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How To Trade Using ElliotWaves
"R.N. Elliott's work on corrective wave patterns allows me to
identify countertrend moveswithin trending markets. Because I'm
familiar with these patterns and their characteristics, Ican
anticipate the points where and when countertrend moves will most
likely end. The morefamiliar you are with corrective wave patterns,
the closer you are to being in the right place atthe right time
when the larger trend resumes."
Jeffrey Kennedy, The Trader's Classroom Collection
Real prices for coffee sank to a 30-year low in 2001, and for
the next three years,nearly every gain was quickly erased. The
low-price, sideways trend was sopersistent that "coffee widows"
became common in Central America and elsewhere,as men literally
walked off their farms to look for other work. Then in early
2004,coffee started to make a more meaningful move.
In Elliott wave terms, coffee's reversal behaved according to a
predictable sequenceof ups and downs: A lengthy three-wave
"correction" had given way to the first five-wave impulse of a new
"motive" trend. The essential Elliott wave pattern, shown in
Figure 1, is five waves in one direction, corrected by three
waves going in theopposite direction.
This wave pattern appears at every degree of trend, progressing
ever upward withcorrections along the way, as shown in Figure
2.
To know this shape and progression helps traders discern what
might come next inthe markets they follow. So, for instance, if a
five wave-move appears complete, acorrection of three waves is
about to ensue. Conversely, if a three-wave correctionappears
complete as coffee's did in 2004 then it's time for an impulsive
five-waveseries.
In Elliott Wave Principle, A.J. Frost and Bob Prechter explain
the details this way:There are two modes of wave development:
motive and corrective. Motive waveshave a five-wave structure,
while corrective waves have a three-wave structure or avariation
thereof. Motive mode is employed by both the five-wave pattern and
itssame-directional components, i.e., waves 1,3, and 5. Their
structures are called"motive," because they powerfully impel the
market. Corrective mode is employed byall counter-trend
interruptions, which include waves 2 and 4. Their structures
are
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called "corrective," because each one appears as a response to
the precedingmotive wave yet accomplishes only a partial
retracement, or "correction," of theprogress it achieved.
When it comes to understanding these patterns in price charts,
the best teachers are
the markets themselves. In essence, following the markets
becomes a "real-timeclassroom." Coffee offers a great example: On
May 19, 2004, Daily FuturesJunctures showed the daily coffee chart
shown here as Figure 3. Editor JeffreyKennedy identified a
"corrective" pattern via the a-b-c legs (green circled
labels)within the downward trend of wave 2 (red label), and here's
what he wrote:
"The reason this is significant is that three-wave patterns are
corrections orcountertrend moves. This means, at minimum, a full
retracement of this decline willoccur."
He also explained the upward line at the conclusion of the
pattern by saying,"Considering the longer-term wave count, I
believe the advance from 69.40 is thebeginning of a third wave,
targeting initially 75.95 (where wave 3 will equal a 1.618multiple
of wave 1)."
Coffee's reversal also taught a more nuanced lesson that Jeffrey
focused on in theJune 2004 issue ofMonthly Futures Junctures. His
"Trader's Classroom" featurespelled out an innovative method of
drawing and using trendlines. Coffee's chart atthe time showed a
near perfect example of an impulsive wave penetrating a
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corrective trend channel.
Along with the charts in figures 4 and 5, Jeffrey explained,
"My theory is simple: Five waves break down into three channels,
and three waves
need only one. The price movement in and out of these channels
confirms eachElliott wave.... In Figure 5, you can see that most of
the January selloff in Coffee waswithin one channel. Since price
action within one channel is typically corrective, I
stillconsidered the larger trend to be up. This approach was
helpful in alerting DailyFutures Junctures subscribers to ...
Coffee on May 19th."
Obviously not all patterns are as clear as the one we present
here, nor do prices
always unfold according to the textbook. Yet here's what we do
know: Patternanalysis is about letting the market be the teacher in
all of our forecasting services,that's never the exception, and
always the rule.
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Elliott Wave File
One complete cycle equals eight waves
One complete cycle has two distinct phases: motive and
corrective
The motive phase includes five waves
The corrective phase follows the motive phase
The corrective phase includes three waves
After the eight wave cycle ends, a similar cycle ensues
Figure 001
Figure 002
