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THE ELLIOT WAVE THEORY

ELLIOT WAVE THEORY

- The –

Elliott

Wave

Theory

Written by

Kingsley

(Head of EWEB)

Contents

1. Introduction

2. Dow Theory

3. Directions of Trend

4. Five Waves

5. Markets do not Move in a Straight Line

6. A Complete Elliott Cycle

7. Repetitive Structure

8. Wave Degrees

9. End of the Trend and Beginning of Another

10. Phases

11. Rules and Guidelines

12. Wave 2 Never Moves beyond the Beginning of Wave 1

13. Wave 3 is Never the Shortest

14. Wave 3 Always Travels beyond the End of Wave 1

15. Wave 4 Never Enters the Territory of Wave 1

16. The Principle of Alternation

17. Extensions (and Counting Waves)

18. Corrective Waves

19. Zigzag Corrective Wave

20. Flats – Corrective Waves

21. Irregular Flats – Corrective Waves

22. Inverted Irregular Flats – Corrective Waves

23. Triangles – Corrective Waves

24. Symmetrical Triangle – Corrective Wave

25. Descending Triangle – Corrective Wave

26. Ascending Triangle – Corrective Wave

27. Running Triangle – Corrective Wave

28. Expanding Triangle – Corrective Wave

29. Triangles – Minimum Price Target (Measuring Technique I)

30. Triangles – Minimum Price Target (Measuring Technique II)

31. Double Three Combinations – Corrective Waves

32. Triple Threes Combinations – Corrective Waves

33. Wave Fibonacci Relationships – Extended Wave

34. Minimum Length of Wave 3

35. Wave 5 Maximum Price Target

36. Wave 5 Minimum Price Target

37. Extended Wave 5 Price Target

38. Zigzag Wave Relationships

39. Correction or Reversal

40. Crowd Psychology

41. Channeling

42. Time Factor

43. How to Trade Wave 3

44. How to Enter in Wave 3 Even Faster

45. How to Trade Wave 5

46. Trading the ABC Reversal

47. Final Thoughts

 

Introduction

As Head of Education at EWEB, I have trained thousands of traders, both beginners and advanced, on different concepts and theories on trading the financial markets. People are very enthusiastic to learn new strategies, tools and concepts, but what I came to realize is that every trader’s dream is to master the Elliott Wave Principle and Fibonacci ratios. They are fascinated by the recurring structure and cyclic model that the wave principle suggests. In this book, I will present both the Elliott Wave Theory and Fibonacci ratios from a trader’s point of view.

About the Author

EWEB’s Head of Education, Kingsley, is a respected FX educator and Certified Technical Analyst. He is a recognised authority in the forex industry, and renowned for his expertise in algorithmic trading. After years of consulting with EWEB on a number of key projects, Kingsley officially joined the company in June 2016 and is the principal driver and architect of EWEB’s extensive educational programme. His department’s international seminars and workshops provide clients across the world with on-location support, while his webinars, e-books, educational articles and videos form the cornerstone of EWEB’s multilingual, open access training resources. The training is tailored to traders’ needs by region and experience level.

kingsley has played a key role in the development of forex education within the industry, training tens of thousands of traders and forex professionals around the world. Traders of all levels value his seminars and workshops for both content and his passionate and lively presentations. As Head of Education, Kingsley also plays a pivotal role in EWEB’s research and development team. In this capacity, he led the development of the EWEB Trading Signals and EWEB Pivot Points Strategy tools, which are designed to help traders spot potential trading opportunities across various trading instruments.    

kingsley has been awarded a number of international professional certificates including: MSTA by the Society of Technical Analysts (UK) and CFTe and MFTA by the International Federation of Technical Analysts (USA) – the highest qualifications in the technical analysis community. He also holds a BSc and MSc in Computer Science from University of Louisiana at Lafayette and Bowie State University, respectively.

