understanding the wave personalities of the complete 8-wave market cycle is a start to learning the Elliott Wave patterns that occur repeatedly in every time frame and with all market instruments. We call this pattern repetition the “fractal” nature of the markets because the 8-wave structure is similar when scaled in different time frames.
Before we leave Elliott, it is important to note the three Elliott rules that cannot be broken, or else the wave count is invalidated:
- Wave 2 never retraces more than 100% of wave 1;
- Wave 3 is never the shortest wave; and
- Wave 4 does not enter the same price territory as wave 1.
Elliott wave strategists attempt to label and count the waves to find market context for the next major move. Understanding how to read analysts wave counts is a skill that can be learned through the study of Elliott Wave analysis. Internalizing the wave personalities is a good place to start.
You have now completed your mentoring session which covered the analysis toolbox in the last 10 articles of this series which is essential for building strategies and trade plans.
If your mission is to become a trader or investor who stays out of the Technical Trader’s Trap, then take the leap to grow into an entrepreneurial trader.
I created the FX Trader’s EDGE Coaching Program modelled after the “10 Habits of Successful Traders”, which is the title of my newly published book by Wiley.
Excerpted with permission of the publisher John Wiley & Sons, Inc. from The Trader’s Pendulum: The 10 Habits of Highly Successful Traders. Copyright (c) 2015 by Jody Samuels. This book and ebook is available at all bookstores, online booksellers, and from the Wiley web site at www.wiley.com.
Jody Samuels
Jody Samuels is one of North America’s leading coaches for successful traders and the creator of The FX Trader’s EDGE™ Program. She works with members of her program in group and private coaching sessions and is passionate about teaching individuals how to trade the market cycles and use entrepreneurial skills and habits to effectively manage their business. Jody Samuels, a professional trader with 15 years of experience trading currencies with a New York international investment bank, successfully made millions of dollars using the proven theories of Elliott Wave analysis. The Wavy Tunnel PRO Course, Jody’s latest accomplishment, illustrates the convergence of Elliott, Fibonacci, and Harmonics in a groundbreaking program to combine precise analysis with a simple strategy.
FAQs
Five waves move in the direction of the main trend, followed by three waves in a correction (totaling a 5-3 move). This 5-3 move then becomes two subdivisions of the next higher wave move. The underlying 5-3 pattern remains constant, though the time span of each wave may vary.
How to trade corrective waves? ›
Simple corrective waves consist of three waves: a small move against the main trend (wave A), a substantial correction (wave B), and a smaller move back in the direction of the main trend (wave C). These patterns are easier to identify and provide valuable trading opportunities.
What is the best time frame for Elliott wave? ›
There is no best timeframe for trading the Elliot Wave strategy. It depends on your trading style and personality. If you are a day trader, you would want to trade on intraday timeframes, such as hourly, 30-minute, 15-minute, and so on.
What happens after Elliott wave ABC correction? ›
And when the whole ABC correction is complete, the prior major trend then resumes. As such, the end of the Wave (C) represents the best point to enter a new trade. As such, Elliott Wave (C) is the end of the correction, before the prior trend resumes.
What is the pattern of 12345 in trading? ›
Traders look for this chart pattern on 1-day chart. For a 1-2-3-4 chart pattern to occur there must be at least 3 subsequent lower lows in parallel with at least 3 subsequent lower highs. A position is bought when the market price trades above the high of the last candlestick in the pattern.
What are corrective waves in forex? ›
A trending market moves in a 5-3 wave pattern.
The second 3-wave pattern is called a corrective wave. Letters A, B, and C are used instead of numbers to track the correction. Waves 1, 3 and 5, are made up of a smaller 5-wave impulse pattern while Waves 2 and 4 are made up of smaller 3-wave corrective patterns.
Does Elliott Wave really work? ›
The Elliott wave principle, as popularly practiced, is not a legitimate theory, but a story, and a compelling one that is eloquently told by Robert Prechter. The account is especially persuasive because EWP has the seemingly remarkable ability to fit any segment of market history down to its most minute fluctuations.
What is the ABC pattern in forex? ›
The ABCD pattern is a visual, geometric chart pattern comprised of three consecutive price swings. It looks like a diagonal lightning bolt and can indicate an upcoming trading opportunity. This is a valuable pattern to know, as it reflects the rhythmic style in which the markets often move.
What is the Elliott wave rule? ›
The theory
Elliott believed that every action is followed by a reaction. Thus, for every impulsive move, there will be a corrective one. The first five waves form the impulsive move, moving in the direction of the main trend. The subsequent three waves provide the corrective waves.
How to identify a corrective wave? ›
Understanding Corrective Waves
- Impulse Waves — net movement is in the direction of the trend at one larger degree. Impulses consist of five sub-waves.
- Corrective Waves — net movement is against the trend at one larger degree. Corrective waves typically consist of three sub-waves.
Award-winning analyst Chris Carolan teaches you how to use his favorite three key technical indicators to spot trends and confirm your Elliott wave analysis — Relative Strength Index (RSI), Jurik RSX and Keltner channels.
Is NEoWave better than Elliott Wave? ›
Neo wave is an Advanced Elliott wave method with more number of rules and newer patterns to increase the overall objectivity. Orthodox Elliott wave was originally discovered by R. N. Elliott in 1930s.
What are the disadvantages of the Elliott wave? ›
The disadvantage of the Elliott Wave Theory is that it is very subjective and it is quite difficult sometimes to pinpoint the beginning or end of a wave in the five-wave cycle. With a lot of practice one can get better at recognizing these patterns.
How to trade ABC correction? ›
Simple ABC Correction: Trading Tips
Draw a trendline from E to B and extend it downward. When price closes above the trendline, buy. For aggressive traders, draw a trendline down from B along the tops and buy when price closes above it. A close above the intraday high at A (blue trendline) also works as a buy signal.
What is a 3 wave corrective pattern? ›
Correction patterns are normally made up of 3 mono waves. Correction only becomes “crystal clear” when they have completed or are near completion. The corrective pattern consists of 3 waves with some exceptions that it moves against the trends of the next larger degree.
How far does wave 5 retrace? ›
Also, wave 4's very often retrace to the about the end of the previous wave 4 of a lesser degree, for instance wave 4 of a larger wave 3. The 5th wave, if the longest, typically travels 1.618 the distance of from the start of wave 1 thru the end of wave 3.
What are the 5 waves in the movie 5th wave? ›
The second wave features natural disasters, the third wave is a deadly virus transmitted by birds (bird flu), and the fourth wave is the alien species taking over human bodies. Finally, without giving the fifth wave away entirely, it involves the aliens using the children.
What is wave 5 Elliott cycle? ›
Elliott Wave Trading Guidelines
Sometimes, Wave 5 does not move beyond the end of wave 3. This is called truncation. Wave 5, more often than not, goes beyond or “breaks through” the trend line drawn off Wave 3 parallel to a trend line connecting the start of Waves 3 and 5.
What is the target for wave 5? ›
The target of Wave 5 is normally about 0.618 of the distance covered by Wave 1 and Wave 3, plotted from the low of Wave 4. If Wave 5 extends, then the probable target is about 1.618 of the distance covered by Wave 1 and Wave 3.
