Elliott Wave correction formations and patterns

What Is Elliott Wave Theory Trading?

 

Elliott wave trading analysis and strategy were invented and introduced by Ralph Nelson Elliott. He analyzed the data from the stock market dating 75 years back. It was from this analysis that Elliott discovered and was able to conclude that the financial markets do not move randomly. Rather, they follow some repetitive cycles.

Elliott concluded that the prices move in alternating waves. In short, during an uptrend, there will be large upward movements that will be occasionally opposed by smaller downward movements.

In the same way, during a downtrend, there will be large downward movements by price accompanied by smaller upward movements. 

Collectively, these alternating price movements create a trend.

Upon further observation, Elliott concluded that these cycles resulted from two factors:

• Investor emotions.
• Mass psychology.

From these observations, Elliott was able to formulate an outstanding trading method that remains one of the most powerful trading approaches to this day.

Let’s see how this principle works:

Elliott Waves Basics

According to this theory, a trending market moves in a 5-3 wave pattern. The “5” wave usually represents the trending phase, while the “3” phase is a reversal of the trend.

In short, once the main trend is complete, a reversal is expected.

The 5-wave Phase

 

The first phase of the Elliott wave theory trading principle consists of 5 waves. Waves 1, 3, and 5 move in the direction of the main trend. They are collectively known as the Impulse waves. Waves 2 and 4 moves against the main trend and are known as the Corrective waves. In this article, we will further analyze the correction patterns and formations and the use in trading strategy along with Price action.

 

Elliott Wave Correction Rules and Characteristics

 

Rule 1: Wave 2 correction must not retrace more than 100% of wave 1.

Rule 2: Wave 4 must not cross into the price territory of wave 1 in an impulse wave, but Wave 4 can overlap wave 1 in a leading or ending diagonal wave.

Rule 3: Wave alteration – If wave 2 is a deep correction – then wave 4 will be shallow.

Rule 4: Wave 2 will bottom in the price territory of the previous 4th wave of one lower degree.

Rule 5: Corrections are always fully retraced by the resuming impulsive trend.

Main types of Elliott Wave Corrective Patterns:

 

1: ABC ZIGZAG correction wave – 5,3,5 internal waveform.

2: ABC FLAT corrections – 3,3,5 internal waveform, regular and irregular types.

3: TRIANGLE  ABCDE corrections – 3,3,3,3,3 internal wave form.

4: COMBINATION corrections – a structure made from multiple simple corrections.

A simple three-wave correction pattern labeled A-B-C, also called a ZIGZAG correction.

ABC ZIGZAG correction wave

The ABC correction wave is the simplest of all Elliott wave correction patterns.

Here are the main Elliott wave rules for ABC corrections:

• The ABC correction pattern subdivides into 5-3-5 internal wave pattern.
• Waves A and C tend towards equality in length.
• The ABC correction wave usually appears in the position of wave ‘2’.
• An ABC correction wave will usually target the 61.8% retracement of the trend move.

Using these guidelines, you can estimate a possible ending point to wave C using the length of wave A.

When the structure is complete and wave C has come to an end, A trader can place an order at the end of wave B, expecting the price to turn back into trend again.

 

ABC FLAT corrections

An ABC flat correction differs from a zigzag in that the waveform traces out a 3-3-5 waveform, in general, ABC flat corrections retrace less than zigzags.
The more powerful the underlying trend, the shorter the flat correction tends to be.

Here are the main Elliott wave rules for ABC Flat corrections:

• The flat correction pattern subdivides into a 3-3-5 internal wave pattern.
• Waves C  tends towards 100% the length of wave A.
• The flat correction wave can appear in any corrective position.
• A flat correction wave will usually target the 50%% retracement level of the previous move.

Using these guidelines, you can estimate a possible ending point to wave C using the length of wave A.

Again, the trader can use the end of wave ‘b’ to enter the market and catch the resumption of the trend move.

 

Expanded flat Elliott wave correction.

The expanding flat Elliott wave pattern takes the same internal form as the normal flat correction pattern.

The only difference being that the end of wave ‘b’ will travel past the beginning of wave ‘a’,

and the end of wave ‘c’, will travel past the end of wave ‘a’.

This causes an expanding range in the flat pattern, which increases the overall distance traveled by the structure.

This pattern is also called an irregular flat correction.

Here are the main Elliott wave rules for ABC expanded Flat corrections:

• The expanded flat correction pattern subdivides into a 3-3-5 internal wave pattern.
• Waves C  tends towards 162% the length of wave A.
• The flat correction wave can appear in any corrective position.
• A flat correction wave will usually target the 50%% retracement level of the previous move.

