Before everything else, let us explain that Elliot waves are fractals. It means that there is an Elliot wave inside an Elliot. In another perspective, we can say that inside waves 1, 2, and 3, you will find smaller 5-wave patterns. On the other hand, you will see three-wave patterns inside waves 2 and 4. This is a repetitive pattern that does not end. These waves have categories from largest to the smallest. Let us enumerate them:
- Grand supercycle = Multi-century
- Supercycle = 40 to 70 years
- Cycle = One to a few years
- Primary = Few months to few years
- Intermediate = Weeks to months
- Minor = Weeks
- Minute = Days
- Minuette = Hours
- Sub-Minuette = Minutes
We can say that there are supercycles inside a grand supercycle. There are cycles inside a supercycle. This goes on until the sub-minuette. You might find it challenging to label these waves, but it gets better when you look at charts often. You will also see that they are not perfect.
When we use the Elliot Wave theory in trading, it is crucial to pinpoint the waves correctly. In this way, you will be able to know which side of the market you will choose. You will also have a good idea of whether to go long or short.
So, before applying the Elliot wave theory, when you trade, you must know how to correctly identify trends, and we are about to tell you three of the most critical rules in Elliot wave theory.
The three most essential rules in Elliot wave theory
- Rule number 1: Wave 3 should not be the shortest impulse waves
- Rule number 2: Wave 2 should not go past wave 1’s beginning
- Rule Number 3: Wave 4 should not cross the same price area as wave 1.
Additional guidelines in Elliot Wave Trading
These are guidelines that can help you label the waves properly. By the way, these are just guidelines. They are not too strict like the rules we mentioned before. Let us enumerate them one by one:
- Truncation is a term that refers to wave five not moving past wave three’s end.
- Most of the time, wave five goes further beyond or breaks through the trend line drawn in wave three. This trend line is parallel to another trend line that connects wave three and wave five’s start.
- Wave three is usually described as a long, extended, and sharp wave.
- Most of the time, wave two and wave four are the ones that bounce off the Fibonacci retracement levels.
What will happen if I fail to identify waves correctly?
We hate to break it to you, but Elliot Wave theory is very keen on correctly identifying waves because you can also know which market the wave is on. You will know which market side you will take and if you will go on a long or short position. So, if you decide to apply this theory in your trades, make sure that you know the rules by heart and be aware of the guidelines because your account will see losses and problems if not.