Elliott Wave Guide for Beginners

Elliott Wave Explained | Elliott waves appeared in 1930, when Ralph Nelson Elliott began studying the stock market after suffering losses in the 1929 stock market crash. Elliott’s discoveries were impressive — after careful study of the markets, he started noticing recurring patterns: five impulse waves and three corrective waves.

But it isn’t that simple. Many traders study the theory and never finish it, because they find it a bit complicated. In this article we’ll give you a starting path for trading with Elliott waves, and your level will build up gradually over time. Our approach on this site is to simplify things so they work for everyone.

Elliott Wave Explained vs. Corrective Methods

Some technical analysts try to make use of wave patterns in the stock, currency, and commodity markets using impulse wave theory. This theory holds that stock, currency, and commodity price moves can be predicted because they move in repeating up-and-down patterns called waves, which are created by investor psychology, or emotions.

In this theory, we look for two types of waves:

Impulse Waves

These move in the same direction as the main trend and consist of five waves, two of which correct against the main trend.

Corrective Waves

These move against the main trend and consist of three waves, one of which moves with the main trend.

We’ll now look at how you can use impulse waves to increase your odds of earning strong returns.

Read also: Elliott wave cycle, degree, and labeling explained

Elliott Wave Explained | Learn How to Trade Elliott Waves

The basic principle of Elliott Wave theory is that, over a given period of time, prices move in specific patterns. According to Elliott Wave theory, any directional move can be broken down into a series of five waves.

He numbered these waves from 1 to 5. Waves 1, 3, and 5 move with the main trend, while waves 2 and 4 move against it. Elliott said that, in most cases, once the five impulse waves finish, three waves form in the opposite direction — the corrective waves, labeled A, B, and C.

The chart below shows the general Elliott Wave pattern.

Impulse and corrective Elliott waves

When numbering impulse waves on a chart, you should start from the largest timeframe and move down to smaller ones, because every wave on a larger timeframe contains a set of smaller waves inside it.

For example, if there are corrective waves A, B, C on the weekly timeframe, then dropping to a smaller timeframe you’ll find five impulse waves formed inside wave A alone, then three corrective waves inside wave B, then five impulse waves inside wave C.

This explains the corrections that happen on smaller timeframes even when the overall trend is clear.

Read also: Elliott Wave courses

Elliott Wave Explained | Elliott Wave Rules

In this article we’ll focus on impulse waves, since they’re a good starting point for mastering wave trading. After that we’ll move up to a higher level — corrective waves — in another article.

An Elliott impulse wave needs to meet a few strict rules for us to make a solid profit and enter the trade with the least risk possible:

• Wave 2 can never move past the start of wave 1. It’s usually between 50% and 61.8% Fibonacci retracement of wave 1.
• Wave 4 also can never move past wave 3. It’s usually between 38.2% and 50% Fibonacci retracement of wave 3.
• Wave 3 must break past the end of wave 1, and it can never be the shortest wave. It usually extends to 161.8% Fibonacci of wave 1.

Read also: Rules of complex correction in Elliott waves

The chart below shows a complete impulse wave that meets all the conditions.

The best way for beginners to trade impulse waves is to wait for the first four waves to form and meet all their conditions, then look for the start of wave 5. This method is the easiest and best for people who are learning impulse waves.

More on Elliott Waves

If wave 3 is the longest wave, then wave 5 will be roughly equal to wave 1.

There’s an alternation between wave 2 and wave 4: if wave 2 is a sharp correction, wave 4 will be a flat correction, and vice versa.

Once the five Elliott impulse waves finish, the price is expected to start forming the ABC corrective waves, which usually end near the endpoint of wave 4.

Elliott Wave Explained | Impulse Wave Trading Strategy

What we’ve covered so far explains the rules, not a complete strategy. Let’s go through the best step-by-step strategy for trading with impulse Elliott waves.

Note: this strategy isn’t tied to a specific timeframe — you can use it on any timeframe.

1. Wait Until at Least Three Waves Form

Since we’re always looking for a trade opportunity in the market’s general trend, the best time to enter a trade is at the start of wave 5, because it moves with the main trend and the earlier waves have already confirmed it.

In the chart above, notice the three waves meet all the conditions: wave 2 didn’t move past the start of wave 1, and wave 3 is the longest wave and extended past 161.8% Fibonacci of wave 2.

Note: you need to check that every wave matches the wave rules mentioned earlier, to confirm the impulse waves are valid.

Now that you’ve identified the waves and confirmed they match the rules above, it’s time to open a trade, which brings us to the next step.

2. Sell When Price Is Between 38.2% and 50% Fibonacci of Wave 3

We mentioned above, in the Elliott Wave rules, that wave 4’s correction falls between 38.2% and 50% Fibonacci of wave 3, so the right time to enter a trade is between these two levels.

Some traders prefer to open a trade as soon as price reaches the 38.2% Fibonacci level, because they don’t want to miss the opportunity and don’t know how far the price will go.

In the chart above, we entered from the 38.2% Fibonacci level, but notice the price rose to the 50% Fibonacci level, bounced off it, then quickly climbed slightly above the 50% level. This is normal — the market isn’t always perfect.

You can use any reversal signal, such as Japanese candlestick patterns, to help time your trade entry.

Now that we’ve set our Elliott Wave entry points, we need to decide where to place the stop loss.

3. Set Your Stop Loss Above the End Point of Wave 1

One of the Elliott Wave rules is that wave 4 never overlaps with wave 4. So the best place to put your stop-loss order is a few points above the end point of wave 1, as shown in the chart.

In the chart above, we’ve marked the ideal place to set your stop-loss order.

The next logical thing we need to set for our Elliott Wave strategy is where to take profit.

See below.

4. Close the Trade When Wave 5 Equals Wave 1 in Points, or When It Reaches the End of Wave 3

In this strategy we’re only trading wave 5, so naturally we close the trade as soon as this wave ends. We mentioned above that if wave 3 is the longest wave, wave 5 will equal wave 1 in points, so we close the trade once wave 5’s points match wave 1’s. If wave 3 isn’t the longest wave, wave 5 ends by breaking past wave 3.

Note: everything above was an example of a sell trade. Use the same rules for a buy trade, just in the opposite direction.

[AFF-CTA: pending]

Conclusion

• Billionaire hedge fund manager Paul Tudor Jones is known for trading using waves. If that’s the case for someone that wealthy, it makes sense to consider learning to trade with Elliott waves.
• When you compare Elliott theory with other theories that try to describe price behavior, such as Wyckoff theory and Gann theory, Elliott theory comes out ahead in this comparison. The reason is that if you’re able to identify the waves, you’re effectively mapping out the path the price will follow.
• When numbering Elliott waves on a chart, start from the largest timeframe down to smaller ones, because each wave on a larger timeframe contains a set of smaller waves inside it. For example, if there are corrective waves A, B, C on the weekly timeframe, then on a smaller timeframe you’ll find five impulse waves inside wave A alone, then three corrective waves inside wave B, then five impulse waves inside wave C.
• You need to check that every wave matches the impulse wave rules mentioned earlier, to confirm the impulse waves are valid.
• The best way for beginners to trade impulse waves is to wait for the first four waves to form and meet all their conditions, then look for entry points at the start of wave 5. This method is the easiest and best for people learning impulse waves.

Elliott Wave Explained | Frequently Asked Questions

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