2. Dow Theory

There is no way to start talking about technical analysis and the important concept of the trend without mentioning Charles Dow. I consider Charles Dow to be the “father” of technical analysis. What intrigues me about the theory is the tenet on trends: a trend will continue to move in the same direction until a definite signal suggests that it has come to an end. This reminds me of Newton’s first law of motion —which states that a body in motion will continue to move in the same direction at the same speed until an external force acts upon it. Naturally, one will ask what is a trend? Well, according to technical analysis, a trend is defined as the direction of successive tops and bottoms – either up or down.

3. Directions of Trend

Successively higher tops and higher bottoms define an uptrend, while successively lower tops and lower bottoms define a downtrend. Of course, there are times that prices do not follow an uptrend nor a downtrend — but instead, they are “trapped” in a range known as a sideways market. A range is defined as an area on the chart where prices are confined by the upper and lower boundaries. In hindsight, it looks very tempting to trade; in reality, it is more complex than it looks, as it takes different shapes and patterns such as a rectangle, triangle or combination of patterns.

4. Five Waves

Ralph Nelson Elliott, who also studied the Dow Theory, suggested that markets unfold in five waves. More specifically, during his empirical observations and after analyzing 75 years of the market’s historical prices and stock market behavior, he concluded that five waves are required to have a structured progression in the market. Three waves in the direction of the trend and two waves in the opposite direction. This is the 5-wave pattern:

5. Markets do not Move in a Straight Line

This is what every trader should learn and understand in the early steps of studying the financial markets. Prices do not move in a straight line, but rather they follow a zigzag path. A good way to comprehend it is to observe the 5-wave structure. Waves 1, 3 and 5 move in the direction of the trend, whereas waves 2 and 4 form a pause in the development of the trend.

6. A Complete Elliott Cycle

Additionally, Elliott noted that a corrective pattern denoted by the letters A, B, C moves in the opposite direction of waves 1, 2, 3, 4 and 5. So, a complete Elliott cycle consists of 8 waves — 5 waves in the direction of the trend, also known as motive waves, and 3 waves countertrend, also known as corrective waves. Interestingly enough, Elliott mentioned that the 8-wave structure is repetitive.

7. Repetitive Structure

Each wave subdivides into smaller waves of one lesser degree. For example, waves 1, 3 and 5 consist of 5 smaller waves, whereas each corrective wave such as 2 and 4 consists of a 3-wave structure A-B-C. So, wave  1  subdivides into smaller waves (1), (2), (3), (4) and (5). Similarly, wave   2   subdivides into waves (a), (b) and (c). Additionally, waves (a) and (c) subdivide into 5 smaller waves, as do waves (1), (3) and (5) - which are also known as impulse waves. Conversely, waves (2), (4) and (b) subdivide into 3 corrective waves. In a nutshell, each wave is part of a wave of a higher degree and at the same time, it subdivides into waves of a lesser degree.of a lesser degree.

8. Wave Degrees

Elliott identified nine degrees, ranging from minutes to decades and even centuries. The naming conventions are as follows, but the most important thing to remember is that the basic 8-wave structure is present at every degree. Each wave subdivides into waves of one smaller degree and each wave is part of the wave of one higher degree.

Grand Super Cycle: ((I))  ((II))  ((III))  ((IV))  ((V))  ((a))  ((b))  ((c))              

Super cycle: (I)  (II)  (III)  (IV)  (V)  (a)  (b)  (c)

Cycle: I  II  III  IV  V  a  b  c

Primary: ((1))  ((2))  ((3))  ((4))  ((5))  ((A))  ((B))  ((C))

Intermediate:  (1)  (2)  (3)  (4)  (5)  (A)  (B)  (C)

Minor:  1  2  3  4  5  A  B  C 

Minute:  ((i))  ((ii))  ((iii))  ((iv))  ((v))  ((a))  ((b))  ((c))

Minuette:  (i)  (ii)  (iii)  (iv)  (v)  (a)  (b)  (c)

