Elliott wave theory and tools
Elliott wave theory helps forecast price movements by analyzing past and current market trends. Studying the theory and related tools can help you better understand market conditions and trade with the trend more effectively.
CONTENTS:
History
In the 1930s, Ralph Nelson Elliott discovered repeating patterns in financial markets and based his assumptions on traders' psychology and behavior. He suggested that people tend to repeat patterns in their lives and that this translates into finance. Thus, he described the eight-wave structure of market price movements, consisting of five motive waves and three corrective waves. Motive waves are price movements that coincide with the direction of the main trend, while corrective waves move against the main trend.
In the screenshot below, the motive waves are (1), (3), (5), (a), and (c). Corrective waves are (2), (4), and (b). According to Elliott, any motive wave in the basic model can be represented as five smaller waves, and any corrective wave as three. The basic 5-3 model can be represented as 2 waves of a higher wave level and as 34 waves of a lower one.
Indicator
The Elliott wave indicator is configured to recognize the most common wave patterns, which are built according to the following rules:
Impulse (motive wave):
- 5-3-5-3-5 structure.
- Wave 2 doesn't retrace more than 100% of the length of wave 1.
- Wave 3 moves beyond the end of wave 1.
- Wave 3 cannot be the shortest among waves 1, 3, and 5.
- Wave 4 does not go beyond the level of wave 1.
Zigzag (corrective wave):
- 5-3-5 structure.
- Wave b is shorter than wave a.
- Wave c goes beyond the level of wave a.
To search for patterns, the indicator analyzes the last 600 bars, conditionally dividing them into two levels by nesting (main and sub-waves). The start and end points of the waves in the found patterns are tied to the most suitable pivot points. Then, the indicator checks the rules for impulse and zigzag patterns and draws the ones that capture the highest amplitude price movements.
The following markings are used to indicate the level a wave belongs to:
- Main waves: (1), (2), (3), (4), (5), (a), (b), (c)
- Sub-waves: 1, 2, 3, 4, 5, a, b, c
This marking is conditional; it doesn't correspond to the historical levels of the Elliott wave theory, but rather displays the nesting level of the pattern.
When the pattern is in "In progress" mode, the indicator builds as many waves as possible based on the pivots and uses a local extremum (highest high or lowest low) to build the last wave. If that last wave doesn't complete the pattern, the indicator draws possible projections of the next wave using Fibonacci proportions.
Depending on the length of wave 3, wave 5 will be projected either from wave 1 or from the height of the movement of the first three waves. The projections of wave c are constructed from the length of wave a. All other projections are calculated based on the wave preceding them. The minimum number of waves in the in-progress pattern is 3.
Alerts
You can set three types of alerts for the indicator: new pattern, new potential wave, and wave formed.
- New pattern: Triggered when a new pattern appears on the chart, or when a previously drawn pattern is rebuilt and the position of two or more points changes simultaneously. The rebuilding of the very first point of the pattern is not taken into account.
- New potential wave: Triggered when a new forming wave is added to a previously found pattern, or when the last formed wave is rebuilt to a new point and begins forming again.
- Wave formed: Triggered when any of the forming waves in the pattern are completed.
Inputs
- Invert pattern: Allows you to change the direction of the pattern to search for an impulse in a downtrend and a zigzag in an uptrend.
- In progress: Enables the search for incomplete patterns that are in the process of being formed.
- Length type: Defines how the wavelength is calculated when checking the rules of pattern construction:
- Absolute: The wavelength is calculated as the price difference between the start and end points of the wave.
- Percent: The wavelength is calculated as the percentage change in price between the start and end points of the wave.
- Show projections: Enables possible projections of future waves when in "In progress" mode.
Note: When new data is received, the indicator updates and clarifies previously found patterns. Changing any settings of the indicator leads to its complete recalculation. The result may differ from what is expected.
Information about expected waves that have not yet formed in "In progress" mode is not a recommendation as to what you personally should do. Do not take this data as investment advice. It should be used only for educational and research purposes. As with any trade, always look at the final result before acting.
Drawing tools
On the left toolbar, click Patterns and choose one of the tools:
- Elliott impulse wave (1·2·3·4·5): Draw a five-wave impulse pattern to identify the main direction of a trend.
- Elliott correction wave (A·B·C): Draw a three-wave corrective pattern to mark a pullback against the main trend.
- Elliott triangle wave (A·B·C·D·E): Draw a five-leg triangle pattern to highlight consolidation before a potential breakout.
- Elliott double combo wave (W·X·Y): Draw a complex corrective pattern made of two connected corrections.
- Elliott triple combo wave (W·X·Y·X·Z): Draw an extended complex correction made of three connected corrective patterns.
The bottom line
The Elliott wave theory and its accompanying indicator and drawing tools can help you analyze repetitive price patterns to forecast market trends. By identifying motive and corrective waves, setting specific alerts, and using precise drawing tools, you can better track market conditions and visualize potential future movements.
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