A trader can use the starting point of wave ‘a’ to enter a trade,

to catch the market as it re-enters the trend to move again within it.

Running flat Elliott wave correction.

The running flat Elliott wave pattern also has an internal 3,3,5 waveform similar to the normal flat correction pattern.

This classifies the pattern as a flat correction.

The big difference between a running flat and a normal flat correction,

is that wave ‘b’ will retrace more than 100% of wave ‘a’.

And then, wave ‘c’ will fail to retrace 100% of wave ‘a’.

So, a running flat will complete in the direction of the larger trend.

In an uptrend wave, ‘c’ will create a higher low.

And in a downtrend, wave ‘c’ will create a lower high.

As shown in the image below.

Here are the main Elliott wave rules for running Flat corrections:

• A running flat correction subdivides into 3-3-5 internal wave pattern.
• Wave ‘B’ breaks the beginning of wave ‘A’.
• Waves C  tends towards 100% the length of wave A and will not break the low of wave ‘A’.
• The running flat correction wave can appear in any corrective position.

Again, a trader can use the starting point of wave ‘a’ to enter a trade, to catch the market as it re-enters the trend to move again.

Although a running flat is one of the trickiest patterns to call as it develops.

 

 

HORIZONTAL TRIANGLES, ABCDE patterns.

Here are the rules and guidelines for triangle waves:

• Elliott wave triangles are overlapping five wave corrections labeled ABCDE.
• Triangle waves usually contract the range of price action from beginning to end.
• Each internal wave takes a three waveform, and the triangle subdivides into a 3-3-3-3-3 pattern.
• An ABCDE pattern causes a sideways movement that is usually associated with decreasing volume and volatility.
• Elliott wave triangle waves usually occur in the position of wave B or wave 4 of the larger pattern.
• A triangle wave is usually the penultimate move in the larger Elliott wave pattern and leads to an explosive move back into the larger trend.

Contracting triangle

The contracting triangle is a horizontal contraction in the range of the price.

• An Elliott wave triangle traces out five internal moves each of three waves.
• The distance traveled by each subsequent wave reduces in length.
• This has the effect of contracting the range of the wave, hence the name!

A low-risk trade can be placed at the end of wave ‘e’ with the idea of catching the market as it turns back into the trend.

 

Descending triangle

A descending triangle usually appears in a downtrend.

The lower bound of this Elliott wave triangle pattern holds in a flat line while the top trend line drops as usual, and the overall range of prices contracts.

A low-risk trade can be placed at the end of wave ‘e’ with the idea of catching the market as it turns back into the trend.

 

Ascending triangle

The ascending triangle usually appears in an uptrend.

The upper bounding trend line of this Elliott wave triangle pattern holds in a flat line and the lower trend line rises, and the overall range of prices contracts into wave ‘e’.

Again, the same strategy applies, a low-risk trade can be placed at the end of wave ‘e’ with the idea of catching the market as it turns back into the trend.

 

 

Expanding triangle

An Elliott wave expanding triangle appears in both downtrends and up-trends.

The top trend line rises and the bottom trend line falls, and the overall range of prices expands into wave ‘e’.

This time the end of wave ‘b’ of the Elliott wave triangle is used to place a trend trade.

 

COMBINATION CORRECTIONS – double and triple 3.

An Elliott wave double or triple three combinations is a corrective Elliott wave pattern.

It happens when simpler waveforms stick together to form a larger structure.

For the most part, double threes and triple threes are horizontal in character.

 

There is never more than one zigzag in a combination wave, also there is never more than one Elliott wave triangle.

All of the Elliott wave patterns shown above take the same form whether the trend is rising or falling, in a falling trend, the image is simply inverted.

The best way to enter a trade-off a combination structure is to place an order at the end of wave ‘x’ and if the market crosses this point, the trend has likely resumed and you can ride that trend until its completion.

Conclusion – Correction patterns are a pause within the larger operating trend and when taking trades they should be used along with the price action trigger.

 

When corrections come to an end, prices usually explode back in the direction of the larger trend.

Knowing how to tell a corrective wave pattern in the market from a trend wave, will help you hold a position open for longer when you are riding a trend,

And it will help you enter the market at the correct time with low, and defined risk levels.

If you master Elliott wave correction patterns, you will be able to get in on the ground floor and ride the trend!

LEARN ELLIOTT WAVE ANALYSIS IN COMBINATION WITH PRICE ACTION!