Subminuette:  I  ii  iii  iv  v  a  b  c

 

 

9. End of the Trend and Beginning                                                                                                                              of Another Waves that move in the same direction as the wave of a higher degree subdivide into 5 smaller waves. On the other hand, waves that move in the opposite direction subdivide into 3 waves. So, it makes sense that after identifying a 5-wave structure that there is more correction to come! That is true for both upward and downward movements. More specifically, after identifying wave 1, which consists of 5 waves of a lesser degree, one can expect more rally to come. This is also true for wave 3 as well. The only exception is the fifth of the fifth wave. This will signal the completion of wave 1 of a higher degree. Usually, Oscillators will be at the extremely overbought area. Similarly, waves A and C will also consist of 5 waves as they move in the direction of the wave of a higher degree, wave 2. Conversely, waves 2, 4 and B consist of 3 waves as they move in the opposite direction of the wave of a higher degree.

10. Phases

A complete Elliott Wave cycle consists of the motive and corrective phase. This includes the waves of the prevailing trend, these being 1, 2, 3, 4 and 5. On the other hand, the corrective phase includes waves a, b and c.

Waves 1, 3 and 5 are called impulse waves, whereas waves 2 and 4 are called corrective waves.

11. Rules and Guidelines

The Elliott Waves follow certain rules and guidelines as observed by Ralph Nelson Elliott. If any of the rules are violated, then the counting of waves is invalidated. So, the following rules must be present at all times:

•    Wave 2 never retraces 100% of wave 1

•     Wave 3 is never the shortest wave among the impulse waves 1, 3 and 5

•    Wave 3 always travels beyond the end of wave 1

•    Wave 4 never enters the territory of wave 1

Also, the following guidelines may be observed as tendencies rather than rules:

•    Alternation. If wave 2 is sharp, then expect wave 4 to be sideways and vice versa

•    If one of the impulse waves 1, 3 and 5 are extended, then the other two will tend to be equal or a Fibonacci ratio.

12. Wave 2 Never Moves beyond the Beginning of   Wave 1

 Most traders who follow Elliott Waves count the waves in an attempt to identify profitable setups and forecast the price direction. In counting the waves, one has to observe certain rules or the counting is invalid. For example, wave 2 should never retrace or fall below the beginning of wave 1. Similarly, in a bearish market, wave 2 should never retrace or exceed above the beginning of wave 1.

13. Wave 3 is Never the Shortest

This is a very important rule which hints at the preferred wave to trade. As wave 3 is never the shortest among the impulse waves 1, 3 and 5, it makes sense that if we had to choose one wave to trade, then wave 3 would be on the top of the list.

14. Wave 3 Always Travels beyond  the End of Wave 1

It makes sense! After all, progress is achieved when prices exceed the previous highs. This is the point at which market participants will enter the market as sentiment and traders’ psychology rises and economic news improves. Crowd psychology and peer pressure draw traders to enter the market, as the temptation to conform to the majority is hard to resist.

15. Wave 4 Never Enters the Territory of Wave 1

 More specifically, the end of wave 4 never enters the territory of wave 1. This is true in many other popular technical analysis concepts  and theories. For example, once price penetrates a top that acts as resistance, it changes the role and it becomes support. This is very common in observing support and resistance. Of course, almost every rule has an exception or two and this is also true for wave 4. At times when the wave 4 correction is a triangle, it might overlap with wave 1 — but the rule states that it should end out of the territory of wave 1.

16. The Principle of Alternation: If corrective wave 2 is sharp, then expect wave 4 to be sideways. Similarly, if wave 2 is a sideways correction, then expect wave 4 to be sharp.

17.  Extensions (and Counting Waves)

One of the impulse waves 1, 3 and 5 will be extended. The other two will tend to be equal or a Fibonacci ratio. Empirically, wave 3 is usually the one to be extended. Extensions may increase potential profits if the trade taken is in the right direction, but at the same time may hinder counting waves.

