Ralph Elliot formulated his wave theory back in the 30s of the last century, when market movements are described by certain recurring waves, on the basis of which forecasts are made for making trading decisions.

Robert Pretker also made a significant contribution to the development of this theory, describing models and trading approaches.

In this article we will talk about the principles of Elliott Waves theory and analyze an indicator that simplifies the work with the application of techniques and models from this area.

Fundamentals of Elliott Wave Theory

The principle of the theory is that according to the wave approach all charts move in repeating segments or waves. And all waves are divided into impulse and correctional waves

Impulse waves are formed on the trend, and corrective waves, respectively, constitute a correction to the main trend.

The main model used in Elliott Waves is called the 1-2-3-4-5/ABC model, and it consists of one impulse (1-2-3-4-5) and one corrective (ABC) wave.

And those, in turn, consist of smaller impulse waves (waves 1, 3, 5, A and C) and correctional waves (waves 2, 4 and B).

It is considered that any trend consists of such 5 digital waves, and after that there is a correction of three ABC waves or a reversal of new 5 waves.

On such schematic drawings everything looks simple and clear. But in practice, it can be quite difficult to identify waves and corrections on real charts. And the main problem is that two different traders can build different waves on the same chart section.

To avoid multiple interpretations Elliott and other followers of his theory created some rules:

On the second wave of an impulse, the price must not fall to the beginning of the first wave. If it does, the trend is probably not continuing.
In the third wave, the maximum should exceed the maximum of the first wave. And the third wave should not be the shortest of the waves.
The fourth wave should not fall below the lows of the first wave. This is a non-critical rule, it can be omitted if the following condition is met.
On the fifth wave, the momentum must be above the maximum of the third wave.

According to these rules, you can identify the wave on the current chart. If it fits the above conditions, it is an impulse wave. If it does not fit, it is a corrective or impulse wave, but it is still in its infancy.

Elliott Wave Trading

Wave trading starts with the identification of a reversal, a change of trend, from which the construction begins. Then you need to wait for the correction after the first impulse and find the entry point at its end.

The main danger here is that the chosen context may turn out to be not a new trend, but a global correction to the previous wave, so it is necessary to carefully monitor the fulfillment of the conditions described above.

At the end of the correction, you can enter in different ways.

The safest is the following. It is necessary to draw a trend or signal line through the reversal point and the end of the correction. Put a breakout order behind the maximum of the first impulse wave, and place a stop below the trend line.

If the price goes below the trend line, you need to make sure that it does not go below the pivot point. If it does, it means that the whole movement was a correction to the previous movement. If it did not leave and started moving up again, then we redraw the trend line through a new local minimum and place a pending order for the maximum of the first impulse.

If the deal was opened, but the price went back and approached the trend line, then you can not wait for the stop and close the deal manually. And wait for the development of events. If it goes higher again, then put again a pending stop order.

Another option, more aggressive, is also possible. Put the pending order not at the maximum, but a little lower at the point B of the correction to our impulse. Otherwise, the principle of working with such a deal is similar to the variant above.

But for beginners, working with wave structures and trading on them can be unfamiliar and therefore difficult. And for experienced traders it is often important to automate the search for waves and work with deals.

Various indicators are created to facilitate these tasks. We will consider one of them below.

Elliot Wave Oscillator

This indicator looks similar to MACD. It looks like the same histograms, which can be above or below the zero level.

The formation of a new wave is indicated by the crossing of the histogram of the level zero. And confirmation of its formation is the appearance of divergence on the first correction. If the correction occurred by about 30%, it is considered that it is possible to enter the market.

Further correction after the new maximum of the histogram by 30-50% will tell about the completion of the 3rd wave, and the new divergence with the update of the maximum will tell about the end of the 5th wave and the probable beginning of the ABC correction.

At the end of the article you will be able to download this and several other indicators that help to determine the Elliott waves. The others simply draw waves on the price chart, add signal lines and other auxiliary elements to simplify the work. You just need to put them on the chart and watch their readings. In this they are much simpler than the disassembled example.

To install indicators, you need to copy the files from the archive to the MQL/Indicators folder, which is located in the data directory of the MetaTrader terminal. You can get there by clicking “File -> Open Data Catalog”. After copying, restart the terminal, and the new tools will be available in the Custom Indicators menu.

Conclusion

Working with Elliott Waves can be challenging because of the ambiguity and non-obviousness of wave patterns. And many people believe that trading according to this theory is ineffective, because you can convince yourself that behind every price jump there may be an impulse or correction.

This question is ambiguous. But for those who have decided to trade or are already trading according to Elliott’s rules, the proposed indicators can be a useful support in analyzing the price chart.