Elliott Wave and Time Analysis

Elliott waves and time analysis are among the most useful tools a trader can use — they identify patterns that form in prices in a set way. This can help you anticipate the likely direction of prices in a market, which is what Elliott wave analysis does, and that is why many traders favor it. In this article, we look at Elliott waves and time analysis.

Definition of Elliott Wave Theory

Elliott Wave Theory is one of the best-known forms of technical analysis. It works by capturing and describing the rhythm of the market, shown through waves that form because prices alternate between corrective and impulsive moves. A full cycle is made up of a five-wave impulsive move and a three-wave corrective move — which is how Elliott showed that the market is not random or chaotic, but moves according to identifiable rules and structures.

So Elliott wave theory identifies two different wave types: impulsive waves and corrective waves. It is a subjective theory — not every trader interprets Elliott wave and time analysis the same way, and not everyone agrees it is a winning trading strategy.

Unlike most other price theories, Elliott wave and time analysis is not a fixed template you can simply follow step by step. Instead, wave analysis offers insight into the direction of the trend and helps you understand price movement in more depth.

In one of his writings, Elliott stated that trading in the market moves through repeating cycles, driven by traders’ emotions in response to outside conditions. This observation helped Elliott develop a method that lets traders identify tops and bottoms — known today as Elliott waves.

The Geometric Fractal Shape

A fractal is one of the irregular shapes and patterns made of endless segments that interlock at set proportions. Many experts note that fractals relate to natural objects and settings, which is why fractal geometry is described as the geometry of nature — seen in things like snowflakes or shells, and it can be broken down into smaller and smaller pieces.

The Impulse Waves

Elliott explained that market trends move in a 5-3 wave pattern: a five-wave pattern known as impulsive waves, and a three-wave pattern known as corrective waves. Let’s look at the five waves:

Wave One

When a number of traders sense that a stock’s price has become cheap, many feel it is a good time to buy, which pushes the price up — this is what happens in wave one.

Wave Two

During wave two, many of the traders who were in wave one start to think the stock has been priced too high, leading some to reduce their holdings. However, the stock does not fall back to its previous lows.

Wave Three

Wave three is usually the longest and strongest wave, drawing in a large number of traders, and it’s regarded as one of the best Elliott waves to trade. Many traders now understand the stock well and want to buy, which pushes the price up and takes it above the high reached in wave one.

Wave Four

In this wave, traders start taking profits because the stock price has risen sharply. This wave tends to look weak and shallow, since a large number of traders are still hoping to profit further and are waiting for the price to pull back.

Wave five: this is the wave in which a large number of traders exit the stock, and it generally does not come without a cost.

Note: Some indicators plot Elliott waves automatically, but they can contain errors and do not always produce accurate results.

Extended Impulse Waves

One important thing to understand about Elliott waves is that one of the odd-numbered impulse waves is usually extended — in most cases, one wave ends up longer than the others. Over time, which wave gets this label can shift, though many traders refer to wave three as the extended wave.

Corrective Waves

Corrective waves are price movements that form as part of an Elliott wave cycle. According to the theory, prices move in cycles that follow specific patterns — the foundation of the theory — through which five-wave trends get adjusted or corrected. These corrections unfold as three-wave trends, and letters are used instead of numbers to label them.

Corrective Wave Pattern Shapes

There are more than twenty corrective patterns, ranging from simple to more complex. Learning this number of patterns isn’t difficult, since they are built from fairly simple, uncomplicated formations. In this article, we’ll go through the upward-trending patterns.

Zigzag in Elliott Waves

In this pattern, the price is low and pulls back sharply against the prevailing trend. This type of formation can appear two or three times, showing up as zigzagging, interlocking shapes — these waves can also be broken down into further zigzag formations.

Flat in Elliott Waves

The flat is a sideways corrective pattern in which the waves are generally similar and close in length. This happens with waves B and A, where wave B moves toward wave A, or wave C lags behind their progress. In some cases, it can extend past the start of wave A.

Triangle in Elliott Waves

This is a corrective pattern connected by lines that either converge or diverge. Triangles are made up of five waves that move sideways against the prevailing trend, and they can be either expanding or contracting.

Elliott Waves Within the Wave (Fractals)

This refers to a wave that branches into smaller sub-waves. Odd-numbered waves tend to form as impulsive patterns, while even-numbered waves tend to form as corrective patterns smaller than wave three.

Wave Categories

The first category spans multiple centuries. Then comes the grand supercycle, lasting 40 to 70 years; the cycle degree, lasting one to three years; the primary degree, lasting 9 months to two years; the intermediate degree, lasting weeks to months; the minor degree, lasting weeks; the minute degree, lasting hours; and the minuette degree, lasting minutes.

The grand supercycle is made up of supercycle waves, which are made up of cycle waves, which are made up of primary waves — and those, in turn, break down into minor, intermediate, minute, and sub-minuette waves.

How to Trade Using Elliott Waves

In this article, we’ve covered the basics of Elliott waves in a simple way. Now we get to the most important part: how to trade using Elliott waves. We’ll focus on two methods:

The First Method

Say you want to move quickly to wave counting: you’ll see the price roll toward a bottom and then start moving upward. In Elliott wave terms, the move up is wave one and the pullback after it is wave two. Often, wave five’s movement stalls before wave three finishes, and wave five can never move beyond the trendline drawn from wave three that runs parallel to it.

Wave three tends to be long and sharp, and waves two and four typically retrace to Fibonacci levels. It’s also difficult for wave two to move past the start of wave one, and as mentioned, waves two and four usually pull back to these Fibonacci levels. Traders often use Fibonacci tools to identify these price levels. Another well-known rule states that wave two never retraces beyond the start of wave one, which lets you place a stop-loss below these levels.

The Second Method

This method uses corrective wave formations to identify entry points. Using a flat pattern, you start measuring waves in the downward direction and see that the waves are moving sideways — this suggests the price could start another impulsive wave once wave C ends.

Applying Elliott wave skills this way can help you sell at the market’s normal trading price, as traders look to catch another impulsive wave. The stop-loss is placed a number of points above the start of wave four, in case the wave count turns out to be wrong.

Read more: Learn Elliott Waves for Beginners

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