18. Corrective Waves:

Corrective waves come in four broad categories:

• Zigzags

• Flats

• Triangles

• Combinations

The complexity and the wide range of combinations make corrective waves risky and almost unpredictable.

19. Zigzag Corrective Wave:

 The Zigzag, or sharp correction as it also is known, is perhaps the simplest form of corrective waves. It is an ABC corrective wave, where wave A moves in the opposite direction of the motive 5-wave structure. Wave A subdivides into 5 smaller waves. Similarly, Wave B moves in the opposite direction of A and it subdivides into 3 smaller waves. The terminal wave of the ABC structure, wave C, extends well beyond the beginning of wave B.

20. Flats – Corrective Waves:

 If the corrective wave is not sharp, then it is expected to be a sideways correction. Sideways corrections come in different shapes and  “flavours”. One of them is the flat (regular) correction, which consists of 3 waves, referred to as ABC. It is considered a "shallow" correction, as the price movement is not as sharp as that of the Zigzag. More specifically, wave B usually terminates close to the beginning of wave A, whereas wave C usually concludes close to the beginning of wave B. Flat corrective waves follow the 3-3-5 structure. It consists of 3-3-5.

21. Irregular Flats – Corrective   Waves:

 A variation of the Flat correction is the Irregular Flat, whereby waves B and C extend beyond the beginning of wave A and B respectively. It is also known as an Expanded Flat.

22. Inverted Irregular Flats – Corrective Waves:

 On the other hand, if wave C falls short and doesn’t extend beyond the beginning of wave B, then this variation is called Running Flat or Inverted Irregular.

23. Triangles – Corrective Waves:

 Another type of sideways correction is the triangle. There are four types of corrective triangles: Ascending, Descending, Symmetrical, and Broadening (or “Megaphone”). They follow a 3-3-3-3-3 structure and, of course, are considered a continuation pattern. At least four points are needed to draw a triangle: 2 points for each side. Remember that we need at least two points to draw a straight line. The opening between the two sides is called the base, and the point where the two sides meet is called the apex. Triangles boast a unique feature of calculating minimum price targets.

24. Symmetrical Triangle –Corrective Wave:

 Geometry teaches us that a symmetrical triangle is made up of two equal sides. A symmetrical triangle follows a structure of 3-3-3-3-3. Symmetrical triangles are also known in the bibliography as Contracting or Coil. When the price eventually breaks out of the triangle, it will most probably follow the direction of the established trend. How far will it travel? That can be estimated with the same measuring techniques that are applied to all triangles.

25. Descending Triangle – Corrective Wave:

 Another type of sideways correction is the triangle. There are four types of corrective triangles: Ascending, Descending, Symmetrical, and Broadening (or “Megaphone”). They follow a 3-3-3-3-3 structure and, of course, are considered a continuation pattern. At least four points are needed to draw a triangle: 2 points for each side. Remember that we need at least two points to draw a straight line. The opening between the two sides is called the base, and the point where the two sides meet is called the apex. Triangles boast a unique feature of calculating minimum price targets.

The only difference with a descending triangle is that one of the sides is flat and is on the bottom. It still follows a 3-3-3-3-3 structure and the measuring techniques are the same. During an uptrend, the price will usually break out of the inclined side, not the “flat” side, in the direction of the prevailing trend. On the other hand, the price will usually break out of the flat side during a decline. An estimation of the minimum price target after the breakout will follow the same principles of the triangle measuring techniques.

26. Ascending Triangle –Corrective Wave:

 An ascending triangle also has a flat side, but this time it is on the top. The price will break out of the flat side during a rally in the direction of the prevailing trend. Similarly, during a downtrend price will break out of the inclined side, not the flat. As expected, it shares the identical structure of 3-3-3-3-3 and the same measuring techniques.

27.  Running Triangle – Corrective Wave:

 Another type of sideways correction is the triangle. There are four types of corrective triangles: Ascending, Descending, Symmetrical, and Broadening (or “Megaphone”). They follow a 3-3-3-3-3 structure and, of course, are considered a continuation pattern. At least four points are needed to draw a triangle: 2 points for each side. Remember that we need at least two points to draw a straight line. The opening between the two sides is called the base, and the point where the two sides meet is called the apex. Triangles boast a unique feature of calculating minimum price targets. A running triangle is very similar to a symmetrical triangle, with the exception that Point B exceeds the beginning of wave A. It also follows the 3-3-3-3-3 structure and the same measuring techniques.

28. Expanding Triangle –Corrective Wave:

 An expanding triangle is also known as a reverse symmetrical,  a  “Megaphone” or a Broadening Formation. Usually, it is considered a topping formation, rather than corrective. It is included here just for completeness as we are discussing triangles. Caution should be taken when trading the expanding triangle, as many false signals are generated.

29. Triangles – Minimum Price Target (Measuring Technique I)

One of the great features of triangles is that they provide a way for us to estimate minimum price targets. This first technique is performed by measuring the base of the triangle and projecting it at the breakout point. This will suggest the minimum price target. Minimum price targets constitute potential take profits for traders to incorporate into their trading strategies.

30. Triangles – Minimum Price Target (Measuring Technique I)

An expanding triangle is also known as a reverse symmetrical, a “Megaphone” or a Broadening Formation. Usually, it is considered a topping formation, rather than corrective. It is included here just for completeness as we are discussing triangles. Caution should be taken when trading the expanding triangle, as many false signals are generated. the lower side (upper side when in a downtrend). The point where the parallel and vertical line intersects suggests the minimum price target. Additionally, by extending the vertical line down to the Date and Time axis, we can forecast the time at which the price target will be reached. Isn’t that brilliant?!

31. Double Three Combinations – Corrective Waves:

At times, the correction will consist of more than one corrective pattern. For example, two flats side by side comprises what is known as a double three. A connecting wave usually denoted by the letter X “glues” together the two patterns. Of course, double threes are not limited to only two flats. Interesting enough, a triangle is very possible to follow a flat. Even though a triangle is not really a three, it is nevertheless acceptable.

32. Triple Threes Combinations –Corrective Waves:

 To make things more complicated, corrections may take the form of triple threes. This is one of the major reasons that sideways markets are a "trap". The only difference from a Double Three corrective wave is that a Triple Three consists of three corrective patterns instead of two.

33. Wave Fibonacci Relationships  – Extended Wave :

 One of the features that Ralph Nelson Elliott introduced in his theory is the wave relationship. He observed that if one of the three impulse waves — that is 1,2 and 3 — is extended, then the other two waves will tend to equality – or a Fibonacci ratio.

34. Minimum Length of Wave 3:

Fibonacci ratios provide a calculation for the minimum length of perhaps the most important wave – wave 3. Usually, wave 3 will travel a minimum distance of 1.618 of the length of wave 1.

35. Wave 5 Maximum Price Target:

 Another interesting calculation is that of the end of the five-wave cycle. That is the end of wave 5. The theory suggests that a 3.236 multiple of the length of wave 1 is projected at the top of wave 1. That will estimate a maximum price target for wave 5.

36. Wave 5 Minimum Price Target:

 Similarly, Fibonacci ratios may be applied to also estimate the mini- mum price target of the top of the five-wave cycle. This is the end of wave 5. Elliott observed that the minimum price target of wave 5 may be calculated by taking a 3.236 multiple of the length of wave 1 and subsequently projecting it at the bottom of wave 2. That will estimate a minimum price target for wave 5.

37.  Extended Wave 5 Price Target:

 Another interesting calculation is that of the end of the five-wave cycle. That is the end of wave 5. The theory suggests that a 3.236 multiple of the length of wave 1 is projected at the top of wave 1. That will estimate a maximum price target for wave 5. Extended waves are a trader’s paradise as they increase potential profits, provided that you are on the right side of the market. On the other hand, extensions may hinder counting the waves. Of course, even though counting the waves is imperative for hardcore Elliottians, remember that nothing is written in stone and these are tendencies. The target of extended wave 5 is another manifestation of wave relationships and the Fibonacci ratios. More specifically, the target can be estimated by multiplying the popular 1.618 Fibonacci ratio by the distance between the beginning of wave 1 up to the top of wave 3; the result is then added to the value of the beginning of wave 4.

38. Zigzag Wave Relationships:

 Another interesting wave relationship stems from the sharp corrective waves popularly also known as zigzag. A zigzag corrective wave consists of three waves, namely a, b, c. Elliott observed that waves a and c usually tend to equality – or a Fibonacci ratio.

39. Correction or Reversal :

 One of the biggest dilemmas that technical analysts and traders alike face is the distinction between a simple retracement and a reversal in the direction of the trend. At times, what looks like an ideal reversal may instead turn out to be a shallow correction. Caution should be taken to apply the appropriate risk management tools, such as a protective stop loss, should the market move in the opposite direction as a result of a simple shallow retracement.

40. Crowd Psychology

Another interesting wave relationship stems from the sharp corrective waves popularly also known as zigzag. A zigzag corrective wave consists of three waves, namely a, b, c. Elliott observed that waves a and c usually tend to equality – or a Fibonacci ratio. It is the mass psychology of the traders that eventually forms the wave structure.

Wave 1: This is the manifestation of extreme emotions such as fear, greed, optimism, and pessimism experienced by the crowd. More specifically, wave 1 is perceived as a counter-trend correction of the prevailing trend of the market. Pessimism and negative sentiment are still present, and fundamental indicators remain negative. This is a wave where the ‘smart money' will be accumulating assets in low volumes.

Wave 2: Wave 2 is confirmation that the negative market sentiment is here to stay. Most gains that were accumulated during wave 1 have now been wiped out, as wave 2 may move as far as the very beginning of wave 1.

Wave 3: Wave 3 sees a change in sentiment, as the crowd psychology shits to a more positive outlook. Here you will see many traders entering the market, as optimism is high and accompanied by positive fundamental factors. The change in the trend direction is confirmed by the high volume of trades.

Wave 4: Wave 4 is usually a shallow, sideways correction and is perceived as a temporary pause in the established direction of the market.

Wave 5: In wave 5, the ‘smart money’ book their profits, while the less-informed traders enter the market at the peak of the trend hoping to profit like other market participants have so far. This may be due to greed, lack of knowledge and skills. When this happens, this creates what is popularly known as a ‘bubble’. Prices are driven sky high and assets are overvalued. Even though fundamental indicators remain positive, they are less so than during wave 3. Volume is relatively low.

Wave A: During wave A, traders believe that this counter-trend retracement is a short pause in the market before it continues to move in the prevailing direction. This is also demonstrated by relatively low participation and therefore low volume.

Wave B: Wave B is seen as a golden opportunity to enter the market at a discounted price. Unfortunately, this is usually proved to be a trap.

Wave C: Wave C shows the end of optimism, happiness and positivity as the trend takes a dramatic change in direction. Any profits gained during the short-lived wave B are eliminated.

41. Channeling

Another interesting wave relationship stems from the sharp corrective waves popularly also known as zigzag. A zigzag corrective wave consists of three waves, namely a, b, c. Elliott observed that waves a and c usually tend to equality – or a Fibonacci ratio. Channeling is another important tool in technical analysis and it would be a big surprise if the Elliott Wave Theory omitted this interesting concept. Channels provide a way to estimate wave targets, as well as count the waves. For that purpose, at least a minimum of 3 points are needed, that is the beginning of wave 1, the top of wave 1 and the end of wave 2. Remember that two points are required to draw a straight line. So, as step 1 a line is drawn from the beginning of wave 1 to the end of wave 2. Next, a parallel line is drawn through the top of wave 1. As the market unfolds in front of us, wave 3 may terminate either above, below or at the parallel line that passes through the top of wave 1. So, it is necessary to adjust this by drawing a new parallel line – again through the top of wave 1, but this time, it is extended through the end, or top if you prefer, of wave 3. Prices are expected to find support near or at the lower uptrend line. When wave 4 is complete, the lower trend line is adjusted as well to pass through point 2 and point 4. As you might have guessed, wave 5 is expected to reach the upper trend line. Channels are therefore another way to identify potential price targets and assist in counting the waves.

42. Time Factor

Wave theory relies on three different factors. The first is form, the second is wave relationships and the third is time. Form has to do with the wave structure, whereas wave relationships center around Fibonacci ratios amongst the waves. The third factor is time but is the least important of the three factors and the least reliable. Wave time analysis as it is more officially known incorporates Fibonacci numbers and sequence to predict future turning points in the price action. To do that, 2 minimum starting points are required. So, as the turning points (that is, tops and bottoms) are formed on the price chart, the distance between them will follow the Fibonacci sequence. This allows us to forecast the next tops and bottoms.

43. How to Trade Wave 3:

As you might remember, wave 3 is never the shortest impulse wave, and more importantly, it is usually the longest. This makes it the preferred wave to trade. Entering at the beginning of a wave or a market move is what most traders aim for. Of course, this is easier said than done! A safer approach is to enter the market when price exceeds the top of wave 1. To incorporate risk management rules into our trading we use a protective stop loss, just below the beginning of wave 1. Remember that if a price drops below the beginning of wave 1, the wave count is invalidated.

44. How to Enter in Wave 3 Even Faster:

 In the interest of capturing as much as possible of wave 3, traders are inclined to enter the wave as early as possible. One way to achieve that is to identify a Japanese Candlestick reversal pattern right at the beginning of wave 3. Based on this method, the Japanese Candlestick reversal may form in the area of 78.6% or 76.4% corrections of wave 1. Once more, a protective stop loss is strongly recommended slightly below the beginning of wave 1.

45. How to Trade Wave 5:

Similarly, if a trader wishes to enter at the beginning of wave 5, one has to identify a Japanese Candlestick reversal near the 38.2% and 61.8% of wave 4. Needless to mention, a protective stop loss is imperative in any trading system and this one is no exception. So, a stop-loss is highly suggested right below the end of wave 4.

46. Trading the ABC Reversal:

Trading the ABC reversal is perhaps one of the most promising trades to attempt. A lot has been written and more has been said about it as it is one of the most reliable reversals in the markets. As you might have guessed, I am referring to the Head and Shoulders. The top of wave 3 is referred to as the Let Shoulder and the top of wave 5 is the Head. The top of wave B is the Right Shoulder.  A Sell Order is initiated when the price falls below the bottom of wave A. As always, a protective Stop Loss is placed at the top of wave B just in case the market moves in the opposite direction so that the trade's capital is protected with a minimum loss. Interestingly, the Head and Shoulders theory provides a way to estimate a minimum price target. Simply put, the height of the Head to the entry-level is projected downwards from the bottom of wave A; this is the minimum price target, which implies that there is most likely more to come. Naturally, to capture and lock more potential profits, a trailing stop may be incorporated after  the minimum price target.

47.  Final Thoughts:

It is important to remember that most of these concepts are tendencies, rather than rigid rules that are set in stone. The Elliott Wave Theory is one of the most important and influential schools of thought in technical analysis – at least in my humble opinion! I have to admit that the Elliott Wave theory is the reason that I was initially drawn to the trading arena and technical analysis itself. Some of the trading systems that I have developed throughout the years are based on this concept. My advice to you is to study and understand the idea behind the Elliott Wave theory so you will be able to develop your own trading systems that reflect your trading profile and character.

Happy trading and good luck capturing the waves!

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